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02/01/2008

Ben Bernanke, Part I

I thought we’d take a look at the Fed and Ben Bernanke the next
few weeks, utilizing my “Week in Review” archives. We start
with 2006, when Bernanke replaced Alan Greenspan. Put your
mindset back to then, not last year, folks.

Background

Greenspan hiked the federal funds rate for a 14th consecutive
time to 4.50% in his last meeting, Jan. 31, 2006. Then Bernanke
took over and hiked 25 basis points each of the next three Fed
Open Market Committee gatherings to 5.25% on June 29, 2006.
That’s where the funds rate sat throughout the rest of ’06 and
well into 2007.

As for the economy, following is the rate of GDP for 2006.

Q1 5.6%
Q2 2.6%
Q3 2.0%
Q4 2.5%

[These were my musings, unedited; warts and all in terms of any
predictions I may have made back then.]

WIR 2/18/06

Mr. Smooth, new Federal Reserve Chairman Ben Bernanke, had
his coming out party this week as he appeared before both the
House and Senate for an update on the economy. Of course this
semi-annual exercise is but another reminder of why a senator is
a senator, and a congressman a congressman. Let’s just say more
often than not one sounds like a college graduate, while the other
comes off as a subscriber to People. But I digress.

Bernanke is good real good. And we can understand what he’s
saying, a gift that eluded his predecessor.

So what did he say? The economy is strong, Bernanke is not
concerned about an inverted yield curve, he is going to focus on
the hard economic data, perhaps more so than Alan Greenspan,
but one of his primary concerns is housing; that and the potential
for inflation to seep through the price chain as it has been in
some sectors.

Which means one thing. Bernanke is going to be hiking rates,
and possibly far more than yours truly thought possible last
December.

That won’t be good because there is no doubt the Fed is going to
overshoot. I would still submit that with the lag effect of past
rate hikes it already has.

Inflation hawks may have their day, but it will be brief and I
have never been more convinced than I am now that the U.S.
economy will flip on a dime, seize up, at some point in the
second half of the year.

Housing, of course, will be a major cause of this reversal and you
can throw out the January housing start numbers that showed
explosive growth in the sector. Heck, even I felt like building a
house this past month with temperatures in the 50s here in the
New York area. And it would appear many builders just told
their guys to throw stuff up, quickly, before more normal
weather set in.

[As luck would have it, we got 20+ inches of snow last weekend
but by Thursday it was gone thanks to a resumption of the
heatwave.]

What amazes me is this leap of faith among the majority on Wall
Street, at least for this past week, that higher rates are no
problem, particularly when one looks at the mortgage sector.

Jonathan Laing of Barron’s had a terrific piece in the 2/13 edition
on the “sub-prime” market. These are the folks who should
probably be renting until they build up a little more capital but
the lending institutions take the risk, at future cost to the
homeowner.

For example, 10% of today’s mortgage debt is in sub-prime loans
that are in the process of resetting. As Laing illustrates, their
monthly payments could rise 50%, easily, over the next two
years due to the steep escalation in short-term interest rates.

Of even more concern is that if home values just stagnate, let
alone go down, these same homeowners will no longer be able to
tap into their equity in order to meet the much higher mortgage
payments.

But back to the January housing data specifically, yes, I’ve
always said never put too much stock in one month when it
comes to this arena, but at the same time I’ve said we’ve now
entered a period in housing where it’s three steps down for every
one up. Housing has peaked. The question is do values now fall.
I’ll go with stagnation until the economy begins to roll over, then
it gets dicey.

One last note on this issue. While some were bamboozled by the
January data, I chose instead to focus on a statement out of
Washington Mutual, a leading loan originator. They were laying
off 2,500.

WIR 3/4/06

Last weekend, Federal Reserve Chairman Ben Bernanke said the
U.S. economy has absorbed the oil shock (one can’t argue with
that), and that his Fed won’t focus on asset price bubbles.
Commenting on Bernanke’s challenges, former Fed chairman
Paul Volcker said, “How would you like to be responsible for an
economy that’s dependent upon $700 billion of foreign money
every year?” in reference to the current $726 billion trade
imbalance.

4/1/06

And then there’s the Federal Reserve. Chairman Ben Bernanke
oversaw his first meeting and took the opportunity to raise the
funds rate a 15th consecutive time, another -point to 4.75%.

But it was the accompanying statement everyone was looking
for. Would the new chairman change the language used by his
predecessor, ol’ what’s his name? [We have fleeting memories,
you understand.]

“Some further policy firming may be needed to keep the risks to
the attainment of both sustainable economic growth and price
stability roughly in balance .The run-up in the prices of energy
and other commodities appears to have had only a modest effect
on core inflation.”

But the Fed also added:

“Possible increases in resource utilization, in combination with
the elevated prices of energy and other commodities, have the
potential to add to inflation pressures.”

Put it all together and the market now expects yet another rate
increase to 5% on May 10 and possibly one on top of that in late
June. If you’re a saver and/or investor in “cash,” you enjoy
seeing your money market fund yields continue to rise; as is
the case with yours truly. Staying ultra short on the yield curve
has been a good bet, in other words. But those investing in
longer maturity paper are getting whacked.

WIR 4/29/06

This week Federal Reserve Chairman Ben Bernanke appeared
before a joint congressional economic committee and said
“vigilance in regard to inflation is essential.” But he also added
he was concerned about a slowing housing market and rising
energy costs and the impact these two in particular can have on
the consumer and overall economic activity. So Bernanke added
the Fed could pause for a spell to examine more data, as the
Fed’s governors are certainly well aware there is a lag effect
from the 15 interest rate increases they’ve already instituted.

The bond market took Bernanke’s comments to heart and yields
on the long end of the curve rose slightly on the week while the
two-year Treasury rallied a bit on the theory that the Fed will
indeed stop for a while.

The long end, of course, is more concerned with an actual
inflation threat, while the shorter end concerns itself with the
here and now.

But what does the actual data tell us? This week’s readings on
housing were decidedly mixed. While existing and new home
sales rose, surprising some, the median price on existing was up
just 7.4% year over year, as opposed to the double digit growth
we’ve been used to, while the median price on new home sales
actually fell 2.2% from a year ago and a full 6.5% between
February and March. No matter how you slice it, the market has
stagnated in terms of price and the issue becomes is housing on
the verge of rolling over?

WIR 5/13/06

Anyway, the Fed concluded for now that while “inflation
expectations remain contained,” pricing pressures could emerge
with the surge in commodity prices. So the real bottom line is:
will the consumer buckle under, finally, to higher energy prices
and/or a stagnating, verging on crumbling, housing market?

I’ve argued it would be housing, pointing specifically to the
second half. As for energy, it’s mostly about Iran for the
foreseeable future; that and weather in the Gulf of Mexico. It’s
almost time for our first tropical wave, after all.

The markets thus took none too kindly to the prospect of further
rate increases and runaway commodity prices and it was a two-
day bloodbath on Thursday and Friday.

China remains the top story in terms of the global economy with
a government think tank forecasting GDP growth of 9.8% in the
second quarter and 10% in the third. China also helped fuel the
metals surge – copper, zinc, nickel, and platinum among the
items hitting record highs, with gold at a 26-year best – in
announcing it was going to start building its strategic reserves in
uranium, iron, copper and other key materials, plus it was
accelerating construction of strategic reserves for oil and coal.

But back to the Fed and Wall Street’s loss of faith in Chairman
Bernanke and Co., one major concern, and the one with most
currency, is the fact the Bank of Japan and the European Central
Bank will both be hiking interest rates this summer (as will
China) while the Fed could be pausing; ergo, will the Fed then be
behind the curve? I don’t think they’ll put themselves in that
position.

We’re going higher on rates, in other words, and if we haven’t
already reached the tipping point, a move to 5.25% end of June
would do it.

WIR 6/17/06

But then “Shazam!” After a dead cat bounce on Wednesday,
Federal Reserve Chairman Ben Bernanke somehow soothed
markets by saying little. For the life of me I don’t understand
Thursday’s rocket launch, when the major indices in the U.S.
rose 2% to 3% each.

You see, Bernanke said in a speech that as long as energy prices
don’t go much higher, overall inflation risks appear to be
“manageable,” though at the same time he offered that the Fed
needed to remain vigilant to inflation expectations.

In other words, he said nothing new. The Fed is still hiking end
of the month, a 17th consecutive time, and if the core consumer
price index for July is up another 0.3%, the Fed could hike again
come August.

The point being, they’ve already gone too far and with the June
29 increase they will have officially overshot. And,
coincidentally, when the economy rolls over, inflation will dry
up faster than you can say “Tiger Woods missed the cut at the
U.S. Open.”

The economy is already slowing, as the Fed’s own report of
regional activity (the Beige Book) noted this week. Retail sales
are on the weak side and a report on industrial production was
kind of punk.

Rising short-term rates are killing consumers with a lot of credit
card debt, adjustable rate mortgages and home equity loans, and
that will be increasingly reflected in the data. The housing sector
is rolling over and the third leg for the economy, capital
spending, is as I’ve said in the past the most squirrelly.
Corporate chieftains are the first ones to panic, given any kind of
bad news, especially on the geopolitical front, and I see cap-ex
falling short of expectations in the second half.

And just a word on energy. Bernanke is right when he says as
long as prices don’t spike higher, the costs to the economy of $70
oil are manageable. That level isn’t great, but it’s not the killer a
slumping housing market can be coupled with rising short-term
interest rates.

But the risks of a price spike are still there for two main reasons
these days; Iran and the hurricane season. It’s why prices have
remained as high as they have given near record levels of
inventories. Otherwise, yes, oil should be $50, or lower, and
gasoline back below $2 a gallon.

WIR 7/1/06

Stocks rallied strongly following the Federal Reserve’s 17th
consecutive rate hike, another -point on the Fed Funds rate to
5.25%. So what did investors find so super about this? Beats the
heck out of me.

Following is part of the statement accompanying the rate move.

“Recent indicators suggest that economic growth is moderating
from its quite strong pace earlier this year, partly reflecting a
gradual cooling of the housing market and the lagged effects of
increases in interest rates and energy prices.

“Readings on core inflation have been elevated in recent months.
Ongoing productivity gains have held down the rise in unit labor
costs, and inflation expectations remain contained. However, the
high levels of resource utilization and of the prices of energy and
other commodities have the potential to sustain inflation
pressures.

“Although the moderation in the growth of aggregate demand
should help to limit inflation pressures over time, the Committee
judges that some inflation risks remain.”

The FOMC then goes on to say it will weigh the data before
making its next move.

Immediately after, the majority of market mavens said, “Ah ha!
The Fed is finished.” I’m sorry, but there is absolutely no way to
deduce that.

Unless, of course, the economic data over the next five weeks,
before the Aug. 8 Fed meeting, reveals the economy to be
slowing even faster than some believe it is and our little inflation
scare to be over. But while I’ve been looking forward to a big
second half drop in economic activity (well, you know what I
mean), it’s likely the inflation indicators will still reveal a
worrisome picture. So the Fed will weigh both the plusses and
minuses and come up with something.

One thing is for sure, though, which the Fed can’t possibly
ignore even though the equity market did this past week, and
that’s the fact we are suddenly back up to $74 on oil and $2.20
on gasoline futures. [And you’ll recall from our little lesson a
few weeks ago that $2.20 gasoline translates into about $3.00 on
average at the pump ergo, no relief in sight it would appear.]

The Fed under Ben Bernanke has continuously voiced concerns
over energy prices so it’s hardly likely it will just look the other
way if by August we’re still at the $70 and $3 levels.

WIR 8/5/06

Due to an unexciting employment report for the month of July,
with the U.S. economy adding all of 113,000 jobs, the experts are
saying it’s a lock the Fed will finally ‘pause’ after 17 straight rate
increases because the evidence clearly speaks to a slowdown.

Some of the manufacturing data released this week was actually
pretty solid, and we got out of the heat by hitting the malls, as
some retailers reported, but we’ve learned in past weeks the days
of 5.6% growth, as in the first quarter, are long gone.

As for inflation, Fed Chairman Ben Bernanke earlier expressed
confidence that any price pressures would abate as the overall
economy slowed so there’s further ammunition for the ‘pause’
camp. This week offered classic evidence of Bernanke’s stance
in the form of Procter & Gamble’s earnings report. The
company said it was able to raise prices on selected items
recently, but it wasn’t confident it would be able to continue to
do so in the future.

WIR 8/12/06

The markets held up well under the renewed terror threat but on
the week both equities and bonds still declined for one reason;
the feeling that the Federal Reserve, despite ‘pausing’ for the
first time since June 30, 2004, may have to resume raising
interest rates in the near future.

In announcing its move on Tuesday to hold the line, but with a
rare dissenter on the board, the Fed’s statement reiterated
Chairman Ben Bernanke’s consistent message of the past two
months, namely that the economy was cooling, thanks to the
housing slowdown and high energy prices, as well as because of
the lag effect of the past 17 rate hikes.

But inflation, it avers, despite running hotter than what the Fed is
normally comfortable with, will decline as the pace of economic
activity slows. However, the Fed will keep focusing on the data
and it is this fact that led to the week’s poor performance.

Friday’s retail sales report for July was stronger than expected,
up 1.4%, which in and of itself would give the Fed pause that
perhaps it put on the brakes too soon, but more importantly the
import price index component was definitively above any Fed
target, up 0.9%.

Ergo, by week’s end traders were screeching to a halt in their
best Roadrunner interpretation. ‘Perhaps we should just wait a
while before committing any new capital,’ they mused.

Let’s face it, for the Federal Reserve to have to raise interest
rates all over again come September would be a major bummer.
But since it’s not likely the Fed wants to admit a mistake, it will
probably wait until October to do so, if need be, and imagine if
the inflation data in between kept flashing warning signs. So
that’s the new conundrum.

Meanwhile, housing is tanking. Don’t take it from me – though
you could have the past year or so and appeared ‘in the know’ at
your cocktail parties, even if not particularly popular – but rather
listen to those whose business depends on correctly forecasting
trends.

Like Angelo Mozilo, CEO of the largest home mortgage lender
Countrywide Financial. “I’ve never seen a soft landing in 53
years.” Or ISI economist Nancy Lazar, who on CNBC said
“housing is weakening very significantly.” Or Robert Toll,
chairman and CEO of luxury home builder Toll Brothers, who
said the current slowdown “is the first downturn in the 40 years
since we entered the business that was not precipitated by high
interest rates, a weak economy, job losses or other
macroeconomic factors. Instead, it seems to be the result of an
oversupply of inventory and a decline of confidence.” Signed
contracts for Toll are down a whopping 45% from a year ago.

Economist Mark Zandi pretty well summed it up. “We could be
underestimating the dark side. Euphoria could turn into abject
pessimism very quickly.”

So the question becomes, just how much will a slowdown in the
housing sector, which has been the engine of growth for years,
impact consumer spending? A lot. And that’s not taking into
consideration the millions in the construction, home
improvement and home-lending industries, for starters, that could
lose their jobs.

It was all so predictable, even if some of us were early in
sounding the alarm. The easiest warning sign, looking back, was
housing affordability. Bloomberg News ran a typical story this
week in examining Naples, Florida. Admittedly, Naples is
bubble central as home prices rose a stupendous 140% since
2001.

But now Naples is losing “teachers, nurses, paralegals and other
middle-income workers” who are pursuing jobs elsewhere
because they’d have to take out sixteen home equity loans on top
of their mortgage to be able to afford to live in this lovely
community.

And, again, this is a global phenomenon. It could be crash city,
sports fans, though by definition this is 2007’s headline, not this
year’s.

One last item on the topic, and far closer to home, concerns a
story in the New York Times on the New York / New Jersey
region.

From 1995-2000, incomes rose 33% while property taxes were
up just 11%.

From 2000-2004, however, property taxes have gone up two to
three times the level of income.

WIR 9/23/06

Meanwhile, down in Washington, the Federal Reserve gathered
for its latest Open Market Committee and, as expected, held the
line on interest rates again, averring as before that “some
inflation risks remain,” though any additional firming depends on
the outlook and data. Chairman Ben Bernanke and crew (with
one dissenting vote) continue to believe that the economy will
moderate enough, in time, to take care of any inflation pressures
still in the system and today it’s helped in this regard by the
tumbling housing market.

So is the economy moderating as nicely as the Fed would like?
We need more information before drawing any real conclusions,
but no doubt it’s slowing as a reading of manufacturing activity
in the Philadelphia region pointed out on Thursday. In fact the
Street was shocked by a negative number for this particular
index, while earlier in the week housing starts were off a
whopping 6 percent, the 5th such decline in the past six months.

What’s good? Energy. The national average for a tank of gas is
already below $2.50 and heading lower still. As I was walking
around Sofia today, thinking of what to write, I came up with
this thought, as weak as it may be.

Today’s situation with the consumer boils down to this.

With the decline in gasoline prices, let’s say the average driver
fills their tank once a week and the car has 15 gallons. At a 60
cent savings off prices from early in the summer, that’s $9.00, or
about $450 a year. Hey, $9 is $9 and $450 is real money,
especially if your commute is long, or you’re a trucker, and the
savings are even higher.

But measure that against the value of your home. I’ve told you
before of the 22-unit townhouse development that I’ve lived in
now for 12 years. I paid $240,000 for my place then, yet a
basically identical unit went for $690,000 last fall. I wrote of
this then and said it was definitely the top. The next sale, about
two months ago, was at $640,000 and I bet anyone selling today
wouldn’t get $600,000. By next spring it will probably be closer
to $550,000.

So how does this affect consumer spending? That remains to be
seen. Bringing things down closer to the national averages, if
you owned a home that cost $200,000 initially, and then saw it
go to $400,000, but now it’s valued at $350,000, do you spend
less? That’s a $50,000 paper loss, you might be thinking, as
opposed to a $150,000 gain, but assume you still have your job
and everything else is equal.

Compare the $50,000 paper loss then with the hard currency gain
of $9 a week, or $450 a year. There is no comparison, by my
way of thinking, but that’s not necessarily how people react.

[Of course I’m ignoring the recent cases where those who bought
are already down.]

I just suspect it will take a bit more time for the wealth effect to
kick in on the downside for the simple reason that bubble mania
of any kind normally takes a while to wear off. The bursting can
be quick, a la Nasdaq 5048 in the spring of 2000, but many
investors didn’t totally throw in the towel until two years later,
which of course represented a terrific buying opportunity for
others.

Well enough on this topic. For now enjoy the savings; splurge
on some premium beer, if you’re really feeling good. But if you
were in the camp that believed your home’s value was going to
rise at 5, 7 or 9 percent forever, it’s time to start readjusting your
targets, and before you know it you may also be adjusting some
of your spending habits; much to the chagrin of Corporate
America and Wall Street, the latter with still frothy earnings
expectations for the former well into the future.

WIR 10/7/06

However, before you go popping the Korbel (hey, it’s not like
Nasdaq hit a new high, you know), Federal Reserve Chairman
Ben Bernanke told you this week, in his strongest words yet on
the topic, that real estate was undergoing a “substantial
correction” and that it would shave one percent off GDP the
second half of the year and who knows how much in ’07;
admitting it was tough to predict the “dynamics” of housing and
its overall impact.

And then Bernanke’s vice chairman, Donald Kohn, said the
falloff in real estate has “proven to have been more rapid and
deeper than many economists had predicted.”

Well I’m no economist (my sheepskin says poli-sci major and
beer drinker), but anyone with half a brain knew real estate had
long entered the frothy stage by last fall .a full 12 months ago,
Mr. Kohn ergo, when bubbles pop, the fall can be rough. Or
maybe Kohn forgot Nasdaq 5048. Moody’s Economy.com also
weighed in with research that predicts the average home price
will decline about 4 percent in 2007, with far greater losses in the
hotter markets.

But lest I get too smug, which I’m not entitled to be anyway
because I thought the three major equity indexes would decline 3
to 7 percent this year, I do agree with Bernanke that it’s tough to
predict the dynamics of housing and its overall impact; which is
why I muse about the psychological impact between $450 in the
pocket and a $20,000 hit to the net worth, as well as the fact that
Americans, overall, are spending more on housing (including for
real estate taxes, insurance and utilities) than ever before,
according to the latest Census Bureau data.

WIR 10/28/06

And I’d be remiss in not mentioning the Federal Reserve. The
fact I waited until now to do so is probably a sign they think
they’re doing a good job. Ben Bernanke and Co. held the line on
interest rates again, but the Fed appears to have far more
confidence in the health of the economy than some of us do. In
fact the Fed appears to be more optimistic than last time, talking
of ‘moderate’ growth going forward, which translates to 2 to 3
percent. A soft landing, in other words. They concede housing
is an issue, but at the same time the board offers inflation isn’t
really one so, net/net, it all comes out a positive by their way of
thinking.

Back to earnings, though, in conjunction with the Fed’s
comments. Bernanke better be right in his forecast of solid
growth for the foreseeable future because many more quarters
like the third and there is no way in hell you’ll see double-digit
earnings growth in the future, as currently forecast by most.

WIR 12/2/06

So whither housing in general? Thanks to the fact mortgage
rates are falling anew, under 6.15% for a 30-year fixed, that’s
supplying some support for the sector. No doubt Ben Bernanke
is focusing on this. He doesn’t dare raise interest rates again
until he’s certain housing is stabilizing. I just see another leg
down coming.

Speaking of the Fed chairman, he offered in a speech this week
that the Fed would still raise rates before cutting, because he
remains concerned about labor costs. Well this is a crock; all
he’s doing is jawboning. You can be sure corporations, with
slowing in evidence now for some time, aren’t about to be
handing out big raises in 2007. Enjoy what increase you
received this year, folks.

WIR 12/16/06

Earlier in the week the Federal Reserve held the line on interest
rates again, as expected, but did admit there was a “substantial
cooling of the housing market.” Yup, there sure is.

But the Fed added, while core inflation remains elevated (above
its preferred 2% target), it expects economic growth to
“moderate” and, thanks to falling energy, coupled with the
slowing economy, inflation will then “moderate” too.

Only one problem with that .energy isn’t going to fall with
what I see going on in the Middle East. Plus OPEC is flexing
some muscles, and exhibiting a little discipline, in instituting
production cuts that are sticking, to a certain extent; “certain
extent” being better than their history of outright shoddy
compliance. And in one of the dumber moves in the history of
commerce, Angola sold its soul to the devil in agreeing to
become the first new member of the cartel since 1975, which
also means Angola will have to comply with OPEC’s wishes and
not necessarily develop its resources in its nation’s best interests.
But then when I’m up late at night, musing about the world and
which places I’d like to visit next, Angola isn’t part of the
equation.

WIR 1/6/07

Before I get to the main topic of discussion this week, I need to
clean up some loose ends from my ’07 forecast as issued last
time. In calling for 1.5% growth for the year it will begin to feel
like a recession even though government reports could show
positive growth. A Wall Street Journal survey of 60 economists
came out this week and their consensus was for 2.3% growth in
the first half and 2.8% growth in the second, mirroring the
previous review’s BusinessWeek forecast. No way either is
right.

But when it comes to stocks, as you’ve seen over the years the
market often defies logic, both up and down. Earnings are
expected to grow at high single digit rates in ’07, the first time
below double digits since 2002. If economic growth is slower
than consensus, we will finally see earnings disappoint. That
would normally be negative, and at times the market will treat it
as such, but I just see the end result for stocks being pretty flat.
For one thing, even bears have to concede valuations aren’t
outrageous; certainly nowhere near 1999/2000 levels that defied
explanation.

What we will see, however, is rising default levels for
individuals; a harbinger of things to come in 2008. A reason
why I’m not calling for outright disaster just yet is because, yes,
there is a tremendous amount of cash sloshing around, as we’ll
expound on further in a moment, and spending at the top levels
of our society will more than make up for shortfalls at the
middle- and lower-income levels. For a while longer, that is.

All of the above is contingent on zero large-scale terror attacks,
no attack on Iran, Iran not testing an authentic nuclear weapon,
and relatively stable oil prices outside of a hurricane induced
spike.

In the here and now, the ISM index on the service sector for
December showed some softening vs. November, while the ISM
manufacturing barometer, echoing the previous week’s Chicago
Purchasing Managers index, came in better than expected.

Then the December employment figure was released on Friday
and the economy created 167,000 jobs for the month, far greater
than anticipated. Stocks sold off, though, because the solid
performance indicates the Federal Reserve will not be lowering
interest rates any time soon and much of the stock market rally in
recent weeks has been based on the assumption it would begin
doing just that early in 2007.

Couple the jobs data with the earlier release of the Fed’s minutes
from its December meeting, where the Fed reiterated its concerns
on inflation, and one can only conclude the Fed isn’t going to be
cutting rates for at least the first two meetings of the year.

Which will be a mistake, because while I talk of basically
muddling through, above, that’s not a good environment for the
majority of Americans; the non-Wall Street/Corporate CEO
money machines, that is.

And if you thought I was too bearish last week in my housing
comments for this coming year, I can thank home-builder Lennar
for making me look good for one week at least.

The Miami developer announced it expects to report a fourth-
quarter loss of around $500 million in the face of land-related
write-downs. CEO Stuart Miller said “Market conditions
continued to weaken throughout the fourth quarter, and we have
not yet seen tangible evidence of a market recovery.”

At the same time Lennar said it would sell a 62% stake it had in a
15,000 acre track in California, not exactly a ringing
endorsement of prospects for a rebound anytime soon there. And
Lennar admitted it is doing everything possible on the incentive
side to move existing inventory, something to remember next
time you see relatively sanguine new home sales data.

I was in Miami myself a few days this week for the Orange Bowl
and not having been to the area in years I was floored by some of
the high-rise condo developments. Now, granted, I was there
over the holiday weekend but on Tuesday, when I expected to
see workers back slaving away on the monstrosities lining the
beaches and waterways, I saw virtually zero activity.

Coincidentally, I saw a Reuters piece by Jim Loney noting that
developers are now pulling the plug on some of the biggest
projects (a la Lennar’s warning). In fact, Miami officials talk of
15 condo projects, representing 1,900 units, that have been
officially pulled, but analysts agree the eventual number will be
much higher, taking into consideration the rest of the overbuilt
market over the entire state. In other words, there are going to be
more than a few eyesores to stare at in the coming years,
buildings half complete or giant pits, waiting to swallow up
unsuspecting tourists.

There were also a number of tidbits this week regarding the New
York City real estate market that foreshadow further softening
rather than a bottom having been hit.

For example, construction permits declined for the first time
since 1998, demand for office space appears to be hitting a wall
(ignore some of the positive spin you may have seen), and the
average sales price for a NYC apartment is now off 4% from a
year ago; this last fact obviously doesn’t represent a crash, but a
pigeon in the mine nonetheless. [The Big Apple being an urban
area and not exactly a haven for canaries .then again it’s been
warm enough for the songbirds, but I digress.]

Of course New York’s housing market will also be the recipient
of much of Wall Street’s largesse, so numbers over the coming
months could be a bit out of whack, especially at the very high
end, though the primary trend now appears to be in place.

But I want to spend some time musing about the Fall of the
Roman Empire, 2007 style.

The Journal’s Alan Murray summed it up terrifically the other
day in talking about all the cash, or to paraphrase Scarface, what
to make of it. [The preceding was heavily censored.]

“There is a steady stream of resources to the most perilous of
emerging markets, the most hopeless of troubled companies and
the most overextended of home buyers. That’s great fun while it
lasts. But does anyone seriously think it will last forever?

“Let’s start with private equity. Private-equity fund raising set a
record last year, as did private-equity deal making. This year
will be even bigger. Look for a precedent-breaking $50 billion
deal to be announced before the big ball falls in Times Square
again.

“The private-equity geniuses would have you believe this is
because they’ve discovered a superior form of running
companies. Perhaps some of them have. But mostly, what
they’ve discovered is an amazing gusher of money .

“(In general), the swollen river of liquidity is also behind happy
predictions that housing will recover later this year. Despite
rising default rates, mortgages remain cheap and easy.

“Lenders are still willing to let borrowers bury themselves in
debt to buy a new home. The money gusher also helps explain
why the federal government in Washington can keep spending
away, without regard for projections of an exploding federal
deficit. And why the dollar remains relatively strong, despite
swelling trade deficits. Or why the Dow Jones Industrial
Average has managed to go for more than 912 trading days (now
913) without a 2% daily decline – the longest such stretch in its
history.

“Perhaps this flood of money will continue through the new year.
Fed Chairman Ben Bernanke has argued money flows are the
result of a ‘global savings glut.’ Newly enriched investors in the
developing world need to put their money somewhere, and
apparently, even the most risky assets will do.

“But as long as the good times are rolling, don’t expect Mr.
Bernanke to cut interest rates. That’s a tool he’ll only use when
the economy takes a serious turn for the worse. Those who
predict otherwise haven’t been listening to what he’s been
saying.

“And don’t be fooled into thinking that more drinking will ease
the inevitable hangover. At some point, something – a string of
big defaults, a sharp decline in the dollar, or, God forbid, a major
terror attack – will cause the intoxicating stuff to stop flowing.

“The world is still a risky place, and liquidity, at the end of the
day, is just another name for confidence. Eventually, this
confidence game will end.”

---

I’m off next week. Wall Street History will return Feb. 15 with
Ben Bernanke, part II. A look at the Fed and 2007. Now it gets
ugly.

Brian Trumbore



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Wall Street History

02/01/2008

Ben Bernanke, Part I

I thought we’d take a look at the Fed and Ben Bernanke the next
few weeks, utilizing my “Week in Review” archives. We start
with 2006, when Bernanke replaced Alan Greenspan. Put your
mindset back to then, not last year, folks.

Background

Greenspan hiked the federal funds rate for a 14th consecutive
time to 4.50% in his last meeting, Jan. 31, 2006. Then Bernanke
took over and hiked 25 basis points each of the next three Fed
Open Market Committee gatherings to 5.25% on June 29, 2006.
That’s where the funds rate sat throughout the rest of ’06 and
well into 2007.

As for the economy, following is the rate of GDP for 2006.

Q1 5.6%
Q2 2.6%
Q3 2.0%
Q4 2.5%

[These were my musings, unedited; warts and all in terms of any
predictions I may have made back then.]

WIR 2/18/06

Mr. Smooth, new Federal Reserve Chairman Ben Bernanke, had
his coming out party this week as he appeared before both the
House and Senate for an update on the economy. Of course this
semi-annual exercise is but another reminder of why a senator is
a senator, and a congressman a congressman. Let’s just say more
often than not one sounds like a college graduate, while the other
comes off as a subscriber to People. But I digress.

Bernanke is good real good. And we can understand what he’s
saying, a gift that eluded his predecessor.

So what did he say? The economy is strong, Bernanke is not
concerned about an inverted yield curve, he is going to focus on
the hard economic data, perhaps more so than Alan Greenspan,
but one of his primary concerns is housing; that and the potential
for inflation to seep through the price chain as it has been in
some sectors.

Which means one thing. Bernanke is going to be hiking rates,
and possibly far more than yours truly thought possible last
December.

That won’t be good because there is no doubt the Fed is going to
overshoot. I would still submit that with the lag effect of past
rate hikes it already has.

Inflation hawks may have their day, but it will be brief and I
have never been more convinced than I am now that the U.S.
economy will flip on a dime, seize up, at some point in the
second half of the year.

Housing, of course, will be a major cause of this reversal and you
can throw out the January housing start numbers that showed
explosive growth in the sector. Heck, even I felt like building a
house this past month with temperatures in the 50s here in the
New York area. And it would appear many builders just told
their guys to throw stuff up, quickly, before more normal
weather set in.

[As luck would have it, we got 20+ inches of snow last weekend
but by Thursday it was gone thanks to a resumption of the
heatwave.]

What amazes me is this leap of faith among the majority on Wall
Street, at least for this past week, that higher rates are no
problem, particularly when one looks at the mortgage sector.

Jonathan Laing of Barron’s had a terrific piece in the 2/13 edition
on the “sub-prime” market. These are the folks who should
probably be renting until they build up a little more capital but
the lending institutions take the risk, at future cost to the
homeowner.

For example, 10% of today’s mortgage debt is in sub-prime loans
that are in the process of resetting. As Laing illustrates, their
monthly payments could rise 50%, easily, over the next two
years due to the steep escalation in short-term interest rates.

Of even more concern is that if home values just stagnate, let
alone go down, these same homeowners will no longer be able to
tap into their equity in order to meet the much higher mortgage
payments.

But back to the January housing data specifically, yes, I’ve
always said never put too much stock in one month when it
comes to this arena, but at the same time I’ve said we’ve now
entered a period in housing where it’s three steps down for every
one up. Housing has peaked. The question is do values now fall.
I’ll go with stagnation until the economy begins to roll over, then
it gets dicey.

One last note on this issue. While some were bamboozled by the
January data, I chose instead to focus on a statement out of
Washington Mutual, a leading loan originator. They were laying
off 2,500.

WIR 3/4/06

Last weekend, Federal Reserve Chairman Ben Bernanke said the
U.S. economy has absorbed the oil shock (one can’t argue with
that), and that his Fed won’t focus on asset price bubbles.
Commenting on Bernanke’s challenges, former Fed chairman
Paul Volcker said, “How would you like to be responsible for an
economy that’s dependent upon $700 billion of foreign money
every year?” in reference to the current $726 billion trade
imbalance.

4/1/06

And then there’s the Federal Reserve. Chairman Ben Bernanke
oversaw his first meeting and took the opportunity to raise the
funds rate a 15th consecutive time, another -point to 4.75%.

But it was the accompanying statement everyone was looking
for. Would the new chairman change the language used by his
predecessor, ol’ what’s his name? [We have fleeting memories,
you understand.]

“Some further policy firming may be needed to keep the risks to
the attainment of both sustainable economic growth and price
stability roughly in balance .The run-up in the prices of energy
and other commodities appears to have had only a modest effect
on core inflation.”

But the Fed also added:

“Possible increases in resource utilization, in combination with
the elevated prices of energy and other commodities, have the
potential to add to inflation pressures.”

Put it all together and the market now expects yet another rate
increase to 5% on May 10 and possibly one on top of that in late
June. If you’re a saver and/or investor in “cash,” you enjoy
seeing your money market fund yields continue to rise; as is
the case with yours truly. Staying ultra short on the yield curve
has been a good bet, in other words. But those investing in
longer maturity paper are getting whacked.

WIR 4/29/06

This week Federal Reserve Chairman Ben Bernanke appeared
before a joint congressional economic committee and said
“vigilance in regard to inflation is essential.” But he also added
he was concerned about a slowing housing market and rising
energy costs and the impact these two in particular can have on
the consumer and overall economic activity. So Bernanke added
the Fed could pause for a spell to examine more data, as the
Fed’s governors are certainly well aware there is a lag effect
from the 15 interest rate increases they’ve already instituted.

The bond market took Bernanke’s comments to heart and yields
on the long end of the curve rose slightly on the week while the
two-year Treasury rallied a bit on the theory that the Fed will
indeed stop for a while.

The long end, of course, is more concerned with an actual
inflation threat, while the shorter end concerns itself with the
here and now.

But what does the actual data tell us? This week’s readings on
housing were decidedly mixed. While existing and new home
sales rose, surprising some, the median price on existing was up
just 7.4% year over year, as opposed to the double digit growth
we’ve been used to, while the median price on new home sales
actually fell 2.2% from a year ago and a full 6.5% between
February and March. No matter how you slice it, the market has
stagnated in terms of price and the issue becomes is housing on
the verge of rolling over?

WIR 5/13/06

Anyway, the Fed concluded for now that while “inflation
expectations remain contained,” pricing pressures could emerge
with the surge in commodity prices. So the real bottom line is:
will the consumer buckle under, finally, to higher energy prices
and/or a stagnating, verging on crumbling, housing market?

I’ve argued it would be housing, pointing specifically to the
second half. As for energy, it’s mostly about Iran for the
foreseeable future; that and weather in the Gulf of Mexico. It’s
almost time for our first tropical wave, after all.

The markets thus took none too kindly to the prospect of further
rate increases and runaway commodity prices and it was a two-
day bloodbath on Thursday and Friday.

China remains the top story in terms of the global economy with
a government think tank forecasting GDP growth of 9.8% in the
second quarter and 10% in the third. China also helped fuel the
metals surge – copper, zinc, nickel, and platinum among the
items hitting record highs, with gold at a 26-year best – in
announcing it was going to start building its strategic reserves in
uranium, iron, copper and other key materials, plus it was
accelerating construction of strategic reserves for oil and coal.

But back to the Fed and Wall Street’s loss of faith in Chairman
Bernanke and Co., one major concern, and the one with most
currency, is the fact the Bank of Japan and the European Central
Bank will both be hiking interest rates this summer (as will
China) while the Fed could be pausing; ergo, will the Fed then be
behind the curve? I don’t think they’ll put themselves in that
position.

We’re going higher on rates, in other words, and if we haven’t
already reached the tipping point, a move to 5.25% end of June
would do it.

WIR 6/17/06

But then “Shazam!” After a dead cat bounce on Wednesday,
Federal Reserve Chairman Ben Bernanke somehow soothed
markets by saying little. For the life of me I don’t understand
Thursday’s rocket launch, when the major indices in the U.S.
rose 2% to 3% each.

You see, Bernanke said in a speech that as long as energy prices
don’t go much higher, overall inflation risks appear to be
“manageable,” though at the same time he offered that the Fed
needed to remain vigilant to inflation expectations.

In other words, he said nothing new. The Fed is still hiking end
of the month, a 17th consecutive time, and if the core consumer
price index for July is up another 0.3%, the Fed could hike again
come August.

The point being, they’ve already gone too far and with the June
29 increase they will have officially overshot. And,
coincidentally, when the economy rolls over, inflation will dry
up faster than you can say “Tiger Woods missed the cut at the
U.S. Open.”

The economy is already slowing, as the Fed’s own report of
regional activity (the Beige Book) noted this week. Retail sales
are on the weak side and a report on industrial production was
kind of punk.

Rising short-term rates are killing consumers with a lot of credit
card debt, adjustable rate mortgages and home equity loans, and
that will be increasingly reflected in the data. The housing sector
is rolling over and the third leg for the economy, capital
spending, is as I’ve said in the past the most squirrelly.
Corporate chieftains are the first ones to panic, given any kind of
bad news, especially on the geopolitical front, and I see cap-ex
falling short of expectations in the second half.

And just a word on energy. Bernanke is right when he says as
long as prices don’t spike higher, the costs to the economy of $70
oil are manageable. That level isn’t great, but it’s not the killer a
slumping housing market can be coupled with rising short-term
interest rates.

But the risks of a price spike are still there for two main reasons
these days; Iran and the hurricane season. It’s why prices have
remained as high as they have given near record levels of
inventories. Otherwise, yes, oil should be $50, or lower, and
gasoline back below $2 a gallon.

WIR 7/1/06

Stocks rallied strongly following the Federal Reserve’s 17th
consecutive rate hike, another -point on the Fed Funds rate to
5.25%. So what did investors find so super about this? Beats the
heck out of me.

Following is part of the statement accompanying the rate move.

“Recent indicators suggest that economic growth is moderating
from its quite strong pace earlier this year, partly reflecting a
gradual cooling of the housing market and the lagged effects of
increases in interest rates and energy prices.

“Readings on core inflation have been elevated in recent months.
Ongoing productivity gains have held down the rise in unit labor
costs, and inflation expectations remain contained. However, the
high levels of resource utilization and of the prices of energy and
other commodities have the potential to sustain inflation
pressures.

“Although the moderation in the growth of aggregate demand
should help to limit inflation pressures over time, the Committee
judges that some inflation risks remain.”

The FOMC then goes on to say it will weigh the data before
making its next move.

Immediately after, the majority of market mavens said, “Ah ha!
The Fed is finished.” I’m sorry, but there is absolutely no way to
deduce that.

Unless, of course, the economic data over the next five weeks,
before the Aug. 8 Fed meeting, reveals the economy to be
slowing even faster than some believe it is and our little inflation
scare to be over. But while I’ve been looking forward to a big
second half drop in economic activity (well, you know what I
mean), it’s likely the inflation indicators will still reveal a
worrisome picture. So the Fed will weigh both the plusses and
minuses and come up with something.

One thing is for sure, though, which the Fed can’t possibly
ignore even though the equity market did this past week, and
that’s the fact we are suddenly back up to $74 on oil and $2.20
on gasoline futures. [And you’ll recall from our little lesson a
few weeks ago that $2.20 gasoline translates into about $3.00 on
average at the pump ergo, no relief in sight it would appear.]

The Fed under Ben Bernanke has continuously voiced concerns
over energy prices so it’s hardly likely it will just look the other
way if by August we’re still at the $70 and $3 levels.

WIR 8/5/06

Due to an unexciting employment report for the month of July,
with the U.S. economy adding all of 113,000 jobs, the experts are
saying it’s a lock the Fed will finally ‘pause’ after 17 straight rate
increases because the evidence clearly speaks to a slowdown.

Some of the manufacturing data released this week was actually
pretty solid, and we got out of the heat by hitting the malls, as
some retailers reported, but we’ve learned in past weeks the days
of 5.6% growth, as in the first quarter, are long gone.

As for inflation, Fed Chairman Ben Bernanke earlier expressed
confidence that any price pressures would abate as the overall
economy slowed so there’s further ammunition for the ‘pause’
camp. This week offered classic evidence of Bernanke’s stance
in the form of Procter & Gamble’s earnings report. The
company said it was able to raise prices on selected items
recently, but it wasn’t confident it would be able to continue to
do so in the future.

WIR 8/12/06

The markets held up well under the renewed terror threat but on
the week both equities and bonds still declined for one reason;
the feeling that the Federal Reserve, despite ‘pausing’ for the
first time since June 30, 2004, may have to resume raising
interest rates in the near future.

In announcing its move on Tuesday to hold the line, but with a
rare dissenter on the board, the Fed’s statement reiterated
Chairman Ben Bernanke’s consistent message of the past two
months, namely that the economy was cooling, thanks to the
housing slowdown and high energy prices, as well as because of
the lag effect of the past 17 rate hikes.

But inflation, it avers, despite running hotter than what the Fed is
normally comfortable with, will decline as the pace of economic
activity slows. However, the Fed will keep focusing on the data
and it is this fact that led to the week’s poor performance.

Friday’s retail sales report for July was stronger than expected,
up 1.4%, which in and of itself would give the Fed pause that
perhaps it put on the brakes too soon, but more importantly the
import price index component was definitively above any Fed
target, up 0.9%.

Ergo, by week’s end traders were screeching to a halt in their
best Roadrunner interpretation. ‘Perhaps we should just wait a
while before committing any new capital,’ they mused.

Let’s face it, for the Federal Reserve to have to raise interest
rates all over again come September would be a major bummer.
But since it’s not likely the Fed wants to admit a mistake, it will
probably wait until October to do so, if need be, and imagine if
the inflation data in between kept flashing warning signs. So
that’s the new conundrum.

Meanwhile, housing is tanking. Don’t take it from me – though
you could have the past year or so and appeared ‘in the know’ at
your cocktail parties, even if not particularly popular – but rather
listen to those whose business depends on correctly forecasting
trends.

Like Angelo Mozilo, CEO of the largest home mortgage lender
Countrywide Financial. “I’ve never seen a soft landing in 53
years.” Or ISI economist Nancy Lazar, who on CNBC said
“housing is weakening very significantly.” Or Robert Toll,
chairman and CEO of luxury home builder Toll Brothers, who
said the current slowdown “is the first downturn in the 40 years
since we entered the business that was not precipitated by high
interest rates, a weak economy, job losses or other
macroeconomic factors. Instead, it seems to be the result of an
oversupply of inventory and a decline of confidence.” Signed
contracts for Toll are down a whopping 45% from a year ago.

Economist Mark Zandi pretty well summed it up. “We could be
underestimating the dark side. Euphoria could turn into abject
pessimism very quickly.”

So the question becomes, just how much will a slowdown in the
housing sector, which has been the engine of growth for years,
impact consumer spending? A lot. And that’s not taking into
consideration the millions in the construction, home
improvement and home-lending industries, for starters, that could
lose their jobs.

It was all so predictable, even if some of us were early in
sounding the alarm. The easiest warning sign, looking back, was
housing affordability. Bloomberg News ran a typical story this
week in examining Naples, Florida. Admittedly, Naples is
bubble central as home prices rose a stupendous 140% since
2001.

But now Naples is losing “teachers, nurses, paralegals and other
middle-income workers” who are pursuing jobs elsewhere
because they’d have to take out sixteen home equity loans on top
of their mortgage to be able to afford to live in this lovely
community.

And, again, this is a global phenomenon. It could be crash city,
sports fans, though by definition this is 2007’s headline, not this
year’s.

One last item on the topic, and far closer to home, concerns a
story in the New York Times on the New York / New Jersey
region.

From 1995-2000, incomes rose 33% while property taxes were
up just 11%.

From 2000-2004, however, property taxes have gone up two to
three times the level of income.

WIR 9/23/06

Meanwhile, down in Washington, the Federal Reserve gathered
for its latest Open Market Committee and, as expected, held the
line on interest rates again, averring as before that “some
inflation risks remain,” though any additional firming depends on
the outlook and data. Chairman Ben Bernanke and crew (with
one dissenting vote) continue to believe that the economy will
moderate enough, in time, to take care of any inflation pressures
still in the system and today it’s helped in this regard by the
tumbling housing market.

So is the economy moderating as nicely as the Fed would like?
We need more information before drawing any real conclusions,
but no doubt it’s slowing as a reading of manufacturing activity
in the Philadelphia region pointed out on Thursday. In fact the
Street was shocked by a negative number for this particular
index, while earlier in the week housing starts were off a
whopping 6 percent, the 5th such decline in the past six months.

What’s good? Energy. The national average for a tank of gas is
already below $2.50 and heading lower still. As I was walking
around Sofia today, thinking of what to write, I came up with
this thought, as weak as it may be.

Today’s situation with the consumer boils down to this.

With the decline in gasoline prices, let’s say the average driver
fills their tank once a week and the car has 15 gallons. At a 60
cent savings off prices from early in the summer, that’s $9.00, or
about $450 a year. Hey, $9 is $9 and $450 is real money,
especially if your commute is long, or you’re a trucker, and the
savings are even higher.

But measure that against the value of your home. I’ve told you
before of the 22-unit townhouse development that I’ve lived in
now for 12 years. I paid $240,000 for my place then, yet a
basically identical unit went for $690,000 last fall. I wrote of
this then and said it was definitely the top. The next sale, about
two months ago, was at $640,000 and I bet anyone selling today
wouldn’t get $600,000. By next spring it will probably be closer
to $550,000.

So how does this affect consumer spending? That remains to be
seen. Bringing things down closer to the national averages, if
you owned a home that cost $200,000 initially, and then saw it
go to $400,000, but now it’s valued at $350,000, do you spend
less? That’s a $50,000 paper loss, you might be thinking, as
opposed to a $150,000 gain, but assume you still have your job
and everything else is equal.

Compare the $50,000 paper loss then with the hard currency gain
of $9 a week, or $450 a year. There is no comparison, by my
way of thinking, but that’s not necessarily how people react.

[Of course I’m ignoring the recent cases where those who bought
are already down.]

I just suspect it will take a bit more time for the wealth effect to
kick in on the downside for the simple reason that bubble mania
of any kind normally takes a while to wear off. The bursting can
be quick, a la Nasdaq 5048 in the spring of 2000, but many
investors didn’t totally throw in the towel until two years later,
which of course represented a terrific buying opportunity for
others.

Well enough on this topic. For now enjoy the savings; splurge
on some premium beer, if you’re really feeling good. But if you
were in the camp that believed your home’s value was going to
rise at 5, 7 or 9 percent forever, it’s time to start readjusting your
targets, and before you know it you may also be adjusting some
of your spending habits; much to the chagrin of Corporate
America and Wall Street, the latter with still frothy earnings
expectations for the former well into the future.

WIR 10/7/06

However, before you go popping the Korbel (hey, it’s not like
Nasdaq hit a new high, you know), Federal Reserve Chairman
Ben Bernanke told you this week, in his strongest words yet on
the topic, that real estate was undergoing a “substantial
correction” and that it would shave one percent off GDP the
second half of the year and who knows how much in ’07;
admitting it was tough to predict the “dynamics” of housing and
its overall impact.

And then Bernanke’s vice chairman, Donald Kohn, said the
falloff in real estate has “proven to have been more rapid and
deeper than many economists had predicted.”

Well I’m no economist (my sheepskin says poli-sci major and
beer drinker), but anyone with half a brain knew real estate had
long entered the frothy stage by last fall .a full 12 months ago,
Mr. Kohn ergo, when bubbles pop, the fall can be rough. Or
maybe Kohn forgot Nasdaq 5048. Moody’s Economy.com also
weighed in with research that predicts the average home price
will decline about 4 percent in 2007, with far greater losses in the
hotter markets.

But lest I get too smug, which I’m not entitled to be anyway
because I thought the three major equity indexes would decline 3
to 7 percent this year, I do agree with Bernanke that it’s tough to
predict the dynamics of housing and its overall impact; which is
why I muse about the psychological impact between $450 in the
pocket and a $20,000 hit to the net worth, as well as the fact that
Americans, overall, are spending more on housing (including for
real estate taxes, insurance and utilities) than ever before,
according to the latest Census Bureau data.

WIR 10/28/06

And I’d be remiss in not mentioning the Federal Reserve. The
fact I waited until now to do so is probably a sign they think
they’re doing a good job. Ben Bernanke and Co. held the line on
interest rates again, but the Fed appears to have far more
confidence in the health of the economy than some of us do. In
fact the Fed appears to be more optimistic than last time, talking
of ‘moderate’ growth going forward, which translates to 2 to 3
percent. A soft landing, in other words. They concede housing
is an issue, but at the same time the board offers inflation isn’t
really one so, net/net, it all comes out a positive by their way of
thinking.

Back to earnings, though, in conjunction with the Fed’s
comments. Bernanke better be right in his forecast of solid
growth for the foreseeable future because many more quarters
like the third and there is no way in hell you’ll see double-digit
earnings growth in the future, as currently forecast by most.

WIR 12/2/06

So whither housing in general? Thanks to the fact mortgage
rates are falling anew, under 6.15% for a 30-year fixed, that’s
supplying some support for the sector. No doubt Ben Bernanke
is focusing on this. He doesn’t dare raise interest rates again
until he’s certain housing is stabilizing. I just see another leg
down coming.

Speaking of the Fed chairman, he offered in a speech this week
that the Fed would still raise rates before cutting, because he
remains concerned about labor costs. Well this is a crock; all
he’s doing is jawboning. You can be sure corporations, with
slowing in evidence now for some time, aren’t about to be
handing out big raises in 2007. Enjoy what increase you
received this year, folks.

WIR 12/16/06

Earlier in the week the Federal Reserve held the line on interest
rates again, as expected, but did admit there was a “substantial
cooling of the housing market.” Yup, there sure is.

But the Fed added, while core inflation remains elevated (above
its preferred 2% target), it expects economic growth to
“moderate” and, thanks to falling energy, coupled with the
slowing economy, inflation will then “moderate” too.

Only one problem with that .energy isn’t going to fall with
what I see going on in the Middle East. Plus OPEC is flexing
some muscles, and exhibiting a little discipline, in instituting
production cuts that are sticking, to a certain extent; “certain
extent” being better than their history of outright shoddy
compliance. And in one of the dumber moves in the history of
commerce, Angola sold its soul to the devil in agreeing to
become the first new member of the cartel since 1975, which
also means Angola will have to comply with OPEC’s wishes and
not necessarily develop its resources in its nation’s best interests.
But then when I’m up late at night, musing about the world and
which places I’d like to visit next, Angola isn’t part of the
equation.

WIR 1/6/07

Before I get to the main topic of discussion this week, I need to
clean up some loose ends from my ’07 forecast as issued last
time. In calling for 1.5% growth for the year it will begin to feel
like a recession even though government reports could show
positive growth. A Wall Street Journal survey of 60 economists
came out this week and their consensus was for 2.3% growth in
the first half and 2.8% growth in the second, mirroring the
previous review’s BusinessWeek forecast. No way either is
right.

But when it comes to stocks, as you’ve seen over the years the
market often defies logic, both up and down. Earnings are
expected to grow at high single digit rates in ’07, the first time
below double digits since 2002. If economic growth is slower
than consensus, we will finally see earnings disappoint. That
would normally be negative, and at times the market will treat it
as such, but I just see the end result for stocks being pretty flat.
For one thing, even bears have to concede valuations aren’t
outrageous; certainly nowhere near 1999/2000 levels that defied
explanation.

What we will see, however, is rising default levels for
individuals; a harbinger of things to come in 2008. A reason
why I’m not calling for outright disaster just yet is because, yes,
there is a tremendous amount of cash sloshing around, as we’ll
expound on further in a moment, and spending at the top levels
of our society will more than make up for shortfalls at the
middle- and lower-income levels. For a while longer, that is.

All of the above is contingent on zero large-scale terror attacks,
no attack on Iran, Iran not testing an authentic nuclear weapon,
and relatively stable oil prices outside of a hurricane induced
spike.

In the here and now, the ISM index on the service sector for
December showed some softening vs. November, while the ISM
manufacturing barometer, echoing the previous week’s Chicago
Purchasing Managers index, came in better than expected.

Then the December employment figure was released on Friday
and the economy created 167,000 jobs for the month, far greater
than anticipated. Stocks sold off, though, because the solid
performance indicates the Federal Reserve will not be lowering
interest rates any time soon and much of the stock market rally in
recent weeks has been based on the assumption it would begin
doing just that early in 2007.

Couple the jobs data with the earlier release of the Fed’s minutes
from its December meeting, where the Fed reiterated its concerns
on inflation, and one can only conclude the Fed isn’t going to be
cutting rates for at least the first two meetings of the year.

Which will be a mistake, because while I talk of basically
muddling through, above, that’s not a good environment for the
majority of Americans; the non-Wall Street/Corporate CEO
money machines, that is.

And if you thought I was too bearish last week in my housing
comments for this coming year, I can thank home-builder Lennar
for making me look good for one week at least.

The Miami developer announced it expects to report a fourth-
quarter loss of around $500 million in the face of land-related
write-downs. CEO Stuart Miller said “Market conditions
continued to weaken throughout the fourth quarter, and we have
not yet seen tangible evidence of a market recovery.”

At the same time Lennar said it would sell a 62% stake it had in a
15,000 acre track in California, not exactly a ringing
endorsement of prospects for a rebound anytime soon there. And
Lennar admitted it is doing everything possible on the incentive
side to move existing inventory, something to remember next
time you see relatively sanguine new home sales data.

I was in Miami myself a few days this week for the Orange Bowl
and not having been to the area in years I was floored by some of
the high-rise condo developments. Now, granted, I was there
over the holiday weekend but on Tuesday, when I expected to
see workers back slaving away on the monstrosities lining the
beaches and waterways, I saw virtually zero activity.

Coincidentally, I saw a Reuters piece by Jim Loney noting that
developers are now pulling the plug on some of the biggest
projects (a la Lennar’s warning). In fact, Miami officials talk of
15 condo projects, representing 1,900 units, that have been
officially pulled, but analysts agree the eventual number will be
much higher, taking into consideration the rest of the overbuilt
market over the entire state. In other words, there are going to be
more than a few eyesores to stare at in the coming years,
buildings half complete or giant pits, waiting to swallow up
unsuspecting tourists.

There were also a number of tidbits this week regarding the New
York City real estate market that foreshadow further softening
rather than a bottom having been hit.

For example, construction permits declined for the first time
since 1998, demand for office space appears to be hitting a wall
(ignore some of the positive spin you may have seen), and the
average sales price for a NYC apartment is now off 4% from a
year ago; this last fact obviously doesn’t represent a crash, but a
pigeon in the mine nonetheless. [The Big Apple being an urban
area and not exactly a haven for canaries .then again it’s been
warm enough for the songbirds, but I digress.]

Of course New York’s housing market will also be the recipient
of much of Wall Street’s largesse, so numbers over the coming
months could be a bit out of whack, especially at the very high
end, though the primary trend now appears to be in place.

But I want to spend some time musing about the Fall of the
Roman Empire, 2007 style.

The Journal’s Alan Murray summed it up terrifically the other
day in talking about all the cash, or to paraphrase Scarface, what
to make of it. [The preceding was heavily censored.]

“There is a steady stream of resources to the most perilous of
emerging markets, the most hopeless of troubled companies and
the most overextended of home buyers. That’s great fun while it
lasts. But does anyone seriously think it will last forever?

“Let’s start with private equity. Private-equity fund raising set a
record last year, as did private-equity deal making. This year
will be even bigger. Look for a precedent-breaking $50 billion
deal to be announced before the big ball falls in Times Square
again.

“The private-equity geniuses would have you believe this is
because they’ve discovered a superior form of running
companies. Perhaps some of them have. But mostly, what
they’ve discovered is an amazing gusher of money .

“(In general), the swollen river of liquidity is also behind happy
predictions that housing will recover later this year. Despite
rising default rates, mortgages remain cheap and easy.

“Lenders are still willing to let borrowers bury themselves in
debt to buy a new home. The money gusher also helps explain
why the federal government in Washington can keep spending
away, without regard for projections of an exploding federal
deficit. And why the dollar remains relatively strong, despite
swelling trade deficits. Or why the Dow Jones Industrial
Average has managed to go for more than 912 trading days (now
913) without a 2% daily decline – the longest such stretch in its
history.

“Perhaps this flood of money will continue through the new year.
Fed Chairman Ben Bernanke has argued money flows are the
result of a ‘global savings glut.’ Newly enriched investors in the
developing world need to put their money somewhere, and
apparently, even the most risky assets will do.

“But as long as the good times are rolling, don’t expect Mr.
Bernanke to cut interest rates. That’s a tool he’ll only use when
the economy takes a serious turn for the worse. Those who
predict otherwise haven’t been listening to what he’s been
saying.

“And don’t be fooled into thinking that more drinking will ease
the inevitable hangover. At some point, something – a string of
big defaults, a sharp decline in the dollar, or, God forbid, a major
terror attack – will cause the intoxicating stuff to stop flowing.

“The world is still a risky place, and liquidity, at the end of the
day, is just another name for confidence. Eventually, this
confidence game will end.”

---

I’m off next week. Wall Street History will return Feb. 15 with
Ben Bernanke, part II. A look at the Fed and 2007. Now it gets
ugly.

Brian Trumbore