GMTP - Stealth QEIII? (US)

STEALTH QE III?
Is the Federal Reserve already in the process of implementing a Stealth QE III?

GLOBAL MACRO TIPPING POINTS - SEPTEMBER 2011
8/24/2011
1 September 2011 Edition

Copyright 2011 Gordon T. Long All Rights Reserved
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general@GordonTLong.com
STEALTH QE III?
Is the Federal Reserve Already in the Process of Implementing a Stealth QE III?
GLOBAL MACRO TIPPING POINTS - SEPTEMBER 2011 US ECONOMY ................................................................................4

KEY MONTHLY ECONOMIC INDICATORS HAVE A CLOSER LOOK AT WHAT THE MAINLINE MEDIA DOESNT DISCUSS. ........................ 5
PHILLY FED BOMBSHELL .................................................................................................................................................................................................... 7 CONSUMER CREDIT ............................................................................................................................................................................................................. 8
JOBS - CONFIDENCE - CONSUMPTION - GROWTH CYCLE................................................................................................................ 10

JOBS ....................................................................................................................................................................................................................................... 11 EMPLOYMENT TRACKING STATISTICS ................................................................................................................................................................... 19 CONFIDENCE & SENTIMENT ............................................................................................................................................................................................ 22 CONSUMPTION .................................................................................................................................................................................................................... 27 GROWTH ................................................................................................................................................................................................................................ 28
STEALTH QE III AHEAD ............................................................................................................................................................................... 30

NBRs (Non-Borrowed Reserves) ......................................................................................................................................................................................... 31 REVERSE REPO MARKET ................................................................................................................................................................................................. 31 CONTINGENT LIABILITIES ................................................................................................................................................................................................. 33 OPERATIONAL READINESS .............................................................................................................................................................................................. 33
CONCERNS WITH BANKS & US CREDIT MARKETS.............................................................................................................................. 35

BANK OF AMERICA ............................................................................................................................................................................................................. 35
WHISTLEBLOWER TELLS ALL AT THE RATING AGENCIES................................................................................................................ 37 REAL ESTATE "DOUBLE DIP" UPDATE ................................................................................................................................................... 38
BIG PICTURE ........................................................................................................................................................................................................................ 38 RESIDENTIAL REAL ESTATE- "STILL HOME SICK" ...................................................................................................................................................... 41 CURRENT SITUATIONAL ANALYSIS ......................................................................................................................................................................... 41 HOME OWNERSHIP TRENDS ..................................................................................................................................................................................... 43 $6.5 TRILLION IN MIDDLE CLASS NET WORTH EVAPORATES .......................................................................................................................... 45 GARY SHILLING LAYS OUT THE HOUSING FACTS .............................................................................................................................................. 46 DISTRESSED MORTGAGES ....................................................................................................................................................................................... 60 NATIONAL STATISTICS................................................................................................................................................................................................ 61 SHILLER WARNING ...................................................................................................................................................................................................... 65 COMMERCIAL REAL ESTATE............................................................................................................................................................................................ 66 COMMERCIAL REAL ESTATE DECLINES 3.7% IN APRIL - NEW POST BUBBLE LOW .................................................................................. 66
R-2011 US ECONOMIC IMPEDIMENTS .................................................................................................................................................... 70
September 2011 Edition 2


MONTHLY PROCESS OF ABSTRACTION

The Global Macro Tipping Points (GMTP) Service is an integral part of our monthly Process of Abstraction research methodology. The process starts monthly with the Tipping Points and completes with a final Synthesis. The sequence is optimized to align with the established Macro Economic Data releases.
Section
II.
Release Date
3rd Saturday of the Month
Service
Global Macro Tipping Points (GMTP)
Focus
Coverage
Tipping Points Abstraction Abstraction III. 1st Day of the Month Market Analytics & Technical Analysis (MTA) Technical Analysis Market Analytics Market Analytics I. Day Following Monthly Labor Report (~ 1st Saturday) Monthly Market Commentary (MMC) Synthesis Thesis Synthesis
Tipping Points Global Macro US Economy
Technical Analysis Fundamental Analysis Risk Analysis Commentary
Commentary Conclusions


US ECONOMY


KEY MONTHLY ECONOMIC INDICATORS Have a closer look at what the mainline media doesnt discuss. U.S. GDP Growth Of 1.3% Disappoints The Commerce Department reported that real GDP grew just 1.3% (SAAR) last quarter. The figure was disappointing for several reasons. It fell short of Consensus expectations for 1.7% growth and it was the softest reading since Q2'09. Moreover, the gain followed a downwardly revised 0.4% in Q1 and the components showed widespread weakness. As if that wasn't enough, GDP fell a revised 3.5% during the recession year of 2009, nearly one percentage point more than earlier indicated. Weakness in consumer spending continued to head the list of soft GDP components as it ticked up just 0.1% last quarter. Government spending, down 1.1%, followed with its third consecutive quarterly decline. It was paced by lower state & local purchases. Business investment continued to be the economy's bright spot and it grew 6.3%, though growth did lag its double-digit pace during much of last year


U.S. Durable Goods Orders Decline New orders for durable goods fell 2.1% last month following an unrevised 1.9% May rise. A 0.4% increase had been the Consensus expectation. Transportation sector orders led the fall and slumped 8.5% (+9.5% y/y). Bookings for aircraft & parts fell 26.0% (+11.4% y/y) and reversed the prior month's jump. Nondefense aircraft orders fell 28.9% (+41.1% y/y) while defense fell 20.5% (-17.6% y/y). Lower orders for motor vehicles & parts added to the decline with a 1.4% drop (+6.8% y/y). However, trend growth is slowing. Electrical machinery orders rose 0.4% (2.1% y/y) after a 15.9% gain last year but machinery orders fell 2.3% (+4.0% y/y) following last year's 22.8% recovery. Orders for computers fell 0.8% (+5.3% y/y) and the y/y gain compares to 30.0% growth last summer. In the nondefense capital goods sector, the 4.1% orders' decline owed to the drop in aircraft, but nondefense orders less aircraft still slipped 0.4%. The 5.6% y/y gain compares to 20.8% growth at its peak in the Spring of 2010.
ISM Manufacturing The Institute for Supply Management indicated that its July Composite Index of factory sector activity dropped sharply to 50.9 from an unrevised 55.3 in June. The figure was nearly the lowest since the economic recovery began two years ago. It also compared unfavorably to Consensus expectations for a just a slight decline to 55.0. The reading continued to indicate positive factory growth and was the twenty-fourth consecutive monthly figure above the break-even level of 50. It was up from the low of 32.5 reached in December '08. Each of the index's five components declined last month, but it was the employment component that declined the most. Its reading of 53.5 still indicated positive jobs growth, but it was the least since it was negative in September, 2009. During the last ten years there has been a 91% correlation between the employment series level and the m/m change in factory sector payrolls.


ISM Services This summer has started out with indications of economic weakness relative to the lethargic Q2. The July Composite Index for the service and construction sectors from the Institute for Supply Management (ISM) fell to 52.7 from an unrevised 53.3 in June. The figure was short of Consensus expectations for 53.7. Since the series' inception in 1997 there has been a 71% correlation between the level of the nonmanufacturing composite index and the q/q change in real GDP for the services and the construction sectors. The figure is consistent with the ISM factory sector index fell last month to 50.9 from 55.3 in June.
U.S. Small Business Optimism Falls To Lowest Since September 2010 The National Federation of Independent Business indicated that its index of small business optimism fell to 89.9 last month from an unrevised 90.8 in June. The latest was the lowest level since last September. Deterioration was notable for the percentage of firms expecting the economy to improve and for those expecting higher real sales in six months. Nevertheless, the percent of firms reporting higher nominal sales now held just below its April high and still was up sharply from the recession low.
PHILLY FED BOMBSHELL The Philadelphia Federal Reserve Bank's index of regional factory sector plunged this month. The Philadelphia Fed General Activity index dropped to -30.7 from an unrevised 3.2 in July. The figure was well short of Consensus expectations for 4.2. Haver Analytics constructs an ISM-adjusted reading of the Philadelphia number and it plunged to 42.1 from 51.7 in July. During the last ten years there's been a 75% correlation between the level of the Philadelphia Fed Business Conditions Index and the three-month growth in factory sector industrial production. There's also been a 75% correlation with q/q growth in real GDP. Month-to-month deterioration occurred in each of the Fed's component series with new orders and shipments falling the most. The employment series turned negative for the first time in twelve months.


During the last ten years, there has been an 86% correlation between the employment index level and the monthly change in manufacturing sector payrolls. The prices paid index fell to its lowest level since September. Twenty-six percent of firms paid higher prices while 13% paid less, the highest in two years. During the last ten years there has been a 72% correlation between the prices paid index and the three-month growth in the intermediate goods PPI.
The Philly Fed matches the New York Manufacturing and Richmond Fed Survey!
CONSUMER CREDIT


The Federal Reserve positively reported a rise in consumer credit July 8th. This data is unfortunately misleading. The Federal Reserve is now adding the Federal Government student loan program (Sallie Mae) to the statistics which gives the consumer credit data the appearance of improving. In fact, IT IS NOT! If you back out this newly added data so you can compare true trend, you actually get a continuation in the negative trend in consumer credit with a month on month decline of $1.6B.
Year over year the figure is still dropping 5.6%. Its not a pretty picture out there despite the governments policy initiatives.
To the right is the Sallie Mae student loan reclassification amount. You can see how this program would skew the consumer credit data if added, without pointing this anomaly out. Source: Pragmatic Capitalist


JOBS - CONFIDENCE - CONSUMPTION - GROWTH CYCLE
A simple but effective way to quickly analyze economic activity is the use of the Jobs-Confidence-ConsumptionGrowth Cycle graphically depicted above. This model distills economic activity and highlights key factors for the investor to focus on. If Jobs are becoming harder to find or keep it is not long before consumer, investor and business confidence erodes. When the erosion in confidence comes cautious spending habits and often increased levels of savings. The consequence is slowing economic consumption. When consumption slows, especially in a 70% consumption economy like the US, economic growth slows. Slowing growth forces business to cut back and we have the beginnings of a death spiral. One of these four elements must be reversed before an self feeding cycle develops. Let's consider where the US is in this cycle. The August 5th, 2011 Non Farm Payrolls report showed the labor participation rate "at a 30-year low". The most recent poll from Thomson Reuters and University of Michigan shows that consumer confidence is the lowest it's been for 30 years. That's not a coincidence. As I said above, if people can't find work, they'll have no confidence in their ability to pay for the things they want or need, or in the economy as a whole. The administration - despite its rhetoric - is doing nothing to decrease unemployment (and see this), and is solely helping the super-rich at the expense of everyone else. Given this situation, it shouldn't be a huge surprise that: 73% of Americans think the country is headed in the wrong direction 79% are dissatisfied with the U.S. political system In fact only a small percentage think that the government is acting with the "consent of the governed"


JOBS
US Payrolls +117,000 US Unemployment Rate -.1 to 9.1%, Participation Rate -.2 to 63.9% accounting for drop in unemployment. Actual number of Employed (by Household Survey) fell by 38,000 Unemployment rose by 156,000 Those dropping out of the labor force rose by 374,000 Civilian population rose by 182,000, Labor Force declined by 193,000 Average Weekly Workweek was unchanged at 34.3 hours Average Private Hourly Earnings Increased by 10 Cents Government employment decreased by 37,000 - a genuine bright-spot
Were it not for people dropping out of the labor force for the past two years, the unemployment rate would be well over 11%.


At 58.1%, we havent seen these levels since the recession of 1983 and match the tops of 1953 and 1973.
The employment situation report showed that conditions for the long term unemployed went mixed in July while remaining distressed by historic standards. Looking at the chart below you can see that todays sorry situation far exceeds even the conditions seen during the double-dip recessionary period of the early 1980s, long considered by economists to be the worst period of unemployment since the Great Depression. Workers unemployed 27 weeks or more declined to 6.18 million or 44.4% of all unemployed workers while the median number of weeks unemployed declined to 21.2 weeks and the average stay on unemployment jumped to 40.4 weeks, a new high for the series.




The July Employment Situation report showed that in July total unemployment including all marginally attached workers declined slightly slipping to 16.1% from the prior month's level of 16.2% while the traditionally reported unemployment rate declined to 9.1%. The traditional unemployment rate is calculated from the monthly household survey results using a fairly explicit definition of unemployed (essentially unemployed and currently looking for full time employment) leaving many workers to be considered effectively on the margin either employed in part time work when full time is preferred or simply unemployed and no longer looking for work. The Bureau of Labor Statistics considers marginally attached workers (including discouraged workers) and persons who have settled for part time employment to be underutilized labor. The broadest view of unemployment would include both traditionally unemployed workers and all other underutilized workers. To calculate the total rate of unemployment we would simply use this larger group rather than the smaller and more restrictive unemployed group used in the traditional unemployment rate calculation.


The August 5th employment situation report showed that in July the full time unemployment rate went flat at 9.8% of the civilian workforce remaining near the highest rate seen in 41 years. The Bureau of Labor Statistics considers full time workers to be those who have expressed a desire to work full time (35 hours or more per week) or are on layoff from full-time jobs. Full time jobless workers currently account for roughly 88.5% of all unemployed workers.
We have over 46M Americans on Food Stamps, We have over 17M Families on Food Stamps, We have 1 in 7 Americans on Food Stamps, We are spending $6.12B a month or over $72B a year.


.. And this doesnt count the absolutely exploding activity at charity Food Banks. Churches and communities are now dramatically burdened with this!! As a logical consequence of the prolonged economic downturn it appears that participation in the federal food stamp program is continuing to rise. In fact, household participation has been climbing so steadily that it has far surpassed the last peak set as a result of the immediate fallout following hurricane Katrina. The latest data released by the Department of Agriculture shows that in May, a whopping 1,105,217 new recipients were added to the food stamps program, an increase of 12.14% on a year-over-year basis, while household participation increased 14.22%. Individual participation as a ratio of the overall civilian non-institutional population has increased 11.43% over the same period. Participation continues to increase with nominal benefit costs climbing a lofty 12.32% on a year-over-year basis to $6.12 billion for the month. REMEMBER There are almost 5 million Americans on welfare. There are 50 million Americans on Medicaid. There are 8 million Americans receiving unemployment compensation. There are 10.5 million Americans on Social Security disability.
This is the symbolic bread being provided to the masses to keep them tranquilized, pliable, satisfied and ignorant


of their civic duty. The government has renamed bread as social benefits and now distributes $2.3 trillion of bread per year to the needy. This constitutes 15% of the countrys GDP and will continue to grow for decades or until the American Empire collapses. THIS DOESNT INCLUDE FOOD BANKS - Demand climbs at U.S. food banks


TERRIBLE NEWS BUT BETTER NEWS THAN WE HAVE BEEN GETTING! The Employment Situation Report showed that though July, net nonfarm payrolls increased rising 117,000 from June, Private nonfarm payrolls added 154,000. Net private sector jobs increased 0.14% since last month climbing 1.68% above the level seen a year ago. Still remains a whopping 5.58% below the peak level of employment seen in December 2007.


EMPLOYMENT TRACKING STATISTICS We have updated the monthly tracking table below. The others have not changed to any significance this month.
The BIRTH DEATH Model is the government's "plug" number so that it can report satisfactory labor numbers on a monthly basis without destabilizing the financial markets. The needed "plug" number required has been steadily rising. This month it simply became too large and therefore the Monthly non-farm report was called a "disaster' by the media -- and it was. However, it was really no new news!
As bad as this chart is, it actually is worse. It doesn't effectively take into account the shift from a Single earner to a Two earner family income, which is now being eroded.
Over the past decade, real private-sector wage growth has scraped bottom at 4%, just below the 5% increase from 1929 to 1939, shown by government data. To put that into perspective, since the Great Depression, 10-year gains in real private wages have always exceeded 25% with one exception: the period ending in 1982-83, when the jobless rate spiked above 10% and wage gains briefly decelerated to 16%. There are several culprits, of which by far the biggest has been the net loss of 2.7 million private nonfarm jobs since March 2001. (Government payrolls rose by 1.2 million over that span.) That excess supply of labor has given employers the upper hand in holding back wage gains. Then there is a dramatic, decade-long job shift that has occurred. The often higher-paying goods-producing sector, including construction and manufacturing, has shed 26% of its workers. Meanwhile, typically lower-paying
IBD
Behind this job shift is the globalization of production, which has fed "the substitution of capital for labor" amid a push for productivity and competitiveness.


service industries have kept growing their payrolls: social assistance (41%), nursing homes (21%), leisure and hospitality (10%). "To the extent you have more hotels and fewer manufacturing jobs," the changing composition of the work force has been a negative for wage growth, said John Silvia, chief economist at Wells Fargo Securities. OVER>>
"Brain, not brawn, is required" for today's high-skilled factory jobs in the U.S., Silvia said. A third trend is the increase in nonwage compensation fueled by the growth of tax-free health care spending which has eroded real wage gains. A fourth factor, rising food and fuel prices, has taken a bite out of real wage growth in the past year. The long dry spell for real wage gains tests the natural resilience of America's consumer economy.
- "labor share of national income has fallen to its lower level in modern history - down to 57.5% in the first quarter from 57.6% in the fourth quarter of last year, 57.8% a year ago, and 59.8% when the recovery began." - "some recovery it has been - a recovery in which labor's share of the spoils has declined to unprecedented levels." - "extremes like this, unfortunately, never seem to lead us to a very stable place." - only look at the great October revolution in Russia for ideas. History always rhymes. Zero Hedge In a 2004 paper from the St. Louis Fed, the authors make the following statement: "The allocation of national income between workers and the owners of capital is considered one of the more remarkably stable relationships in the U.S. economy. As a general rule of thumb, economists often cite labors share of income to be about two-thirds of national incomealthough the exact figure is sensitive to the specific data used to calculate the ratio. Over time, this ratio has shown no clear tendency to rise or fall." EXTRA


JOLTS REPORT: Job Openings Turns Down The job separations rate jumped to 3.1%, its highest since last August. The actual number of separations also jumped 5.9% m/m (3.3% y/y). Separations include quits, layoffs, discharges, and other separations as well as retirements. The layoff & discharge rate alone jumped m/m from its all-time low to 1.4%. The private sector layoff rate increased to 1.5% but in the public sector it was 0.5%.
We have a JOBLESS Recovery!


CONFIDENCE & SENTIMENT On Friday 08-12-11 we were treated to the August reading for the University of Michigan Consumer Sentiment report which showed a reading of 54.9, the third worst reading in history and well below the median estimate of 62.0. This has been the case now for the past month in which economists have been way off the mark in terms of their estimates and reality. This often occurs at major tipping points (both bearish and bullish) as economists often extrapolate past results into the future and thus overshoot at economic peaks and undershoot at economic troughs. The string of overshoots in estimates from the ISM Manufacturing Index to GDP to consumer sentiment indicates we are yet at another economic inflection point in which the economy is rolling over. What is troubling about the Michigan Consumer Sentiment reading is that it often leads turns in consumption trends. Below is the A. C Neilson Global Consumer Confidence report. This is not just a US, nor EU problem it is a Global issue! Confidence has been steadily falling around the world because jobs are harder to find and for those with jobs their real disposable income is falling and thereby eroding confidence in our cycle model.
One reliable leading indicator for the U.S. ISM Manufacturing index is the Australian Consumer Confidence reading which typically leads the ISM by several months and is forecasting an ISM reading near 40 by November.




Additionally, the Consumer Confidence numbers dropped significantly AGAIN in June. What stands out to me to the right is that against comparable prints taken at financial crises and tragedies of the past such as the October 1987 markets crash, Desert Storm, LTCM, the dot com collapse, September 11, Katrina, and Lehman they are WORSE and getting WORSE!
BACKGROUNDER: Michigan Consumer Sentiment: A Stunning Setback Doug Short 08-15-11 The University of Michigan Consumer Sentiment Index preliminary report for August came in at 54.9, a stunning decline from the July final number of 63.7. The Briefing.com consensus expectation had been for 62.5 and Briefing.com's own forecast was for 62.0. The August preliminary number is the third lowest in the history of this indicator. The two lower months (52.7 and 51.7) were at the depths of the 1980 recession. See the chart below for a long-term perspective on this widely watched index. Because the sentiment index has trended upward since its inception in 1978, I've added a linear regression to help understand the pattern of reversion to the trend. I've also highlighted recessions and included real GDP to help evaluate the correlation between the Michigan Consumer Sentiment Index and the broader economy.


To put the report into the larger historical context, since its beginning in 1978 consumer sentiment is about 36% below the average reading (arithmetic mean), 35% below the geometric mean, and 37% below the regression line on the chart above. The current index level is at the 0.4 [!] percentile of the 404 monthly data points in this series. (I had to add a decimal place in my spreadsheet to get a reading other than zero.) The Michigan average since its inception is 85.9. During non-recessionary years the average is 88.5. The average during the five recessions is 69.3. For the sake of comparison here is a chart of the Conference Board's Consumer Confidence Index (monthly update here). The Conference Board Index is the more volatile of the two, but the general pattern and trend are remarkably similar to the Michigan Index.
And finally, the prevailing mood of the Michigan survey is also similar to the mood of small business owners, as captured by the NFIB Business Optimism Index (monthly update here).


Consumer and small business sentiment remains at levels associated with other recent recessions. The trend in sentiment since the Financial Crisis lows has been one of slow improvement. But the August preliminary numbers from the Michigan survey constitute a giant step backward. This suggests things are going to get worse before they get better.
According to the Misery Index above, Americans havent felt this bad in almost three decades. The Misery Index is the highest since May 1983 when unemployment was 10.1 percent, inflation was 3.5 percent and the economy was recovering from the 1981-82 recession.


The chart shows the correlation between the U.S. Misery Index, or the sum of the unemployment and inflation rates, and measures of consumer confidence. The Misery Index stands at 12.8, the highest in 28 years. Consumer sentiment slumped in July to the lowest level in more than two years, shown last week in a report from Thomson Reuters/University of Michigan. CONSUMPTION SPENDING AND ECONOMIC ACTIVITY WILL FOLLOW! The chart to the right takes a stab at linking confidence and spending, with the red figure measuring the 12-month change in personal consumption expenditure (adjusted for prices).
The Bloomberg Consumer Comfort Index was reported to be lower than it was at the start of the year.
First consumers moods change and then spending patterns follow suit. The sharp drop in consumer sentiment suggests consumers are likely to pullback sharply on spending in the months ahead.


GROWTH The global economy and markets are heading into "a new danger zone" that will require strong policy action to restore confidence, Robert Zoellick, the president of the World Bank, said. (World Bank's Zoellick Cautions on Economy) The collective result of global monetary tightening over the past year has been a marked deceleration in global growth, and now it appears their actions have gone too far as leading economic indicators have not only decelerated but have dropped into negative territory. Shown below is the composite leading economic indicator (LEI) for the 34 countries of the OECD. The growth rate for the LEI has now turned negative after being positive for the first time since October 2007. Looking back over the last decade, the only false signal in the OECD LEI that didnt lead to a recession here in the U.S. was in 2003, though that signal came after a prolonged bear market and sluggish economy. However, the current reading is coming after a strong bull market in equities and thus carries far more significance. I do not expect we are seeing a false signal. The fact that the 34-member OECD LEI is now negative tells us risks are as high as they were in the last recession and that another global recession may be upon us. Within the OECD, the G7 block of countries shows most of the weakness with their own LEIs turning negative in April. Countries that now have negative LEI readings as of June are listed below: Canada Mexico UK Germany France Italy Spain Switzerland Brazil The collective OECD LEI is being pulled lower by the developed countries while the emerging countries LEIs, while decelerating, are still positive. Here in the U.S., economic breadth is also deteriorating and pointing towards a possible recession occurring later in the year. While individual countries can bring down the collective OECD growth rate, individual states within the U.S. can bring down the national growth rate. Thus, it is never a good sign to see more and more states slip into contractionary mode as when enough states' economic growth rates rolls over, eventually so too does the country.


. one more sign of the U.S. slipping into recession was the recent GDP report which showed real GDP on a yearover-year basis has slipped below the 2% growth mark. Going back more than half a century shows this 2% level is vitally important to hold as we have slipped into a recession within 12 months every time, no exception. Thus, the recent 1.6% growth rate is not an encouraging sign for the U.S. economy going forward. Since August 7th, here are a few of the actions being taken by global central bankers: Fed extends 0% rates until mid-2013 Bank of England indicated it's ready to add stimulus Switzerland is intervening in currency markets by printing more francs to fight currency overvaluation Japan concerned over its overvalued currency South Korea kept rates flat two consecutive months signaling tightening may be over; the Kospi is down 11.2% ECB after 18 month hiatus is stepping up bond purchases, including the debt of Italy & Spain France, Italy, Span and Belgium introduce a ban on short-selling financial stocks for the next two weeks


STEALTH QE III AHEAD
It is likely that the Fed has no intention of introducing QE3 in any recognizable form we are anticipating given that: 1. 2. 3. The expansion of narrow money so far has led only to a degree of price inflation, without much benefit to asset prices. And with the ECB still reluctant to print euros, QE3 would probably collapse the dollar/euro rate and propel gold considerably higher, putting unwelcome strains on the financial system. The Fed also finds itself having dramatically expanded the monetary base for little economic benefit: against all its expectations, the economy is sliding into recession again. Perhaps it is a case of all the people being no longer fooled all of the time with respect to what QE actually is.
No, another approach is called for. To the Keynesian mind the obvious alternative must be to expand bank credit, particularly when there is an accumulation of non-borrowed reserves sitting on the Feds balance sheet.


To understand the stealth game that lies ahead you need to understand some technical terminology which includes: 1. 2. 3. Non-Borrowed Reserves (NBR) Reverse Repurchase Agreements (Reverse Repos) Contingent Liabilities
Let's begin with NBRs. NBRs (Non-Borrowed Reserves) WHAT THEY ARE: The NBRs represent the excess capital owned by the commercial banks, which have not been drawn down for use as the capital base for the expansion of bank credit. They currently stand at about $1.76 trillion while in normal circumstances NBRs would be no more than a few tens of billions. High levels of NBRs reflect the reluctance of banks to lend and bankable borrowers to borrow: they are symptomatic of an economy that refuses to expand. WHY: It is against this background that Ben Bernanke announced at the recent post-FOMC meeting press conference that interest rates would be held at current levels (close to zero) for the next two years. This could be the basis for shifting the funding of government debt from printing raw money to expanding bank credit. The public do not understand the inflationary implications of expanding bank credit as easily as they do that of printing money: switching to bank credit as a funding route for government debt allows the Fed to fool all of us a while longer.
Theoretically, that $1.76 trillion of NBRs could fund nine times that amount of government debt, or more than doubling it to $30 trillion. The point is that the successful development of the repo market in this way is an obvious and more powerful solution than extending quantitative easing. REVERSE REPO MARKET HOW: The logical way to do this is by developing the repo market, where THE BUYER of government securities conducts a reverse repurchase agreement, or a reverse repo. THE INVESTOR in a reverse repo buys securities with an agreement to sell them back to the seller at a fixed price at a future date. For the seller of the securities, the deal is defined as a simple repurchase agreement and is the mirror-image of the reverse repo. If the cost of financing a reverse repo is profitable then the transaction can be highly geared to give a substantial return on the underlying capital. By encouraging this market for short-term government debt, the Fed can exercise tight control over short-maturity government bond yields with benefits extending to medium maturities, irrespective of the quantity issued. The key to it is to get the banks to lend to the institutions on the Feds Reverse Repo Counterparty List, and the key to that is reducing the interest rate paid on non-borrowed reserves to slightly below the targeted government bond yield rate. (SET UP HAPPENING NOW)
The development of the repo market is the way to getting the NBRs put to constructive government use. Given that short-term US government paper is seen as the lowest investment risk and the highest quality collateral, gearing up a reverse repo fifty or even a hundred times is a no-brainer. Theoretically, that $1.76 trillion of NBRs could fund nine times that amount of government debt, or more than doubling it to $30 trillion. The point is that the successful development of the repo market in this way is an obvious and more powerful solution than extending quantitative easing. We know from FOMC minutes last year that the Fed have been assessing the repo market, so it is a definite possibility. All that is required is interest rate certainty, and that is what the Fed gave the market in its announcement that it would peg rates at close to zero for the next two years.


The probability that the repo market will be developed in this way has been increased by the inclusion on the 27th July of both Fanny Mae and Freddy Mac on the Feds Reverse Repo Counterparty List. We should be interested in this development, because it allows these government-owned entities to gear up their fast-accumulating cash for certain returns, and using government entities allows the Fed to exercise further controls on the development of the repo market. The apparent disadvantage is that reliance on the repo market will shorten the overall debt maturity profile. But successful funding at the short end of the yield curve will have the effect of keeping yields down for longer maturities, and the Fed can also use derivatives to extend its control to the longer end. Correctly managed, the Fed will believe that it can keep the cost of government borrowing low and at the same time manage the overall debt maturity profile. We cannot be certain the Fed will use the repo market in this way, but the problems with a new round of quantitative easing, the studies of the repo market admitted in FOMC minutes, and the recent entry of Fannie Mae and Freddie Mac to the Reverse Repo Counterparty List are strong evidence they will. Furthermore, the establishment Keynesians and monetarists will be unconcerned by inflationary consequences. To them, the greater danger is still a 1930s style deflationary depression, the result of not enough government economic stimuli. Unlocking the NBRs and gearing them up through the repo market gives them all the room for manoeuvre they could wish for. And if the Fed unlocks bank credit in this way, other central banks will want to follow. This will not be so simple, since most banks in other jurisdictions operate under Basle rules, which require them to maintain a minimum level of risk-adjusted capital, instead of keeping reserves at the central bank. Basle rules are being tightened, forcing most banks to increase core capital as a percentage of loans, so there is less capital available to back a dramatic expansion of repo markets for government debt. Other central banks will have to use more imagination to expand bank credit to finance government deficits.


In the short run, this may not matter too much. All currencies are on a de facto dollar standard, so they will benefit from the dollars extended low interest rates. Furthermore the expansion of bank credit as a means of government funding in the US will reduce demands on the global savings pool, easing the imbalance between government deficits and funding availability. So we have a workable monetary solution for all the worlds ills. There are market benefits, too. Extended low interest rates should help place a floor under asset prices, and the resolution of the immediate uncertainties over US sovereign debt and less pressure for government spending cuts will be seen as a confidence restorative. But expanding bank credit to finance increasing government spending is no solution to the underlying causes of the real economic difficulties. Importantly, it guarantees yet more price inflation down the road: bank credit expansion always has in the past, and it always will in the future. Above all, it guarantees the next leg upwards in the precious metals bull market. CONTINGENT LIABILITIES Contingent liabilities are liabilities that may or may not be incurred by an entity depending on the outcome of a future event such as a court case. These liabilities are recorded in a company's accounts and shown in the balance sheet when both probable and reasonably estimable. A footnote to the balance sheet describes the nature and extent of the contingent liabilities. The likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate a loss is described as known, reasonably estimable, or not reasonably estimable. If the Fed contractually guarantees buying Repo Assets back then the contingent liability borders on zero. OPERATIONAL READINESS


The best way Ben can assess the outcome of this plan is:


CONCERNS WITH BANKS & US CREDIT MARKETS BANK OF AMERICA Something is terribly wrong at Bank of America. Henry Blodget penned a post titled "Here's Why Bank Of America's Stock Is Collapsing Again" in which he used Zero Hedge data among other, to determine that the capital shortfall for the bank is between $100 and $200 billion. It took BAC exactly 6 hours to retort. Below is the key part of the Bank of America statement. Mr. Blodgett is making exaggerated and unwarranted claims which is what the SEC stated publicly when he was permanently banned from the securities industry in 2003. The sovereign exposure is off by a factor of 10. The commercial real estate figures are off by a factor of four. The mortgage analysis was provided by a hedge fund that has acknowledged it will benefit if our stock price declines. The recommendations on goodwill accounting would be prohibited by generally acceptable accounting practices. Traditional bank valuation relies upon tangible book value per share, which excludes by definition 100 percent of goodwill and other intangibles. As of June 30, our tangible book value per share was $12.65.


Something is also seriously wrong with US the US Credit Market We can expect counter party risk from the Bank of America to impact the other banks. This shows itself in the Credit Default Spread increases in BOA and other banks shown to the right. It is also showing in North American Corporate Credit CDSs (see bottom right). OBSERVATIONS: the 30 Year Bond just fell through the 2010 crisis low The 2-10 Year Spread is fast approaching 175 basis points which marked Japan falling into a protracted Deflationary Recession. We were as low as 185 but this AM are about 25 bps above this threshold that the credit markets are glued to. The 5 & 10 year TIPs have gone negative. Though narrow and broad money supply is expanding significantly Money Velocity is rolling over. The Fed just cant get any traction on Money Velocity!
The issue is nominal GDP is nowhere near the 6-7% required and is below 4% with more than 20% government expenditure. There are a whole range of solutions out there from Kenneth Rogoff to Larry Summers to use Inflation Targeting to help with this REMEMBER: Since the Fed froze short rates at 25bps until 2013 there has been a frantic scramble to borrow at 25bps and buy the long end of the treasury this has drive prices up dramatically and yields below 2% on the 10 year. SO what is to be done. The first thing to do is make sure the $1.7T deficit is going to be financed because Japan and China arent going to do it. THE FED MUST URGENTLY GET THE BANKS TO DO SOMETHING WITH THEIR 1.76T they have on deposit with the FED (What I will refer to as Non Borrowed Reserves or NBRs)
Caution Advised - Something is seriously wrong somewhere!!


WHISTLEBLOWER TELLS ALL AT THE RATING AGENCIES SOURCE: MOODY'S ANALYST BREAKS SILENCE: Says Ratings Agency Rotten To Core With Conflicts BI A former senior analyst at Moody's has gone public with his story of how one of the country's most important rating agencies is corrupted to the core. The analyst, William J. Harrington, worked for Moody's for 11 years, from 1999 until his resignation last year. From 2006 to 2010, Harrington was a Senior Vice President in the derivative products group, which was responsible for producing many of the disastrous ratings Moody's issued during the housing bubble. Harrington has made his story public in the form of a 78-page "comment" to the SEC's proposed rules about rating agency reform, which he submitted to the agency on August 8th. The comment is a scathing indictment of Moody's processes, conflicts of interests, and management, and it will likely make Harrington a star witness at any future litigation or hearings on this topic. some key points:
Moody's ratings often do not reflect its analysts' private conclusions. Instead, rating committees privately conclude that certain securities deserve certain ratings--but then vote with management to give the securities the higher ratings that issuer clients want. Moody's management and "compliance" officers do everything possible to make issuer clients happy--and they view analysts who do not do the same as "troublesome." Management employs a variety of tactics to transform these troublesome analysts into "pliant corporate citizens" who have Moody's best interests at heart. Moody's product managers participate in--and vote on--ratings decisions. These product managers are the same people who are directly responsible for keeping clients happy and growing Moody's business. At least one senior executive lied under oath at the hearings into rating agency conduct. Another executive, who Harrington says exemplified management's emphasis on giving issuers what they wanted, skipped the hearings altogether.


REAL ESTATE "DOUBLE DIP" UPDATE BIG PICTURE
COMMERCIAL REAL ESTATE COLLAPSE


BACKGROUNDER: A Deep Dive Into The New Home Sales Miss Calculated Risk The Census Bureau reports New Home Sales in July were at a seasonally adjusted annual rate (SAAR) of 298 thousand. This was down from a revised 300 thousand in June (revised from 312 thousand). The first graph shows New Home Sales vs. recessions since 1963. The dashed line is the current sales rate. Sales of new single-family houses in July 2011 were at a seasonally adjusted annual rate of 298,000...This is 0.7 percent ( 12.9%)* below the revised June rate of 300,000, but is 6.8 percent (13.5%)* above the July 2010 estimate of 279,000. The second graph shows New Home Months of Supply.
Image: Calculated Risk
Image: Calculated Risk


Months of supply was unchanged at 6.6 in July. The all time record was 12.1 months of supply in January 2009. This is still higher than normal (less than 6 months supply is normal). The seasonally adjusted estimate of new houses for sale at the end of July was 165,000. This represents a supply of 6.6 months at the current sales rate. On inventory, according to the Census Bureau: "A house is considered for sale when a permit to build has been issued in permit-issuing places or work has begun on the footings or foundation in nonpermit areas and a sales contract has not been signed nor a deposit accepted." Starting in 1973 the Census Bureau broke this down into three categories: Not Started, Under Construction, and Completed. This graph shows the three categories of inventory starting in 1973. The inventory of completed homes for sale was at 61,000 units in July. The combined total of completed and under construction is at the lowest level since this series started. The last graph shows sales NSA (monthly sales, not seasonally adjusted annual rate). In July 2011 (red column), 27 thousand new homes were sold (NSA). The record low for July was 26 thousand in 2010 (following the expiration of the homebuyer tax credit). The high for July was 117 thousand in 2005. This was below the consensus forecast of 313 thousand, and was just above the record low for the month of July - and new home sales have averaged only 300 thousand SAAR over the 15 months since the expiration of the tax credit ... moving sideways at a very low level.


RESIDENTIAL REAL ESTATE- "STILL HOME SICK" CURRENT SITUATIONAL ANALYSIS
Nationally, home prices are down over 40% on average, with the Northeast and South weathering the bust far better than the rest of the country. Despite government intervention and tax credits, this disturbing trend doesn't appear to be ending anytime soon. Thompson argues that the current crisis may be too complex for Washington to solve.


BACKGROUNDER: 20 Wacky Statistics About The U.S. Real Estate Crisis Economic Collapse The following are 20 statistics about the U.S. real estate crisis.... #1 According to Zillow, 28.4 percent of all single-family homes with a mortgage in the United States are now underwater. #2 Zillow has also announced that the average price of a home in the U.S. is about 8 percent lower than it was a year ago and that it continues to fall about 1 percent a month. #3 U.S. home prices have now fallen a whopping 33% from where they were at during the peak of the housing bubble. #4 During the first quarter of 2011, home values declined at the fastest rate since late 2008. #5 According to Zillow, more than 55 percent of all single-family homes with a mortgage in Atlanta have negative equity and more than 68 percent of all single-family homes with a mortgage in Phoenix have negative equity. #6 U.S. home values have fallen an astounding 6.3 trillion dollars since the housing crisis first began. #7 In February, U.S. housing starts experienced their largest decline in 27 years. #8 New home sales in the United States are now down 80% from the peak in July 2005. #9 Historically, the percentage of residential mortgages in foreclosure in the United States has tended to hover between 1 and 1.5 percent. Today, it is up around 4.5 percent. #10 According to RealtyTrac, foreclosure filings in the United States are projected to increase by another 20 percent in 2011. #11 It is estimated that 25% of all mortgages in Miami-Dade County are "in serious distress and headed for either foreclosure or short sale". #12 Two years ago, the average U.S. homeowner that was being foreclosed upon had not made a mortgage payment in 11 months. Today, the average U.S. homeowner that is being foreclosed upon has not made a mortgage payment in 17 months. #13 Sales of foreclosed homes now represent an all-time record 23.7% of the market. #14 4.5 million home loans are now either in some stage of foreclosure or are at least 90 days delinquent. #15 According to the Mortgage Bankers Association, at least 8 million Americans are currently at least one month behind on their mortgage payments. #16 In September 2008, 33 percent of Americans knew someone who had been foreclosed upon or who was facing the threat of foreclosure. Today that number has risen to 48 percent. #17 During the first quarter of 2011, less new homes were sold in the U.S. than in any three month period ever recorded. #18 According to a recent census report, 13% of all homes in the United States are currently sitting empty. #19 In 1996, 89 percent of Americans believed that it was better to own a home than to rent one. Today that number has fallen to 63 percent. #20 According to Zillow, the United States has been in a "housing recession" for 57 straight months without an end in sight. So should we be confident that the folks in charge are doing everything that they can to turn all of this around? Sadly, the truth is that our "authorities" really do not know what they are doing.


HOME OWNERSHIP TRENDS Case Shiller projects a 21% decline in home prices from 2010 to 2012. 6.7 million delinquent mortgages are waiting to flood the market around the country -- and with near-zero cure rates most of them will. Another 2 million homes in foreclosure are being held off the market by banks.
HOME OWNERSHIP America's home ownership rate, after holding steady for a while, took a pretty big plunge in Q4, from 66.9 percent to 66.5 percent. That's down from the 2004 peak of 69.2 percent and the lowest level since 1998. Homeownership is falling at an alarming pace, despite the fact that home prices have fallen, affordability is much improved and inventories of new and existing homes are still running quite high. Bargains abound, but few are interested or eligible to take advantage.
OCCUPANCY RATE Of the nearly 131 million housing units in this country: 112.5 million are occupied. 74.8 million are owned - only dropped by about 30 thousand in the past year. 38 million are rented, but that's up by over a million year over year. That means more new households are choosing to rent.
VACANCY RATE More concerning than the home ownership rate is the vacancy rate. There were 18.4 million vacant homes in the U.S. in Q4 '10 (11 percent of all housing units vacant all year round), which is actually an improvement of 427,000 from a year ago, but not for the reasons you'd think. The number of vacant homes for rent fell by 493 thousand, as rental demand rose. 471,000 homes are listed as "Held off Market" about half for temporary use, but the other half are likely foreclosures. And no, the shadow inventory isn't just 200,000, it's far higher than that.
So think about it. Eleven percent of the houses in America are empty. This as builders start to get more bullish, and renting apartments becomes ever more popular. Vacancies in the apartment sector have been falling steadily and dramatically, why? Because we're still recovering emotionally from the toll of the housing crash. Younger Americans have seen what home ownership has done to their friends and families, and many want no part of it. Credit has become very nearly elitist. Home prices, whatever your particular data provider preference might be, are still falling. Delinquent mortgages are one threat


Loans staying in foreclosure are another


$6.5 TRILLION IN MIDDLE CLASS NET WORTH EVAPORATES Home Values Saw their Biggest Drop Since 2008 When you don't have a job or you have a wageless recovery real estate is going to feel it. This is another reason we have a real estate double dip Housing has declined in value for 57 straight months, almost 5 years. American homeowners have lost $6.5 trillion in equity in those 57 months. The data from the Fed Flow of Funds household balance sheet shows the following: Homeowner's equity: 2006: $12.8 trillion 2011: $6.3 trillion
This $6.5 trillion was roughly half of the middle class's total net assets.
These catastrophic losses are taken by someone: either the homeowner, the lender, or the taxpayer. A house purchased in 1996 for $100,000 has to be worth $142,000 today just to keep up with inflation. Factoring in transactions costs, then the house would have to be sold for roughly $152,000 for the owner to extract $142,000--the sum needed to simply maintain purchasing power. A house that rose 50% over the past 15 years has simply kept pace with inflation. The nominal "gain" is utterly illusory.


GARY SHILLING LAYS OUT THE HOUSING FACTS BACKGROUNDER: Still Home Sick Gary Shilling All may be well. Thats what many housing optimists proclaimed a year ago when prices appeared to have stabilized, indeed, started to recover from their collapse (Chart 1). As Insight readers are well aware, we emphatically disagreed. We pointed out that the earlier extremes in the housing market made rapid revivalor any revival for that matterextremely difficult. In the earlier salad days, housing was propelled by low mortgage rates, lax or nonexistent underwriting standards, securitization of mortgages that passed seemingly creditworthy and highly-rated but really toxic assets on the unsuspecting buyers, laissez-faire regulation, and most of all, almost universal conviction that house prices never fall on a nationwide basiswhich they hadnt since the 1930s.
But housing activity remains at post- World War II lows (Chart 2).


The Administration's Home Affordable Modification Program (HAMP) was a bust. Tightening lending standards, the renewed decline in house prices, fears of job loss as unemployment remains high and the drying up of mortgage securitization have handily offset the positive effects of low mortgage rates and new homeowner tax credits. Indeed, the jumps in home sales in anticipation of the tax credit expiration first in November 2009 and then in April 2010 were promptly retraced and followed by still-weaker sales (Chart 3).


Mortal Enemy Most of all, in making the case for continuing housing weakness, weve continually hammered home the ongoing negative effect of excess inventories on house sales, prices, new construction and just about every other aspect of residential real estate. In housing, as in every goods-producing sector, excess inventories are the mortal enemy of prices. Its that simple. Lower prices are needed to unload surplus inventory, but in turn lower prices bring forth more inventory from anxious sellers. And the anxiousness of house sellers and reluctance of buyers is enhanced by the realization that house prices can fall, and are falling for the first time in 70 years. Just how big are excess house inventories and how long will it take to absorb them? As discussed in many past Insights, we measure excess house inventories by the excess over the earlier trendless norm of about 2.5 million (Chart 4). We consider 2.5 million to be the normal working level for total existing units and new single-family houses (new multi-family inventories are not reported). Notice that this flat pattern, except for the recent extreme volatility, matches the equal trendless patterns of housing starts and completions over time. Note also that total inventories jumped to 5 million as housing collapsed, and still equals 4 million, or 1.5 million over and above the norm.


Hidden House Inventory But wait! Theres more! The Census Bureau, in its estimate of housing inventory, lists a category called Held off the market for other reasons very descriptive! This category leaped by over 1 million between the first quarter of 2006 and the first quarter of this year. It includes unspecified numbers of houses that have been foreclosed but not yet sold and units that people want to sellfirst or second homesbut have not listed due to current market conditions. Of course, if those in foreclosed houses and those who want to sell finally do so and move into other abodes, theyre still occupying housing units and total inventories dont change. But if theyre unloading extra and vacant houses or doubling up with family and friends, additional excess inventories are created. Many are now beginning to give up hope of higher prices as they continue to fall and throwing their houses on the market for whatever they will bring. How Long? Our total estimate of 2 million to 2.5 million excess house inventories, then, may well rise with further foreclosures that will be spurred by falling prices. This surplus is already huge since in the long run the U.S. builds about 1.5 million houses per year (Chart 2). To forecast the length of time to work off this excess inventory, we need to project supply and demand for residential units. New conventional construction of single-family house and apartment units plus manufactured home shipments is running about 700 thousand at annual rates. Theres no reason to expect this rate to change in the next few years, given falling prices excess inventories and other constraining factors. About 300,000 of these units are offset each year by dilapidated houses that are torn down, houses converted to nonresidential purposes and other factors that remove them from the housing stock. So the net supply will probably continue to average about 400,000 annually. On the demand side, house sales data, especially existing house sales reported by the National Association of Realtors, appear to be overstated. Well, what did you expect? Did you ever meet a residential realtor who isnt wildly optimistic about house sales and prices? The NAR uses models to expand its actual survey to national total sales numbers. With the collapse in housing activity, many of the multi-listing services that trade group samples have consolidation so the sales of those remaining expanded because their area of coverage has grown. Since the NAR doesn't correct for this, the sales


numbers are likely overstated. Also, the NAR doesnt sample but estimates the share of sales by owners that dont go through multi-listing services. That segment of the market collapsed with the housing bust but the NAR has not subsequently adjusted its estimates downward. In contrast, CoreLogic measures sales by checking property transfer records at local court houses and reports that its data covers about 85% of all house sales. Its numbers are consistently lower than the NAR numbers (Chart 5). In 2010, NAR reported 4.9 million in sales, down 5.7% from 5.2 million in 2009. But CoreLogic recorded only 3.3 million in 2010, a drop of 10.8% from 3.7 million in 2009. So the NAR data may overstate home sales by a third.
If so, and if house inventory data reported by the NAR are correct, it will take much longer to unload excess inventories at current sales rates. In March, NAR reported inventories of existing houses would take 8.4 months to sell at the trade groups reported sales rate. Thats down from 12.5 months in July of last year but still almost about twice the level of healthy markets. And if NAR sales data are overstated by a third, the months supply is still back in double digits. Household Formation Because of the NAR's likely overstatement of sales and for other reasons, we prefer to rely on household formation data gathered by the Census Bureau to forecast housing demand. Now, theres a lot of misunderstanding about household formation numbers. Many assume that there is a one-to-one relationship between the growth in the population and the number of new households formed. With population growing around 1% per year, or by about 3 million, then with an average 2.77 people per household, 1.08 million new households will be formed, the reasoning goes. But the link between demographics and household formation is at best a very tenuous one, especially in a cyclical time frame. In the 2001-2010 decade, household formation averaged 888.5 thousand per year. Since those years included boom and bust years, this average, about 900 thousand per year, seems like a reasonable, probably optimistic forecast for the years ahead, given the likely further fall in house prices, high unemployment and declining real incomes in the years ahead. So if demand is averaging 900 thousand per year while supply runs 400 thousand, about 500 thousand of the excess housing inventory will be


absorbed per annum. Consequently, it will take four or five years to absorb the 2 million to 2.5 million housing units, over and above normal working inventory, that we believe exist at a minimum. Prices Down Another 20% Four or five years is plenty of time for the inventory overhang to depress prices another 20% as weve been forecasting. Prices, after reviving somewhat with the new homeowner tax credit, are now essentially back to their April 2009 lows (Chart 1). Another 20% drop would bring the total decline from the peak in April 2006 to 45% and take them back to their longrun flat trend (Chart 6). In that graph, median singlefamily house prices are corrected for two types of inflation. The first is general inflation affecting all goods and services. The second is the tendency over time of houses to get bigger and, therefore, intrinsically more expensive. As living standards rise, people want more bathroom, fancier kitchens, etc. in their homes. A further 20% price drop may be an optimistic forecast since declines tend to overshoot on the downside just as bubbles expand to the stratosphere.
Other forecasters are coming into agreement with our forecast, dire as it is. The Dallas Federal Reserve Bank states that a 23% decline is needed to return house prices to their long-run trend. Prof. Robert Shiller of Yale says there is a substantial risk of another 15% or 20% decline in house prices. The NARs March survey of members revealed that 42% of everoptimistic realtors expect home prices in their areas to fall in the next 12 months. Starting last year, Shillers firm, Macro Markets LLC, asked us and 110 other housing experts to forecast house prices over the next five years. Since that survey commenced, we have consistently forecast a 20% cumulative decline for 2011-2013, with an 11% drop this year. Last June, the average forecast was a 1.3% price rise this year, but the last survey in early March reported a 1.4% drop. There are other reasons to expect house prices to fall sharply in coming quarters. Now that the moratoria while mortgage modifications were attempted and during the robo-signing flap are over, foreclosures are likely to resume in earnest. And, as noted earlier, lenders and servicers tend to dump foreclosed houses on the market for quick sales, regardless of prices. These fire-sale prices put more homeowners under water and lead to more foreclosures, but they do attract investors looking for cheap houses who often pay all cash. Cash-Ins


Many underwater homeowners, of course, still are committed to service their financial obligations, or want to stay in their abodes. Some are even doing cash-in refinancing, the reverse of the cash-outs of yesteryear, and contributing money from other sources to reduce their mortgage balances. A total of $1.1 trillion was withdrawn in 2006 and 2007, and at the peak of the housing bubble in 2006, cash-outs ran $80 billion per quarter and accounted for 90% of refinancings. By the fourth quarter of 2010, however, cash-outs dropped to 16% of refinancings and cash-ins jumped to 33%. Homeowner deleveraging through cash-ins reduces the vulnerability to further house price declines, but they also reduce the funds available for other investments and current spending. So, too, do the higher downpayments lenders are requiring on house purchases, which also freeze out many potential buyers and otherwise discourage home ownership. Regulators are proposing 20% downpayments for high-quality new mortgages underwritten by private lenders, and Wells Fargo, the countrys largest mortgage lender, has suggested 30%. For these loans, borrowers will also need to maintain 75% loans-to-market value ratios, 75% for refinancings and 70% for cash-out refinancings. Borrowers can't have missed two consecutive payments on any consumer debt within two years. Mortgage-related debt payments can be no more than 28% of income and total debt service can't exceed 36% of income. And mortgage loans must be fully amortizing no interest-only borrowing. According to CoreLogic, 46% of all mortgagors at the end of 2010 had less than 20% equity in their homes. Mortgages that dont meet these standards will be subject to 5% retention by the original lender if they are sold to others or securitized. In other words, regulators intend to end the days when subprime mortgages were packaged as securities by the original lender and sold with no further recourse. Buy them, securitize them, sell off the securitized tranches and forget them was the strategy. In fact, median downpayments on conventional mortgages already were 22% last year in nine major U.S. cities, according to an analysis by Zillow.com, up from 4% in the fourth quarter of 2006. Those cities are Chicago, Stockton, Calif., Las Vegas, Los Angeles, Miami-Fort Lauderdale, Phoenix, San Diego, San Francisco and Tampa. To be sure, private lenders are now making very few mortgages, with most initiated by Government-Sponsored Enterprises (Chart 7). The Federal Housing Administration, which required only 3.5% up front, accounted for 23.4% of residential mortgages last year. In contrast, in 1950, the median downpayment for FHA first mortgages was 35%, for Veterans Administration first mortgages, 8%, and 35% for non-government conventional first mortgages. Underwriting standards have tightened, but are still loose by those earlier standards.


The elimination of home equity for most mortgages will no doubt have severe detrimental effects on consumer sentiment and spending. It also will magnify the mortgage delinquencies and defaults, and severely depress the value of existing mortgages and derivatives backed by them In recent quarters, banks have booked profits as they reduced their reserves against potential loan losses, but that process will be dramatically reversed. And it goes without saying that mortgage lenders and servicers will severely tighten their mortgage underwriting standards with a further 20% drop in house prices. The top 10 mortgage servicers account for the majority of the market and include the nations largest banks. Needless to say, another big decline in house prices almost guarantees another recession because of its financial impact. At the same time, further declines in residential construction won't matter much to the overall economy. It was 6.3% of GDP at its peak in the fourth quarter of 2005, but plummeted to a mere 2.2% in the first quarter of this year. No Help to the Economy Conversely, we don't look for any revival of homebuilding in the years ahead that will boost the economy. The housing collapse prevented residential construction from serving its usual role in spurring economic recovery from the recession. Rather than contribute meaningfully, residential construction actually declined in the first seven quarters of recovery. The ongoing housing crisis will probably continue to trouble financial markets, depress consumer spending and keep residential construction depressed for years. Keep Em Out Or In? From a regulator standpoint, tighter controls will continue to discourage homeownership. The Dodd-Frank financial overhaul law requires banks to retain 5% of the credit risks on lower-quality residential mortgages that are securitized and sold to others. These new rules will obviously discourage mortgage loans to all but the most creditworthy borrowers. Also, since Fannie Mae and Freddie Mac are backed by the U.S. government, they are exempt from the retention rules, which therefore will drive mortgage loans to these Government-Sponsored Enterprises. Still, their fates are uncertain.


Government attitudes toward homeownership also appear to have shifted with the housing collapse. On Oct. 15, 2002, when the housing boom was inflating, President George W. Bush said at the White House Conference on Increasing Minority Homeownership, We want everybody in America to own their own home. Thats what we wantAn ownership society is a compassionate society. In contrast, in February 2011, the white paper released by the Treasury Department and Department of Housing and Urban Development, which addressed the future of Fannie and Freddie, also stated that homeownership isnt for every American. The Administration believes that we must continue to take the necessary steps to ensure that Americans have access to an adequate range of affordable housing options. This does not mean, however, that our goal is for all Americans to become homeowners. Instead, we should make sure that all Americans who have the credit history, financial capacity, and desire to own a home have the opportunity to take that step. At the same time, we should ensure that there are a range of affordable options for the 100 million Americans who rent, whether they do so by choice or necessity. Become Renters Again The statement echoes the muchmaligned comments by then-Treasury Secretary Henry Paulson of the Bush Administration in the midst of the housing collapse. He said in a December 2007 online Q&A session: And let me be clearwe will not avoid all foreclosures. Borrowers who are struggling even with the lower initial ARM rate are unlikely to be eligible for assistance, and likely will become renters again. Furthermore, Congressional Republicans are proposing the end of tax deductibility of mortgage interest, which would further reduce the appeal of owning abodes. This is the largest of the tax expenditures and will cost the federal government $600 billion from 2009 to 2013, according to the Congressional Joint Committee on Taxation. Whether this tax break aids homeowners is questionable, however. In the European Union, where mortgage interest is not tax deductible, the homeownership rate is 75% compared with the earlier U.S. peak of 69%. Furthermore, lack of mortgage interest deductibility may encourage homeowners to pay off their loans faster, and avoid that false assumption that owning an abode is cheaper than renting. At the same time, homeownership continues to be very political powerful, and many recent government actions can certainly be viewed as an unstated attempt to keep people in their homes, even those who clearly can't afford to own them. The reality that many foreclosures have tossed homeowners out is powerful not only to those affected directly, but also to many others in and out of Washington. Our friend and superb housing analyst Tom Lawler has taken a hard look at the numbers and worked his way through the many assumptions needed to determine the number of homeowners who lost their homes to foreclosure last year. He concludes it was about 1 million. Tom goes on to point out that many others have really lost their homes but not technically since foreclosures are not yet completed. These "owners" may still be living in those houses rent-free, by the way! Theres also sympathy for the many who, despite concerted efforts, have been unable to reduce their mortgage and other debts such as auto, student and credit card loans. Their total debt in relation to disposable personal income (after-tax income) peaked in the third quarter of 2007 at 131%. Debt itself peaked three quarters later in the second quarter of 2008. From then through the fourth quarter of 2010, mortgage debt dropped $517.9 billion and consumer (other) debt has fallen $174.6 billion for a total decline of $691.5 billion. No Debt Repayment But in those same 10 quarters, $542.2 billion in mortgage debt was charged off and $333.8 billion in consumer debt for an $875.9 billion total. As shown in the last three columns, after accounting for chargeoffs, mortgage debt actually rose a bit, $24.2 billion to $10 trillion, consumer debt climbed $159.2 billion to $2.4 trillion and the total rose $183.4 billion to $12.4 trillion. The rise in mortgage debt ex charge-offs is so small that its merely a rounding error, but its surprising that it didnt fall significantly. Perhaps financially stressed homeowners who didnt lose their homes to foreclosure have not been able to reduce their mortgage debt.


To encourage home-buying, Washington enacted tax credits for new homeowners, which initially expired in November 2009 and then was renewed until April 2010. HAMPs goal is to stave off foreclosures for underwater homeowners by making their mortgage payments more affordable. The government essentially told major mortgage lenders and servicers to forestall foreclosures while HAMP modifications were being attempted. More recently, 14 large financial institutions have been ordered by regulators to revise their mortgage servicing practices to encourage more successful modifications and speed up foreclosures. Those 14 have until mid-June to establish their plans and then 60 days to implement them. Among other things, the mortgage servicers will be required to have a single point of contact for borrowers to avoid their being bounced from one servicer employee to another and getting lost in the shuffle. They also must set appropriate deadlines for deciding whether borrowers can qualify for a loan workout, and have enough staff to deal with the multitude of troubled mortgages. The goal is to get servicers to contact borrowers earlier and more frequently after one missed payment in order to have a better chance of modifying troubled loans. Fannie and Freddie The U.S. Treasury-HUD white paper cited earlier indicates that the Administration, like many other Democrats as well as Republicans, wants a significantly smaller role for government in housing finance, including a winding down of Fannie and Freddie and a smaller role for the FHA. House Republicans want Fannie and Freddie eliminated and only the FHA left as a source of federal backing. Currently, federal agencies including Fannie and Freddie guarantee 87% of new mortgages. As discussed in our new book, The Age of Deleveraging, back in mid-2008, many FDIC-insured institutions were heavily leveraged but still had an average capital-to-asset ratio of 7.9%. In contrast, Freddie and Fannie had less than 2%, so for each buck of capital, they owned or guaranteed $50 in mortgages. Lobbyists from the two convinced Congress that they didnt need more capital since defaults would be tiny as house prices rose forever. But when the housing sector nosedived, Fannie and Freddies houses of cards fell apart. So in September 2008, both were seized by the government in a legal structure called conservatorship. They are regulated, indeed controlled, by the Federal Housing Finance Agency. Initially, each had up to $200 billion backing from the Treasury, but it later was made open-ended through 2012. Washington regarded Freddie and Fannie as part of the government. Assistant Treasury Secretary Michael Barr said that because they are owned by the taxpayers in the biggest housing crisis in 80 years, it is logical that they be used to stabilize the housing market. But since the two technically remain private corporations, their finances remain off the federal budget and their huge prospective losses from sour mortgages dont need to be counted in the federal deficit. Its ironic that the government is using Fannie and Freddie as the biggest off-balance-sheet financing vehicles in the economy at the same time it blasted banks for using off-balance-sheet entities in earlier years. Also, by using these GSEs to support housing, with an open credit line to the Treasury, the Administration doesnt have to approach Congress for funding bit by bit. The Treasury simply injects enough money, quarter by quarter, to cover their losses. As of Feb. 25, 2011, that was $153 billion for the pair, and the Congressional Budget Office estimates the losses through 2020 at almost $400 billion. Treasury Secretary Timothy Geithner in March 2010 said, There is a quite strong economic case, quite strong public policy case for preserving, designing some form of guarantee by the government to help facilitate a stable housing finance market, even after Fannie and Freddie are restructured or unwound. More Private Capital Nevertheless, the February 2011 white paper advocated a number of short-term measures to attract private capital into the mortgage marketwith higher costs for house financing and its detrimental effects on home ownership. These include allowing the maximum loan limits to fall to $625,000 from $729,750 as scheduled on October 1, increasing downpayments on Fannie and Freddie guaranteed loans to 10%, and increasing FHA insurance premiums, which subsequently was announced to rise by 0.25 percentage points on 30- and 15-year loans to 1.15% on low downpayment loans.


The Administration believes that given the fragile state of the housing sector, it will take at least five to seven years to move to a longer term structure of housing finance. It offered in the white paperbut did not discuss in detailthree options, which no doubt will be hotly debated going into the 2012 elections. The first is a privatized system with Fannie and Freddie eliminated. Their $1.5 trillion combined mortgage portfolio, out of the $10 trillion mortgage market, is already set to fall 10% per year. Government financial support would be confined to FHA and VA loans, which accounted for 23% of mortgages last year, targeted to help narrow borrower groups. Private lenders would originate and securitize mortgages without government guarantees. Interestingly, small banks oppose this option because they believe it would concentrate the business in the hands of large lenders, much to their detriment. The second option would create a mostly private mortgage market as well as FHA/VA involvement, with a government backstop mechanism to insure access to credit during a housing crisis. Option three involves a privatized market as well as FHA-VA participation. New, privately-owned companies would buy mortgages from lenders and securitize them. Those securities would be guaranteed by the government as long as they met standards. These new private entities would essentially replace Fannie and Freddie. Regardless of how government legislation and regulation unfold, the nations zeal for homeownership may be weakening outside as well as inside Washington. Homeowners have learned the hard way that for the first time since 1930s, house prices nationwide can and do fall. Zeal for a sound home financing system involves measures that discourage homeownership. And the likely leap in the percentage of renters and falling portion who own their abodes will reduce the power of homeownership advocates. More Renters Homeownership is falling, as the earlier boom and quick route to riches in a loose-lending environment has been replaced with collapsing prices, tight underwriting requirements, more regulation and horror stories of huge homeowner equity losses. As homeownership slides, the flip side, the renter population grows. Of course, many former and current homeowners are really renters with an option on their house's price appreciation. They put little if anything down and planned to refinance with cash-out before their mortgage rates reset upward or, in some cases, even before they skipped enough monthly payments to be foreclosed. Homeownership bulls, naturally, argue that owning a house has never been cheaper. In calculating this index, the NAR assumes that a family with median income buys a median-priced single-family house with 20% down and financed at the current 30-year fixed mortgage rate. The collapse in house prices and decline in mortgage rates in recent years have more than offset the weakness in median family income that, according to the NAR, dropped from $63,366 in 2008 to $61,313 in 2010. Nevertheless, comparisons between the current attractiveness of buying a home and that in the 1990s and early 2000s is like comparing an octopus to an ant. Back then, incomes were growing; now theyre weak. Unemployment rates were lower; now theyre high. House prices were rising as they had been since the 1930s; now theyre falling and even the stabilization last year has given way to renewed declines. Financing a mortgage was easy with little or nothing down and spotty credit; now it takes 20% or more in downpayments and sterling credit scores. Back then, the prospects of huge house price declines and massive foreclosures werent even the subject of horror films; now theyre the real, everyday reality. Rents Still Cheaper Despite the collapse in house prices, they are still expensive relative to rentals, even as apartment rental rates rise and vacancies decline. Those rent rises are having an interesting effect on the CPI. In the total index, 32% is weighted for shelter including 5.9% for the rental of primary residences. But an additional 24.9% is owners equivalent rent of residences. The idea is that homeowners rent their abodes from themselves at market rental rates. Of course they dont, but this creates an odd situation where house prices are falling, but ownersequivalent rent is rising.


This, in effect, overstates the recent rise in the CPI. Chart 8 shows the year-over-year change in the core CPI, which excludes the volatile food and energy components, and the core excluding the shelter component, which is dominated by owners equivalent rent. That component is 32.3% of the core index and total shelter is 41.5%.
Notice that without shelter, the year-over-year core index rose 0.8%, or 0.4 percentage points less than the 1.2% rise in the total core. Back in 2007 and early 2008 before housing collapsed, owners equivalent rent was rising considerably faster than other prices in the core index, as shown by the gap in Chart 8 and in Chart 9. The fall in rent rates in 2008-2009 pushed the year-over-year change in shelter costs into negative territory.


The price index for personal consumption expenditures, which we and the Fed prefer to the CPI, also uses homeowners' equivalent rent, but only weights it at 15% of the total index and 17.5% of the core. Partly as a result of this lower weighting, the core index in March rose 0.9% from a year earlier compared to 1.2% for the core CPI. Homeownership Downtrend The fall in the homeownership rate has been swift, but probably understated. The overall rate in the first quarter, 66.4%, was down from the 69.2% peak in the fourth quarter of 2009 and was the same as in the fourth quarter of 1998. But Tom Lawler wrote on April 27 that if the Q1/2011 homeownership rate by age group werecorrect, but the age distribution of households had been the same last quarter as it was in 1998, then the homeownership rate last quarter would have been 65.1%, or 1.4 percentage points lower than in 1998! In any event, continuing the rate of fall since its peak will bring the total homeownership rate back to its earlier base level of 64% in the fourth quarter of 2016 from 66.4% in the first quarter of this year. That's a return to trend. And we are strong believers in reversion to trend. Continuing the average annual growth in households over the last decade of 888.5 thousand increases the total number of households by 5.1 million from the first quarter to the fourth quarter of 2016. This is enough to increase the number of new homeowners by 608 thousand even with the drop in the homeownership rate to 64%. But it also means the addition of 4.5 million new renters, or 782.7 thousand at annual rates. Thats a lot, but were not alone in this forecast. Greenstreet Advisors believes that a drop to 65% homeownership in the next five years will produce 4.5 million new rental households. Some of those people will no doubt rent cheap single-family houses, but most will probably be in rental apartments. In the longer run, only about 300 thousand multi-family units have been produced per year, or less than half our projected increase in renters. Apartment construction may again boom after the absorption of current vacancies pushes rental rates up enough to justify new building. Our Theme


As we hope youre well aware, weve been advocates of rental apartments as an investment theme for some time. Its one of our long-term buy themes in The Age of Deleveraging. We also listed it as an investment strategy for 2011 in our Jan. 2011 Insight. In addition to all the reasons covered in his report, we noted in our January issue that rental apartments will benefit from the separation that Americans are beginning to make between their abodes and their investments. The two used to be combined in owneroccupied houses back when owners believed house prices never fall. So they bought the biggest homes they could finance. The collapse in house prices has shown them otherwise. Further weakness in the prices of singlefamily houses and condos due to the depressing effects of excess inventories (Chart 4) will add fat to the fire. Contrary to general belief, a single-family house, excluding the effects of increasing size and general inflation, has been a flat investment for over a century (Chart 6). It does provide a place to live, but that value is offset, at least in part, by maintenance, taxes, utilities, real estate commissions and other costs. Furthermore, even with the tax deductibility of mortgage interest, renting a single-family house or apartment is cheaper than home ownership, absent price appreciation. Our repeated analyses over the years have shown this to be true, and even more so in the period of deflation we foresee when nominal house prices will probably fall on average. Over time, houses have sold for about 15 times rental income. But thats in the postWorld War II years when owners of rental properties expected inflation to enhance their 6.7% returnbefore the costs of income taxdeductible maintenance and property taxes. When we were young and house price appreciation was not expected in the aftermath of the 1930s, the norm for rentals was 10% of the houses value. If were right about our outlook for slow economic growth and falling house prices, houses and apartments may sell for closer to 10 times rentals than 15 times, much less the 20 times rental income in the housing boom days. The separation of abodes from investments should work to the advantage of rentals in future years. Were not suggesting that Americans will give up on single-family owneroccupied housing. The idea of a singlefamily home of your own is just too deeply embedded in the American culture. But many who have no pride of home ownership and who would vastly prefer to yell for the super (New York-ese for the building superintendent) than to apply a wrench to a leaky pipe have bought houses and apartments in past decades only to participate in capital appreciation. The Old And The Young Theyll be more inclined in future years to occupy rental apartments. This might be especially true of empty-nesters who dont like to mow their lawns and who decide to unload their suburban money pits especially because these homes are no longer appreciating rapidly but rather falling in price. At the front end of the life cycle, young couples may decide that because houses are no longer a great investment, theres no reason to strain their financial, physical, and emotional resources to buy big, expensive houses as soon as possible. So theyll stay in rental apartments a bit longer and wait until their kids are of the age that a single-family house makes sense. Reinforcing our earlier analysis of the future demand for rentals is the surprisingly small shift in housing patterns it will take to make a big difference in the demand for and construction of rental apartments. Today, there are 131 million housing units in the U.S., including vacancies, of which 42 million are rentals. If only 1% of the total 112 million households decided to move to rentals, the demand for apartments would increase by over one million, most of which would need to be newly built after current vacancies are absorbed. This is a big number compared to new apartment starts of about 300,000 on average in the past. Rental apartments will also appeal to the growing number of postwar babies as they retire, downsize, and want less responsibility and more leisure time. Like other REITs, apartment REITs rose rapidly last year (Chart 10) and may have over-anticipated the performance of the underlying investments in coming quarters. Direct ownership and other forms of investment in rental apartments may be more rewarding in the near future.


Rental apartments are not without their problems for investors. Prices havent risen dramatically lately compared to office and industrial buildings, but capitalization rates are relatively low, indicating that prices are high. Also, multi-family mortgage delinquencies and foreclosures are a problem, especially for Fannie, which with Freddie bought apartment loans in 2007 and 2008 as private lenders withdrew. Their share of multi-family loan purchases jumped to 85% in 2009 from 29% two years earlier. They own or guarantee 40% of the $325 billion multi-family mortgage market. Nevertheless, rental apartments are likely to be an attractive investment area for years as the joys and profitability of homeownership continue to fade. DISTRESSED MORTGAGES Distressed mortgages represented over ten percent of all mortgages in ten large markets, as of Q3 2010. LOCATION Active Loans 90+Days Delinquent 26,735 21,939 Foreclosed Off Market 64,708 44,251 Distressed Total % 24.9% 20.1%
Miami-Dade, FLA Broward (Ft Lauderdale), FLA
366,775 328,781
Orange (Orlando), FLA Clark (Las Vegas), NEV Riverside, CA Prince George's, M.D. San Bernadino, CA
204,944 360,192 368,432 148,228 315,992
13,020 32,932 32,622 13,800 27,051
24,839 32,388 17,965 6,367 14,980
18.5% 18.1% 13.7% 13.6% 13.3%


San Joaquin (Stockton), CA
105,519
8,887
5,021
13.2%
Kern (Bakersfield), CA Maricopa (Phoenix), Ariz
114,227 715,944
8,031 43,164
4,929 31,807 Source:
11.3% 105% CoreLogic
NATIONAL STATISTICS
Severe winter weather and continuing fragility in the homebuilding market interacted once again to produce still another decline in construction put-in-place in February, as well as marked downward revisions to January and December results. February activity was off 1.4%, with January revised to -1.8% from -0.7% and December to -3.2% from -1.6%. Consensus expectations as indicated in the Actions Economics survey had called for no change in February.
Home prices continue weak and fell during January to their lowest since mid-2003. During January, the seasonally adjusted Case-Shiller 20-City Home Price Index fell 0.2% after an unrevised 0.4% December drop. It was the seventh consecutive monthly drop in the seasonally adjusted series and the sixth when not seasonally adjusted. During the last twelve months, prices fell 3.0%. The narrower 10 City Composite Home Price Index of prices fell 0.2% (2.0% y/y) during January, also down for the seventh consecutive month. Price declines remained widespread through the U.S.


Total new home sales in February fell 16.9% to 250,000 (AR) after a 9.6% January decline. Sales have fallen by three-quarters from the all-time record 1,279,000 in 2005. The decline in February sales was most pronounced in the Northeast where a 57.1% m/m drop left them at a record low. The inventory of unsold homes rose to an 8.9 months supply and roughly equaled the recent high of 9.1 in August. The median price of a new single family home dropped 13.9% to $202,100 from an upwardly revised January level.
The National Association of Realtors reported that sales of existing homes fell during February to 4.880M (AR), from a revised January reading of 5.400M, initially reported at 5.560M. Sales of existing single-family homes alone fell 9.6% (-2.7% y/y) from January to 4.250M. (These data have a longer history than the total sales series.) Sales of condos and coops rose 4.7% m/m (7.9% y/y).


The inventory of unsold homes rose 3.5% m/m but was down modestly y/y. It was down onequarter from the 2008 high and amounted to an 8.6 months' supply. The median price of all existing homes fell 1.1% m/m to $156,100. Prices reached the lowest level in exactly ten years. The price of a singlefamily home slipped 0.9% last month to $157,000 (-4.2% y/y). Price weakness has raised home affordability to another record high, up more
Building permits declined 8.2% m/m (-20.5% y/y), roughly the same as during January. Permits for single-family units fell 9.3% (-27.0% y/y) while multi-family permits fell by 4.9% (+6.3% y/y).


The year-over-year decline in home prices, as measured by the Case-Shiller, accelerated to 2.4% from over 1.5% in November.
Don't buy the real estate spin that this downturn is regional. This is a National Double Dip in Housing. You see all major metropolitan areas peaking between March and May 2010 (the end of the first-time home-buyer tax credit). After only 8 months in positive territory, the overall index comprising 20 cities is back into the red (-1% in October and -4.1% in November).


18 out of 20 regions now show declining house prices. It's another bust. Things are good in WASHINGTON however!! Lots of well paying jobs there!
SHILLER WARNING Schiller Warns:
"Economy Is At A Tipping Point... A 10-25% Slump In Home Prices Would Not Surprise Me At All"
Rents on the Rise Again


COMMERCIAL REAL ESTATE COMMERCIAL REAL ESTATE DECLINES 3.7% IN APRIL - NEW POST BUBBLE LOW Below is a comparison of the Moodys/REAL Commercial Property Price Index (CPPI) and the Case-Shiller composite 20 index. Beware of the "Real" in the title - this index is not inflation adjusted. CRE prices only go back to December 2000. The Case-Shiller Composite 20 residential index is in blue (with Dec 2000 set to 1.0 to line up the indexes). According to Moody's, CRE prices are down 13% from a year ago and down about 49% from the peak in 2007. Prices are at new post-bubble lows - and at new lows for the index.
BACKGROUNDER: Commercial Real Estate Prices declined 3.7% in April, Prices at new Post-Bubble Low Calculated Risk Moody's reported that the Moodys/REAL All Property Type Aggregate Index declined 3.7% in April. Note: Moody's CRE price index is a repeat sales index like Case-Shiller - but there are far fewer commercial sales and there are a large percentage of distressed sales - and that can impact prices and make the index very volatile. The Moodys/REAL Commercial Property Price Index dropped 3.7 percent from March and 13 percent from a year earlier. Its now 49 percent below the peak of October 2007 and at its lowest point in data going back to December 2000 ... In a case of the strong getting stronger and the weak getting weaker, major asset/major market prices


have recovered more than half of their post-peak losses, while prices for distressed transactions continue to bounce around the bottom, Moodys said in the report.
The following analysis was done by MyBudget360. Their findings tell the story very clearly. The media has done a fantastic job painting over the enormous sinkhole of a problem that is commercial real estate (CRE). U.S. banks hold over $3 trillion in commercial real estate loans on properties that were once valued at over $6 trillion. Today those values are down to roughly $3 to $3.5 trillion depending on what metric you believe. How is it possible for a market that has lost $2.5 to $3 trillion to become largely hidden in the dark from the mainstream media? We constantly hear about $3 billion deficits or other issues but is the trillion dollar figure just so enormous that they dont even bother investigating? It is probably more likely that the Federal Reserve has concealed massive failures in CRE by allowing banks to play a game of extend and pretend that continues today. The shadowy problems of empty shopping centers, vacant car dealership lots, and misplaced strip malls is largely a taxpayer problem now. Banks made these irresponsible loans but had the Fed hand over taxpayer loot in exchange for worthless real estate.
Source: MIT
CRE values are still hovering near their trough and are likely to move lower. The only reason these prices havent moved lower is because banks are more generous with the borrowers of CRE debt since these


holders are grappling with multi-million dollar cuts in each deal. Banks would rather pretend a mall is valued at $100 million instead of marking it to a real value of $40 million or less. The fact that the Federal Reserve allows this to happen is financial chicanery. Can you pretend to the government that you really dont make $100,000 a year so instead you will act as if you make $30,000 a year and act accordingly? This is what is happening here. Banks are essentially allowing these toxic loans to be laundered through the system in exchange for taxpayer dollars. The Fed is betting that the public doesnt wake up to this scam. CRE is a giant and pernicious problem. With residential real estate it hits directly home and many American families are considered home owners. This bubble has garnered most media attention as it should. Yet CRE debt is enormous, larger than every state budget deficit combined by many times! In fact, the losses on CRE loans is larger than the state budget issues. Of course the Fed wants the public to look away from the real culprit behind the decline of the American middle class. The scheme was to build junk and pawn off the loans to average Americans whether they wanted to accept the debt or not. The cost of CRE problems
Banks have no faith in this recovery. Look at the above regarding commercial loans. Banks continue to claim that the reason for the taxpayer bailouts was to help the American public weather the economic storm and for banks to continue lending to average Americans. Instead, as you can see above, commercial loan lending has collapsed and banks have hoarded money and speculated on the stock market casino on the taxpayer dime. This money was used to shore up bad balance sheet problems and for gambling on the stock market to boost profits. In short it was one giant swindle perpetrated on the public. And think about the supposed recovery we are experiencing. If we were truly growing and expanding dont you think there would be healthy demand for loans as businesses expand their workforce? Wouldnt it be logical to conclude that commercial loans would reflect the supposed increased demand from a booming American economy? Of course the only boom occurring is for the top 1 percent who are siphoning off the wealth from average Americans to spin their continuing speculation in the stock market. Many are starting to wake up from this collective sleepwalk where taxpayers were robbed in open daylight.


The problems are coming up
Source: ZeroHedge What is even more problematic is many of the CRE loans are going bad in the next few years. Just like residential real estate is now experiencing a second collapse, CRE will have another move lower. Banks can only carry fantasy paper for so long. So far we have been paying for it through QE1, QE2, TARP, and other convoluted programs to launder money and devalue the U.S. dollar and decrease the quality of life of average Americans. The public did not sign up for this. The banks talk about shared responsibility and many are paying for it by losing their homes and going bankrupt. Millions are facing this economic responsibility on a daily basis. What penalty for the banks? Instead, they get bailouts and continue to pretend the junk loans they made on concrete disasters are worth inflated values only to shovel them off to taxpayers. How is it that there are no buyers for these supposedly highly priced items? CRE debt exposes the worst aspect of the bubble. Pure profit motive by supposed sophisticated investors on both sides of the coin with no financial responsibility or ownership. This isnt some poor family in a low-income neighborhood taking out a subprime loan. This is actually a supposed responsible bank and a supposed financially savvy investor. There is no justification for one penny of a bailout here. Yet the Federal Reserve continues with their hidden bailout where they support malls in Oklahoma to Chick-fil-A. Dont expect to hear about this on your nightly news.


R-2011 US ECONOMIC IMPEDIMENTS We agree with Hoisington & Lacy and see seven main impediments to economic progress in 2011 that will slow real GDP expansion to the 1.5%-2.5% range. 1- Fiscal policy actions are neutral for 2011. - Personal taxes, including federal and non-federal, rose to 9.44% of personal income in November, up from a low of 9.1% in the second quarter of 2009. Even with the tax compromise this effective tax rate will continue moving higher as a result of higher state and local taxes. - Total real federal expenditures are likely to contract (in real terms) this year. 2- State and local sectors will continue to be a drag on the economy and labor markets in 2011. - Municipal governments face substantial cyclical deficits and significant underfunding of their employee pension plans. - Municipal bond yields rose sharply in the second half of 2010 and will continue increasing borrowing costs. Any trend toward increased bankruptcy would raise caution in the broader municipal market and add to higher borrowing costs. - (1) cut personnel; (2) reduce expenditures including retirement benefits; (3) raise taxes; (4) borrow to fund operating deficits; or (5) declare bankruptcy. All retard economic growth. 3- Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy. - Fed actions have affected stock and commodity prices. The benefits from higher stock prices accrue very slowly, are small, and are slanted to a limited number of households. Conversely, higher commodity prices serve to raise the cost of many basic necessities that play a major role in the budget of virtually all low and moderate income households. 4- While consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable. - From 6.3% in June 2010, the personal saving fell by a significant 1%, to 5.3% in November (Table 1). Consumer spending is slightly in excess of 70% of real GDP. Without the one percentage point reduction in the personal saving rate, the second half growth rate would have been 2.6%, a shade slower than the first half growth pace, and materially less than the presumed second half growth rate. - When job insecurity is high, and defaults, delinquencies and bankruptcies are at or near record levels, a drawdown in the saving rate would seem to be an unlikely event. 5- Expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011. - In the second half of 2010, real GDP grew at an estimated 3.3% annual rate (assuming the fourth quarter growth rate was 4%), up from 2.7% in the first half of the year. Transitory developments in two of the most erratic and unpredictable components of the economy---the personal saving rate and inventory investment---accounted for all of this acceleration. - Inventory investment was the main driver of economic growth since the recession ended in mid-2009. Based on published data, real GDP grew at a 2.9% annual rate over this span. However, real final sales, which excludes inventory investment from GDP, increased at a paltry 1.1% pace. - At a minimum, the dominant source of aggregate economic strength will not repeat in 2011. 6- Housing will continue to be a persistent drag on growth. - Prices have re-accelerated to the downside over the past four months, as mortgage yields have risen and the housing overhang has increased. - As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85% to their highest level in August 2006. They have since declined 33 percent... In fact, home prices still must fall 23% if they are to revert to their long-term mean


7- External economic conditions are likely to retard U.S. exports. - Higher food and fuel prices will serve to significantly depress growth in countries like China, India and Brazil where food and fuel are known to be a much higher percentage of household budgets. Already reports have surfaced from international agencies on the growing adverse consequences of higher food prices, and social unrest has also been witnessed on a limited basis. - Chinese economic policy is designed to slow growth and reduce inflationary pressures. Thus, changing global conditions should serve to moderate U.S. exports. - A firm dollar will serve to keep U.S. disinflationary trends intact.


Gordon T Long
general@gordontlong.com
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments. Copyright 2010 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.



GMTP - Stealth QEIII? (US)

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GMTP - Stealth QEIII? (US)

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STEALTH QE III?

Is the Federal Reserve already in the process of implementing a Stealth QE III?

1 September 2011 Edition

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GLOBAL MACRO TIPPING POINTS - SEPTEMBER 2011 US ECONOMY ................................................................................4

JOBS - CONFIDENCE - CONSUMPTION - GROWTH CYCLE................................................................................................................ 10

STEALTH QE III AHEAD ............................................................................................................................................................................... 30

CONCERNS WITH BANKS & US CREDIT MARKETS.............................................................................................................................. 35

R-2011 US ECONOMIC IMPEDIMENTS .................................................................................................................................................... 70

September 2011 Edition 2

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MONTHLY PROCESS OF ABSTRACTION

Tipping Points Global Macro US Economy

Technical Analysis Fundamental Analysis Risk Analysis Commentary

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We have a JOBLESS Recovery!

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