Friday, August 17, 2007

Today's Econ Round-up

Before we get started with today's edition, let's review the highlights:

A year ago, it was common to say that while home prices could fall on a regional basis, they could not on a national basis, because that had not happened since the 1930s. Well, now home prices are falling on national basis, as measured by the S&P/Case-Shiller U.S. National Home Price Index.

Six months ago, people were saying that it looked like the housing market was bottoming and stabilizing. Nope.

Three months ago, as the subprime bust grew worse, people assured the market that the problems would be confined to the “relatively small” subprime mortgage sector and would not spread further. Not a good call, either.

Of course, the big news of the day was the rate cut by the Fed:

If the United States is now the weakest link in the global financial system, Asia may be the strongest. But you wouldn't necessarily think so if you looked at the sinking Asian markets today. Investors around the world are becoming worried that the credit crunch will hurt economic growth. Hence the U.S. Federal Reserve just reduced the discount rate in order to "promote the restoration of orderly conditions in financial markets". More on that story here.

But what that will exactly do remains to be seen. The Wall Street Journal expressed skepticism that lowering the rates would have a positive effect on the economy

[People advocating for the rate cuts] ignore two major risks. The first is the "moral hazard" problem of rescuing Wall Street banks and hedge fund players that walked too far on the wild side during the boom. They made money then, and they need to absorb the losses now. Without enduring the discipline of losses, the offenders will go even further out on the risk curve next time.

The second problem is that a Fed reflation could lead to even more trouble if it causes a loss of confidence in the dollar. One of the best cards Treasury and the Fed have is confidence in their financial stewardship. If investors detect that the Fed will sacrifice the currency to throw money at Wall Street, today's credit seizure could become a heart attack. Confidence in the U.S. is even more vital given that the coming weeks are likely to see more than one problem overseas. Emerging markets have been selling off even harder than Wall Street in recent days, another sign of risk adjustment. Yesterday's firming of the dollar against most currencies was a rare sign of global confidence in something.

The housing thing, the subprime thing -- all of this is starting to scare the guys in charge of other industries:

Top U.S. executives are watching the spread of the economic contagion that started with a slump in U.S. home prices and spread through the financial sector as default rates on risky subprime mortgages rose, spooking investors the world over.

And with good reason. This quote pretty much speaks for itself:

“The carnage is far from over,” write analysts at Comstock Partners, who note that some are minimizing the current problems as market-oriented only. “Some studies indicate that as much as one-half to two-thirds of the increase in output and employment since the last recession bottom were a result of housing, housing-related activities and MEW [mortgage equity withdrawals].”

That carnage won't be confined to U.S. -- it'll go on something of a world tour. The Germans in particular seem to have a taste for not mincing words:

The current mini-crash is a painful sign of what the companies constructed of air and the extremely convoluted financial constructions are capable of. Whether this gambling pays off will all depend on more down-to-earth economics: If Joe Average in the USA can't pay his mortgage, we're all screwed."

Andrew Samwick, while in the process of arguing against possible bail-out for financial institutions that don't make it, has a glimpse of what the scene will look like once the carnage is over:

And what of the Wall Street entities that have taken a financial beating as the bottom dropped out of this market? They get to be the roadkill on the capitalist highway, food for scavengers in the financial market. You wouldn't know it from the headlines dominating the news media today, but there are plenty of financial institutions that have been prudent and maintained their liquidity though this chaos. They are going to get some bargains in the months to come.

Barry Ritholtz shares a nifty chart that diagrams the anatomy of a liquidity intervention. It's lovely reading -- if you enjoy VCR programing manuals.

On the bright side, credit raters are shaping up -- or at least getting a little more cautious:

Moody's Investors Service said on Thursday that it downgraded 691 mortgage-backed securities because of "dramatically poor overall performance." These residential mortgage securities were originated in 2006 and backed by closed-end, second-lien home loans, Moody's said. ... The downgraded securities had an original face value of $19.4 billion, representing 76% of the dollar volume of securities rated by Moody's in 2006 that were backed by subprime closed-end second lien loans ... "The actions reflect the extremely poor performance of closed-end second lien subprime mortgage loans securitized in 2006," Moody's said. "These loans are defaulting at a rate materially higher than original expectations."

Sen. Chris Dodd, presidential aspirant and Chairman of the Senate Banking Committee, asks a question that I'm sure will be echoed by other Democrats in the weeks to come:

"Where's the president?" asked the Connecticut Democrat, speaking from Iowa, where he is spending the week campaigning for the Democratic presidential nomination. "This is an economic crisis that demands the leadership of the president and the treasury secretary."

Presidential politics aside, the man most people are looking to right now is Fed Chairman Ben Bernanke. If his predecessor, Alan Greenspan, was famous for his Delphic ambiguity, Bernanke may earn his reputation on how well he guides the markets through the rough spots of the foreseeable future:

In the days and weeks to come, Mr. Bernanke must clearly communicate the Fed’s assessment of the economy’s overlapping conditions and its likeliest approach to addressing them. More than anything, what everyone needs to know is that someone with good judgment, steady nerves and able advisers is in charge.

Just to clarify: “Ben Bernacke is not bringing the sexy back.”

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