July 9, 2012

Economic issues, good and bad

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, Federal Reserve, Finance, government, greece, Housing Market, International Swaps and Derivatives, investment advisor, investment banking, investments, Italy, recession, sovereign debt, Spain, taxes, Unemployment tagged , , , , , , , , , , , , , , , , , , , , , , , , , at 3:17 PM by Robert Barone

This is a mid-year overview of the economic and policy issues in the U.S. and worldwide, both positive and negative. I have divided the issues into economic and policy issues. With enough political will, policy issues can be addressed in the short run, while economic issues are longer-term in nature and are clearly influenced by policy.

Positives

• Cheap energy (economics and policy): There is growing recognition that cheap energy is key to economic growth; the next boom will be based on cheap energy.
 
• Manufacturing (economics): After years of decline, American manufacturing is in a renaissance, led by the auto industry.

• Corporate health (economics): Large corporations are extremely healthy with large cash hoards and many have low cost and low levels of debt.

• Politics (policy): Americans are tired of special interests’ ability to pay for political favors.

 
Negatives
 
• Recession in Europe (economics): This has implications for world growth because Europe’s troubled banks are the engines of international lending; Europe’s economy rivals that of the U.S. in size.

• European Monetary Union (policy): A Greek exit from the euro is still probable after recent election and is likely to spread contagion to Portugal, Spain and even Italy. There is also danger here to America’s financial system.

• Brazil, Russia, India, China or the BRIC, Growth Rate (economics): China appears to be in danger of a hard landing, as is Brazil. India is already there. This has serious implications for commodity producers like Canada and Australia.

• Fiscal cliff and policy uncertainties (policy): A significant shock will occur to the U.S. economy if tax policy (Bush tax cut expiration and reinstatement of the 2 percent payroll tax) isn’t changed by Jan. 1, 2013.

• Entitlements (policy): Mediterranean Europe is being crushed under the burden of entitlements; the U.S. is not far behind. This is the most serious of the fiscal issues but the hardest for the political system to deal with.

• Housing (economic & policy): In the U.S., housing appears to have found a bottom, but because of falling prices and underwater homeowners, a significant recovery is still years away. Housing is a huge issue in Europe, especially Spain, and it will emerge as an issue in Australia and Canada if China has a hard landing.

• Energy costs (economics & policy): The current high cost of energy is killing worldwide growth (see “Positives” above).

• U.S. taxmageddon (policy): The U.S. tax system discourages savings and investment (needed for growth), encourages debt and favors specific groups.

• Too Big To Fail (TBTF) (policy): The U.S. financial system is dominated by TBTF institutions that use implicit government backing to take unwarranted risk; TBTF has now been institutionalized by the Dodd-Frank legislation; small institutions that lend to small businesses are overregulated and are disappearing.

• Debt overhang (economics): The federal government, some states and localities and many consumers have too much debt; the de-leveraging that must occur stunts economic growth.

• Inflation (economics & policy): Real inflation is much higher than officially reported. If a true inflation index were used, it is likely that the data would show that the recession still hasn’t ended.

It is clear from the points above and from the latest data reports that worldwide, most major economies are slowing. It is unusual to have them all slowing at the same time and thus, the odds of a worldwide recession are quite high.

In the context of such an event or events, the U.S. will likely fare better than most. But that doesn’t mean good times, just better than its peers. There is also greater potential of destabilizing events (oil and Iran, contagion from Europe, Middle East unrest), which may have negative economic impacts worldwide. Thus, in the short-term it appears that the U.S. economy will continue its lackluster performance with a significant probability of an official recession and vulnerable to shock type events. (Both the fixed income and the equity markets seem to be signaling this.)

 
 
The extension of Operation Twist by the Federal Reserve on June 20 (the Fed will swap $267 billion of short-term Treasury notes for long-term ones through Dec. 31 which holds long-term rates down) was expected, and continues the low interest rate policy that has been in place for the past four years. That means interest rates will continue to remain low for several more years no matter who is elected in November. Robust economic growth will only return when policies regarding the issues outlined in the table are addressed.

Looking back at my blogs over the years, I have always been early in identifying trends. The positive trends are compelling despite the fact that the country must deal with huge short-term issues that will, no doubt, cause economic dislocation.

The only question is when the positives will become dominant economic forces, and that is clearly dependent on when enabling policies are adopted. 1) In the political arena, there is a growing restlessness by America’s taxpayers over Too Big To Fail and political practices where money and lobbyists influence policy and law (e.g., the Taxmageddon code). 2) The large cap corporate sector is healthier now than at any time in modern history. Resources for economic growth and expansion are readily available. Only a catalyst is needed. 3) America is on the “comeback” trail in manufacturing. Over the last decade, Asia’s wages have caught up.

Cultural differences and expensive shipping costs are making it more profitable and more manageable to manufacture at home. 4) Finally, and most important of all, unlike the last 40 years, because of new technology, the U.S. has now identified an abundance of cheaply retrievable energy resources within its own borders. As a result, just a few policy changes could unleash a new era of robust economic growth in the U.S. Let’s hope those changes occur sooner rather than later!

 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.
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The New Bank Paradigm: Squeezing Out the Private Sector

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, greece, Italy, Spain, Uncategorized tagged , , , , , , , , , , , , , , , , , at 3:08 PM by Robert Barone

Since the world adopted Basel I in 1988, it has allowed the Europeans to dictate the bank capital regime for major industrial economies. We are now in the process of adopting Basel III capital rules. Unfortunately, these rules have so biased the financial system that the private sector, the engine of job creation, has all but been squeezed out.Under all of the Basel regimes, “sovereign” debt is considered riskless. Everything else has a varying degree of risk to it which requires a capital reserve. Loans to the private sector have the highest capital requirements. Americans have always viewed our US Treasury debt as “riskless.” So, on the surface, it appears reasonable that no capital should be required, and Americans think no further. But, further thought would reveal two significant issues: 1) The “sovereign” debt of other countries may not be riskless (ask the private sector holders of Greek debt, or Jon Corzine and MF Global (MFGLQ) folks about the risks associated with Italian debt); 2) The bias imparted with this sort of capital regime makes loans to the private sector unattractive, especially in times of economic stress where bank capital is under pressure. But, it is in times of such stress that loans to the private sector are needed to create investment, capital spending, and jobs.

One of the reasons for all of the stress in Europe is the fact that their banking system holds huge amounts of periphery country debt (Greece, Spain, Portugal, Italy) with no capital backing. On a mark to market basis, most, if not all, of the capital of the periphery banks disappears. In fact, the European Central bank (ECB) itself is still carrying the Greek debt it holds on its books at par, as if there is no chance that they won’t be repaid in full.

Since the financial crisis of ’08-’09, Western banking systems have come to rely on government, at first as the capital provider of last resort, but now, at least in Greece and Spain, as the capital provider of first resort (most likely because there is no other). In a symbiotic relationship, those same governments have come to rely on the banks to purchase their excessive supply of debt. The capital rules favor this unhealthy relationship. In effect, we now have a banking DNA bias against private sector lending.

We have heard the politicians in Washington rail against the banks for not making loans to the private sector. Yet, all of the rules, regulations, and enforcement processes make it difficult, if not impossible, to do just that. The overbearing regulatory process strangles private sector lending at small community banks. And, as indicated above, the capital regime itself, which impacts all banks, discourages private sector loans. For example, a $1 million loan to the private sector requires $200,000 in capital backing plus an additional $20,000 to $30,000 in loss reserve contribution from the capital base. That same $1 million loan to the US Treasury, via purchases of Treasury securities, requires no capital or reserve contribution. The ultimate result is that, since the financial crisis when western governments found out that it was politically okay to “save” (i.e. recapitalize) large banks with public monies, they also found out that the capital and regulatory regime now made those same banks major buyers of excessive government debt.

Unfortunately, while governments like this and will continue to promote it because it keeps the cost of borrowing low and provides them with a ready market for deficit spending, government is not the economic engine. That is what the private sector is. Simply put, the banking model in the west now promotes moral hazard (banks making bets that are implicitly backed by taxpayers) and Too Big To Fail (TBTF) policies while it stifles private sector lending. The Dodd-Frank legislation has institutionalized this model with government intervention now seen as the first response to a banking issue. If it hasn’t, then why did President Obama say on The View the business day after JPMorgan Chase (JPM) announced its trading loss that it was a good thing that JPMorgan had a lot of capital else the government would have had to “step in.” Or why has Jamie Dimon, JPMorgan’s CEO, been required to testify before both House and Senate Committees about a loss of less than 3% of the bank’s $190 billion capital base? As further proof of government control of the banking system, the FDIC recently announced that, under its Dodd-Frank mandate, it is ready to take over any TBTF institution, “when the next crisis occurs.” Isn’t it clear that the relationship between the US federal government and the banking system is unhealthy, perhaps even incestuous, to the detriment of the private sector? That very same banking model is emerging in Europe with the emergency funding by the European Financial Stability Fund (EFSF) to recapitalize the Spanish banks and talk of a pan-European regulatory authority and deposit insurance.

The emerging banking model is one in which central governments and the money center banks co-exist in a mutual admiration society where government capitalizes the banks and the banks are the primary buyers of excessive government debt. Because government doesn’t create any real economic value (it regulates it and transfers it from one group to another), the domination of government assets on bank balance sheets in place of private sector assets spells real trouble for the future economic growth in the Western economies.

 
 
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

June 6, 2012

Analysis: Little to like about last week’s employment data

Posted in Banking, Big Banks, Economic Growth, Economy, Europe, Housing Market, recession, Unemployment tagged , , , , , , , , , , , , , , , , at 5:31 PM by Robert Barone

Worse yet, the March and April Establishment Survey reports were revised downward by 49,000, not an insignificant revision. So, employment has been much weaker than originally indicated for the past three months. Further, we’ve recently seen an upward pop in the weekly first-time applications for unemployment insurance.
 
The more comprehensive unemployment rate (U-6, which is the broadest measure of labor-market slack) rose to 14.8%, from 14.5%. We are seeing employers substituting part-time workers for full-time workers — again, a negative indicator.
 
Average weekly earnings fell 0.2% in May because of fewer hours worked, on average. This indicator has fallen in two of the past three months and is a harbinger of what we are likely to see in second-quarter consumption spending.
 
Construction employment, while up slightly in the actual number count, was negative when seasonal adjustment is applied. May normally shows positive hiring in the industry, but this May, hiring was significantly below expectations, thus the negative seasonally adjusted number. I suspect this is because of housing markets still struggling with falling prices and excess inventory (Nevada, Arizona, Florida and parts of California). Additionally, we have recently seen a fall in the number of building permits.
 
Downward revision to first-quarter gross domestic product, to 1.9%, from 2.2%, was mainly because of a weaker consumer. Given this poor employment report, second-quarter real GDP might barely be positive in the official reporting.
 
I have written about downward bias flaws in the reporting of official inflation indexes. That means real inflation is higher than what is reported. Those who buy gasoline and food already know this. The implication is that official real GDP numbers are biased upward. Think about that! If inflation is only 2% higher than that officially reported, then the recession that “officially” ended three years ago might be ongoing.
 
None of the above speaks to the potential future shock that might hit the U.S. economy from the fallout of the European banking and debt crisis and the deep recession unfolding there. Any contagion from Europe will only compound the issues identified above.
 
The only silver lining is that weakening demand so evident in the reports has pushed oil prices down precipitously. Thus, we can expect some relief at the pumps this summer. Otherwise, the report was abysmal.
 
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives
of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.
 
Universal Value Advisors, LLC is a registered investment adviser with the Securities and
Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the
Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

April 24, 2012

After further review, employment remains unhealthy

Posted in Economic Growth, Economy, Federal Reserve, Finance, investment advisor, investment banking, investments, recession, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , , , , , , , at 3:40 PM by Robert Barone

 Most of the business media is content to rehash headline data, simply passing on what the large wire services report with no further analysis. The headline, then, becomes the “conventional wisdom.”

Such was the case on the first Friday of April with the reporting of the unemployment rate. The conventional wisdoom was that there was some disappointment in that, using the Establishment Survey of the Bureau of Labor Statistics (BLS), the nation only created 120,000 new jobs. But the unemployment rate itself sank to 8.2 percent. For that we should be grateful, at least according to the conventional wisdom.
 
The accompanying chart tells quite a different story. It is a long-term chart. The period measured (horizontal axis) begins in 1988, so it covers about a quarter of a century. The right hand vertical axis measures the “headline” unemployment rate. That’s the headline rate most often reported. In government jargon, it is known as the U-3.
 
The scale is inverted, so a rising line means the unemployment rate is falling. This unemployment rate is supposed to measure the number of people looking for work who can’t find it as a percentage of all people with and without jobs. The left hand scale is a measure of the employment rate in its most basic form. Most readers won’t recognize this, as it is seldom reported, but it measures the number of people employed as a percentage of the population. As such, it is a better measure of the job market in that, unlike the unemployment rate, its definition can’t be changed (more on that later).
 
Looking at the chart, note that in the late 1980s, 63 percent of the population was employed. This rose to nearly 65 percent at the turn of the century. After falling to 62 percent in the 2001-02 recession, it rose back to 63 percent in 2007. Since the Great Recession, this measure of employment has been bottom bouncing just above 58 percent.
 
But what is really noticeable is the huge divergence between the two since 2010. The question to be asked is, “How can the ’employment rate’ show little to no improvement, while the ‘unemployment rate’ would lead one to conclude something altogether different?” The answer lies in how things are defined.
 
In 1994, BLS redefined the term ‘discouraged worker.’ This person was counted as unemployed only if he or she had been ‘discouraged’ for less than a year. After that, he or she was longer counted as ‘looking for work.’ Today, with jobs so hard to find, we clearly have many people who have been out of work for more than a year but are still actively seeking employment. Our social safety net even recognizes jobs are hard to find – unemployment insurance payments are available for 99 weeks. But our measurement of “unemployment” stops counting people as unemployed or even looking for work after 52 weeks. They are simply defined away! This goes a long way toward explaining the increasing discrepancy between the two series.
 
This past weekend, I made an off-the-cuff observation to my wife as we visited a fast food establishment with the grandchildren in tow. I noted employees seemed to be a lot older than what I remembered from a few years back. In recent blogs, both David Rosenberg (Gluskin Sheff) and John Hussman (Hussman Funds) wrote about the changes in the distribution of job creation since the end of the recession in June 2009. According to the Federal Reserve Bank of St. Louis, total employment in non-agricultural industries (seasonally adjusted) has grown 2.15 million since that time. For workers 55 and older, employment has grown by 2.98 million.
 
That means that employment has continued to contract for those under 55 years of age since the recession’s so-called end! How can that be healthy?
 
There is a term business media uses called “financial repression.” Essentially, it refers to the zero interest rate environment in which savers and retirees are no longer able to live off the interest on assets they accumulated prior to retirement. So they re-enter the labor force, working for minimum wages to supplement now inadequate retirement incomes.
 
The employment picture, then, when viewed from this lens, is much worse than the headline data and conventional wisdom would have you believe. I don’t think this is a surprise to most Americans, but it would certainly help if the business media stopped pretending.
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.   Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.
 
Universal Value Advisors, LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

April 9, 2012

Financial armageddon: Should you worry?

Posted in Armageddon, Banking, crises, debt, Economic Growth, Economy, Finance, government, Housing Market, investment advisor, investment banking, investments, IRS, medicare/medicaid, Nevada, payroll tax reductions, recession, social security, taxes tagged , , , , , , , , , , , , , , , , , at 8:37 PM by Robert Barone

You’ve probably seen them in your email, or even on TV — I’m talking about the “approaching financial armageddon” forecasts. People must be responding to them, because they keep on appearing in my email — several per week, and others I know get them too. Should you be concerned?To answer this, we examine data from the six largest categories of Federal expenditures in 2000, 2012, projections for 2016, and their associated compounded annual growth rates (CAGR). Much of this data comes from USdebtclock.org. Caution, the website is not for the faint of heart.Six expense categories (Medicare/Medicaid, social security, income security, federal pensions, interest on debt and defense) account for nearly $3.1 trillion of spending in 2012, represent more than 86 percent of total federal spending and account for 137 percent of taxes collected. These six spending categories are critical when trying to understand the nature and extent of the structural deficit.Growth rates in CAGR show Medicare/Medicaid spending growing to $1,050 billion per year in 2016. The demographics of the U.S. population don’t show us getting younger and baby boomers are just beginning retirement. Social Security will also advance much more quickly than its 5.4 percent growth rate of the past 12 years. All in all, the projection of expenses I’ve shown in the table for 2016 ($3,692 versus $2,265 in 2012) appear quite optimistic. But, let’s go with it.Americans, in general, will tell you they oppose bigger government, at least in the abstract. But in poll after poll, when asked where Congress should make significant cost cuts, almost no specific program eliminations are favored by a majority of Americans. Given this predilection among Americans and assuming that these six categories again account for 86 percent of Federal spending in 2016, then, total Federal spending will be approximately $4.3 trillion.

Some analysts fret about the “fiscal cliff” on Jan. 1, 2013 when the Bush tax cuts are scheduled to expire along with the 2 percent payroll tax reduction for individual social security contributions.

Those analysts put the impact of these at a 3 to 4 percent GDP reduction. When the Bush tax cuts expire, the Federal government theoretically could collect about $300 billion more in taxes if economic activity were otherwise unchanged (a heroic assumption). In addition, the reinstatement of the 2 percent social security tax on individuals will add about $160 billion to tax revenues (again, assuming no decline). The breakout with this story is an estimate of what the deficit would be and its relationship to 2016 GDP. It assumes the Bush tax cuts have been eliminated, the payroll taxes are reinstated, and economic activity is not negatively impacted, so it is likely to understate the deficit. The tax revenue growth rates (left hand column) begin in 2013, after the “fiscal cliff.”

As you can see from the table, reinstatement of the Bush tax cuts and the payroll tax reductions alone do little to solve the issue, as the deficit remains at $1.54 trillion if no further tax increases occur.

 

OUR ‘FISCAL CLIFF’

If Tax CAGR is: Deficit/GDP will be: Deficit will be ($trills):
0% 9.1% $1.54
5% 6.6% $1.12
7% 5.5% $0.93
8% 4.9% $0.83
10% 3.7% $0.63
16% 0.0% $0.00
 
Such a tax regime will clearly keep the economy in a no growth or recessionary mode. If America resists the tax increases, then deficits will balloon, interest rates will rise as the world spurns the dollar, the Fed will continue to print money and purchase the debt that can’t be placed externally, a nasty inflation will likely set in (it has already begun — look at food and energy prices), and we will find ourselves in a Greek type tragedy. The only way out is to significantly cut the growth of Medicare/Medicaid, Social Security, Income Security and Federal Pensions. Which Congress and president will do that?So, should you be concerned about an approaching financial armageddon? Yes.
  

Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Universal Value Advisors, LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah
Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.

 Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

 

March 26, 2012

Robert Barone: Is U.S. housing healing?

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Finance, Foreclosure, government, Housing Market, investment advisor, investment banking, investments, Nevada, recession, Uncategorized tagged , , , , , , , , , , , , , , , , , , , at 5:15 PM by Robert Barone

Last Tuesday, a headline in the business media read: “U.S. housing heals as starts near three-year high.”
I scratched my head. The last three years have been the worst in recorded U.S. housing history. The accompanying chart tells the story. It is a real stretch to believe that this data indicates “healing.” Worse, everybody knows that the extremely mild winter has pulled demand forward; this is especially true for housing starts, as contractors don’t pour foundations in freezing weather, but use mild periods in the winter to get a head start for spring sales.
The data shown in this chart is “seasonally adjusted,” a statistical process that attempts to normalize fluctuations in data caused by such things as weather or holiday shopping. The seasonal adjustment process assumes January and February have typical winter weather. So, if the mild winter caused contractors to pour more foundations than they would have in a normal winter, then the seasonal adjustment process overstates what would be a normalized level of housing starts.
There is a similar story for sales of existing homes — the data was released last Wednesday. Because of the weather and other significant issues, I suspect that new starts and sales (where the “seasonal factors” normalize to the downside) will disappoint in the months ahead. Here’s why:
There are 3 important price categories: less than $300,000; $300,000 to $800,000; $800,000 and above.
There are three important buying groups: first-timers; move-ups; retirees. Generally, the first-timers purchase the under $300,000 homes, while the move-ups purchase in the other two categories. Retirees, usually sell from the upper two categories and “downsize.”
Government stimulus programs and record low interest rates have made homes the most affordable in decades (current index = 206; 100 means that a median income family can afford a median income home). First-time buyers can get a low down payment low interest rate loan (what happens if interest rates rise?), but those in the move-up category must rely on traditional bank-type financing, which requires a big down payment.
The home price downdraft since 2007 has taken many of the move-up buyers out of the market. CoreLogic data shows that 50 percent of current U.S. homeowners (the move-ups and the retirees) have less than 20 percent equity in their homes. That means that a significant percentage of move-ups cannot sell their existing home, pay a realtor’s commission (usually 6 percent), and have a 20 percent down payment for the move-up property.
History shows a healthy housing sector is critical to U.S. economic growth, and that when the move-ups are not healthy the sector does poorly.
Retirees are finding their homes are not worth what they thought. Their tendency is to stay put and wait for a better market. In fact, the media hype around “healing” is probably keeping them in their homes, as they now believe that a better market is just ahead! This is called “shadow” inventory, which means that the number of homes officially for sale understates the real supply.
With this view, we would expect the low-priced homes to be doing well but the upper two price brackets to be doing poorly. February data from Dataquick for the Southern California housing market confirms this view. First-time buyer price point sales (under $300,000) are up 9.5 percent from a year earlier, while the other two price point sales are both down (the $300,000 to $800,000 down by .8 percent, and the $800,000 and above down by 12.6 percent).
Nothing in this data, from the seasonal adjustment bias to the health of two of the three buying groups, tells me U.S. housing is healing.

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