San Diego Housing Bubble News and Analysis

Congress is discussing a horrible idea, putting a "transaction tax" on every stock or option purchase or sale. Please consider AFL-CIO, Dems push new Wall Street tax.
08/30/09
The nation’s largest labor union and some allied Democrats are pushing a new tax that would hit big investment firms such as Goldman Sachs reaping billions of dollars in profits while the rest of the economy sputters.

The AFL-CIO, one of the Democratic Party’s most powerful allies, would like to assess a small tax — about a tenth of a percent — on every stock transaction.

Small and medium-sized investors would hardly notice such a tax, but major trading firms, such as Goldman, which reported $3.44 billion in profits during the second quarter of 2009, may see this as a significant threat to their profits.

“It would have two benefits, raise a lot of revenue and discourage speculative financial activity,” said Thea Lee, policy director at the AFL-CIO.

“The big disadvantage of most taxes is that they discourage some really productive activity,” she said. “This would discourage numerous financial transactions. People flip their assets several times in an hour or a day. They make money but does it really add to the productive base of the United States?”

Lee said that taxing every stock transaction a tenth of a percent could raise between $50 billion and $100 billion per year, which could be used to pay for infrastructure projects and other spending priorities. She said the tax could be applied nationwide or internationally.

In Congress, Rep. Peter DeFazio (D-Ore.), chairman of the Highways and Transit Transportation Subcommittee, has seized on the idea as a way to help pay for a new massive surface transportation reauthorization bill, estimated to cost $450 billion over six years.

Instead of taxing all stock transactions, as the AFL-CIO has contemplated, DeFazio wants to focus on oil-based derivatives.

At the end of July, shortly before the House broke for the August recess, DeFazio introduced legislation that would impose a 0.2 percent transaction tax on crude oil futures contracts. The legislation would tax the options for oil futures (in other words, the premium paid to have the option to buy a futures contract) at 0.5 percent.
Potential Financial-Transaction Tax of 0.25% on proceeds and purchases

Earlier this year Money Blogs was discussing Potential Financial-Transaction Tax of 0.25% on proceeds and purchases
Monday 01/19/2009
Details of a new, proposed tax — a financial-transactions tax on the sale or transfer of financial assets — have come to light, and it’s not good news for traders. This new tax sounds small in percentage terms — it’s only 0.25 percent of proceeds and purchases as proposed — but it can add up to large sums for day traders and other hyperactive traders and force them to exit this business activity. Many active traders have sales proceeds of $10 million or more per year; some have well over $100 million. A 0.25-percent financial-transaction tax on $10 million of proceeds and $10 million in purchases equals a $50,000-tax per year, even if they breakeven or lose money.

This new financial-transaction tax was proposed to apply to stock, options, futures, and perhaps many other types of financial instruments too. Passage would spell disaster for the trading and brokerage industries, including collateral service providers. Our firm is dedicated to online traders and hedge funds, so we would also be impacted if this tax is passed. We need to take action to see that this doesn’t happen.

How did this tax proposal come to fruition?

A “financial-transaction tax” reappeared as a tax proposal during the first round of TARP legislation negotiated and passed in the fall of 2008. But that proposal failed. The proposal for this new tax was buried in the fine print of the TARP bill and it did not receive much public attention at the time; the much bigger TARP issues overshadowed it.

Thankfully, this proposal did not survive final negotiations in Congress, as has been the case many times in the past. Can we count on Congress to keep putting this fire out over the next several years, considering that that media may turn negative toward traders and Wall Street in general? Britain and U.S. Clash at G-20 on Tax to Insure Against Crises

Unfortunately this ridiculous idea has surfaced again. Please consider Britain and U.S. Clash at G-20 on Tax to Insure Against Crises.
November 7, 2009
The United States and Britain voiced disagreement Saturday over a proposal that would impose a new tax on financial transactions to support future bank rescues.

Prime Minister Gordon Brown of Britain, leading a meeting here of finance ministers from the Group of 20 rich and developing countries, said such a tax on banks should be considered as a way to take the burden off taxpayers during periods of financial crisis. His comments pre-empted the International Monetary Fund, which is set to present a range of options next spring to ensure financial stability.

But the proposal was met with little enthusiasm by the United States Treasury secretary, Timothy F. Geithner, who told Sky News in an interview that he would not support a tax on everyday financial transactions. Later he seemed to soften his position, saying it would be up to the I.M.F. to present a range of possible measures.

“We want to make sure that we don’t put the taxpayer in a position of having to absorb the costs of a crisis in the future,” Mr. Geithner said after the Sky News interview. “I’m sure the I.M.F. will come up with some proposals.”

The Russian finance minister, Alexei Kudrin, also said he was skeptical of such a tax. Similar fees had been proposed by Germany and France but rejected by Mr. Brown’s government in the past as too difficult to manage. But Mr. Brown is now suggesting “an insurance fee to reflect systemic risk or a resolution fund or contingent capital arrangements or a global financial transaction levy.”

Supporters of a tax had argued that it would reduce the volatility of markets; opponents said it would be too complex to enact across borders and could create huge imbalances. Mr. Brown said any such tax would have to be applied universally. Tax Would Increase Volatility And Reduce Liquidity

I am aware of several large hedge funds that would move their operations overseas if this measure passed. If I am aware of some, I am sure there are hundreds more.

Think of the implications on traders thinking about stepping into a plunging market to buy. With this transaction tax who would want to step in? It sure won't be the LTBH clowns because they would already be in.

Right now shorts and short-term traders are the only ones who might step into plunging markets. The former to cover shorts, the latter to take a chance. Both provide much needed liquidity. The traders could count on a stop loss nearby where they can exit if wrong.

If this bill were to pass, there will be no one willing to step into plunging markets. Liquidity would immediately dry up.

Proposed as a way to soak the rich while decreasing volatility, this bill would soak all stock holders and increase volatility. The markets will crash if this bill passes. Of course Congress is doing so many other stupid things, the market is likely to crash anyway.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

The case of Mortgage Lender Implode-O-Meter vs. Mortgage Specialists Inc (MSI) has reached the New Hampshire Supreme Court. MSI has demanded Implode-O-Meter reveal the identity of one of its sources in a defamation case and Implode-O-Meter refuses.

Please consider New Hampshire Suit Challenges Mortgage Blogger's Use of Anonymous Sources
The New Hampshire Supreme Court heard oral arguments Wednesday in a lawsuit that calls into question the legal protections available to independent Web sites that cover news.

The case involves mortgage lender Implode-Explode, a Las Vegas-based site launched in 2007 that publishes stories about the meltdown of the mortgage industry.

The dispute began in November 2008 when The Mortgage Specialists Inc (MSI) won a temporary injunction requesting that a confidential document, "2007 Loan Chart," be removed from Implode-Explode's site, ml-implode.com. MSI also requested the identity of the source and of a commenter, "Brianbattersby," who they allege made defamatory comments about the company and its president.

Implode-Explode removed both the loan chart and the comments, but refused to either provide the identity of their anonymous sources or promise to refrain from posting the document again in the future. Unsatisfied, MSI pressed for a permanent injunction against the site and won the case in a New Hampshire Superior Court in March 2008.

Aside from those facts, nearly everything else about the case remains in dispute. During their extended 15-minute presentations before the court, the two lawyers called on precedents from Dendrite International v. Does and The New York Times v. United States to argue their claims of anonymous sources and confidential documents, and what constitutes a real journalist.

Jeremy Eggleton of the Orr & Reno, the firm representing Implode Explode, spoke first, calling the injunction a case of prior restraint and a violation of the "basic principals of the First Amendment," that, "tramples on the rights" of his client to speak freely.

Alexander Walker of Devine Millimet & Branch, speaking for MSI, dismissed the First Amendment concerns as a red herring in the case. "This is not the Pentagon Papers," he said. "They [Implode Explode] are not journalists."

According to Sam Bayard, a fellow at the Berkman Center for Internet & Society at Harvard, and assistant director of the Citizen Media Law Project, the potential impact of any decision is the shortage of case law dealing with these issues in an online context. "As we are moving online and our journalism is going online," he said, "this could have a big impact."

If the court rules against Implode, Bayard also cited the precedent-setting New York Times v. United States as an example of the concern. In today's environment, The New York Times would post the Pentagon Papers Web-first. If MSI's claim is upheld, he said, it would be as if "two days later the government came along and filed an injunction" and then the papers were removed as if they never existed. Fraud Charges Against Mortgage Specialists

The origin of the dispute goes back to Summer of 2008 when Mortgage Specialists Faces Fraud Charges.
The New Hampshire Banking Department has received nine consumer complaints about The Mortgage Specialists in the last few years, but it was the department's routine check of the business that led to fraud charges.

The Mortgage Specialists was issued a cease-and-desist order it must respond to within 30 days, according to department spokesman Rich Arcand. The company, which received the order last week, could face $200,000 in fines and revocation of its license.

Banking Department staff visited the main office in Plaistow a few weeks ago to perform an examination that is routinely administered every 18 months, Arcand said.

When the department asked for 20 files stored at a site within a 10-minute drive, it took more than four hours for employees to return with the folders, according to the cease-and-desist order. Documents were missing from all the files, but the department said it later found some of them in a bin waiting to be shredded.

The department found customers' signatures had been photocopied and attached to new documents, the order said. Two broker fee agreements and an application for a federal mortgage loan were also altered.

The Mortgage Specialists couldn't provide two requested files of canceled loans, and the Banking Department said it also found those files in the shred bin.

The Massachusetts Division of Banks was just finishing its own routine examination when it uncovered the use of unfair and deceptive practices, such as inflating borrower income, according to the cease-and-desist order the state issued yesterday.

"The division's temporary cease-and-desist order requires The Mortgage Specialists to place all remaining loans with a qualified lender or broker with no loss to consumers and forbids the company from initiating any new mortgage loan transactions," spokeswoman Kimberly Haberline said.

The charges include 14 counts of fraud, 20 counts of incomplete records, 15 counts of dishonest and unethical practices, and three counts of destruction of records.Scandal-tainted N.H. mortgage co. gets to keep Mass. license

Inquiring minds are reading Lenders cry foul over firm.
A scandal-tainted home-loan firm that's using Red Sox knuckleballer Tim Wakefield as a pitchman should be thrown out of the mortgage game, some Bay State lenders say.

Home-loan executives are blasting regulators' decision to let Plaistow, N.H.-based The Mortgage Specialists Inc. stay in business despite allegedly forging client signatures and dumping incriminating records.

Massachusetts and New Hampshire regulators OK'd a settlement under which Mortgage Specialists will keep licenses in both states but pay $725,000 in fines.

The firm - which admitted no wrongdoing - will also hire outside auditors to review records back to 2005, as well as going forward for up to three years.

The deal comes after state inspectors allegedly found Mortgage Specialists had cut-and-pasted customer signatures onto some documents instead of getting real sign-offs.

In one case, a client who applied for a 30-year mortgage allegedly wound up with a much-more-costly 40-year loan - apparently without the person's knowledge.

Another loan application reputedly inflated a woman's 2005 income to $99,000, even though she made just $17,700 as of 2007, according to court filings.

Inspectors allegedly found many suspect documents in a shredding bin after Mortgage Specialists took four hours to produce files stored just 10 minutes away.

Mortgage Specialists President Michael Gill has a controversial history.

Outside of the loan business, Gill is one of thoroughbred racing's most successful horse owners, winning millions of dollars in purses. He's even netted an Eclipse Award, the industry's top honor for owners.

However, tracks in New York, Delaware and elsewhere have partly or fully banned Gill's horses over the years amid speculation that his animals received performance-enhancing drugs.

Gill has denied such charges, but one of his horses did test positive for the substance benzylpiperazine at Boston's Suffolk Downs in 2001.

Six years earlier, New Hampshire racing officials banned Gill for three years after a horse he trained came up positive for the drug clenbuterol. I spoke with Aaron Krowne this morning via Email.Aaron writes:

Here are some additional statements I can give.

(1) Our belief is the "brianbattersby" forum comment now removed from the site was substantially true. We do not think we should have to censor it or disclose who the person is.

(2) We have received substantial, additional highly-detailed information from a person or person(s) who clearly was at the company or close to it while fraudulent activities were going on, and is attempting to leak them. However, we no longer can release this information thanks to the lower court's ruling and the general air of "shoot the whistleblower" surrounding this case.

(3) The Loan Chart that MoSpec is claiming is "secret" is not only not secret according to the law (NH banking regulations state only that the Banking Commission can't release the info), but our best information is that it was actually sent openly to MoSpec investors. So MoSpec themselves would be the "leaker". After all, it is merely their production volume, and theoretically, any company MoSpec sells or brokers loans to would have a copy of that chart.(4)

Point #2 above is in all likelihood the real reason for this "SLAPP" suit. I believe the court ruled improperly in forcing the documents to be removed from Implode-O-Meter. Moreover, I believe Aaron should be able to post all of the relevant documentation he has on The Mortgage Specialists.

While some may consider a $725,000 fine substantial. I do not believe it was substantial enough. The sad irony in this case is that The Mortgage Specialists is fighting to shut down Implode-O-Meter, when it is The Mortgage Specialists who should be shut down.

This case has profound implications on the right of online journal and blogs to state their case. This is both a freedom of speech case and a journalist right to protect sources case.

Aaron Krowne and Implode-O-Meter deserve your support.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

This morning, the Bureau of Labor Statistics (BLS) released the Odctober Employment Report.

The unemployment rate rose from 9.8 to 10.2 percent in October, and nonfarm payroll employment continued to decline (-190,000), the U.S. Bureau of Labor Statistics reported today. The largest job losses over the month were in construction, manufacturing, and retail trade..




Establishment Data



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Highlights

• 190,000 jobs were lost in total vs. 263,000 jobs last month.
• 62,000 construction jobs were lost vs. 64,000 last month.
• 61,000 manufacturing jobs were lost vs. 51,000 last month.
• 61,000 service providing jobs were lost vs. 147,000 last month.
• 40,000 retail trade jobs were lost vs. 39,000 last month.
• 18,000 professional and business services jobs were added vs. 8,000 lost last month.
• 45,000 education and health services jobs were added vs. 3,000 added last month.
• 37,000 leisure and hospitality jobs were lost vs. 9,000 last month.
• 00,000 government jobs were lost vs. 53,000 last month.

A total of 129,000 goods producing jobs were lost (higher paying jobs). Retail and professional services contributed to to the plus side.

Last month I noted "The one cheery bit of news in the above numbers is the loss of 53,000 government jobs. Unfortunately, this trend is likely to reverse in a major way with as of yet unannounced son-of-stimulus and grandson-of-stimulus jobs packages."

On a month to month basis Government jobs were up by 53,000 even though they did not add any overall jobs. Government jobs, education, and to a lesser extent professional jobs accounted for all (and then some) of the improvement vs. last month.

Note: some of the above categories overlap as shown in the preceding chart, so do not attempt to total them up.

Index of Aggregate Weekly Hours

Work hours were flat at 33.0. Short work weeks contribute to household problems. Moreover, before hiring begins at many places, work weeks will increase.

Birth Death Model Revisions 2008



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Birth Death Model Revisions 2009



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Birth/Death Model Revisions

After the typical in January in which the Birth/Death Model revisions bore some semblance of reality, the Birth/Death numbers remain in deep outer space.

At this point in the cycle birth death numbers should have been massively contracting for months. The BLS is going to keep adding jobs through the entire recession in a complete display of incompetence.

However, what does stand out last month at -33,000 jobs and again this month at -36,000 Leisure and Hospitality Jobs.

Leisure and Hospitality Categories

• Arts, entertainment, and recreation
• Food services and drinking places
• Hotels and other accommodations

Think consumers are not cutting back on discretionary spending?

Please note that one cannot subtract or add birth death revisions to the reported totals and get a meaningful answer. One set of numbers is seasonally adjusted the other is not. In the black box the BLS combines the two coming out with a total. The Birth Death numbers influence the overall totals but the math is not as simple as it appears and the effect is nowhere near as big as it might logically appear at first glance.

BLS Black Box

For those unfamiliar with the birth/death model, monthly jobs adjustments are made by the BLS based on economic assumptions about the birth and death of businesses (not individuals). Those assumptions are made according to estimates of where the BLS thinks we are in the economic cycle.

The BLS has admitted however, that their model will be wrong at economic turning points. And there is no doubt we are long past an economic turning point.

Here is the pertinent snip from the BLS on Birth/Death Methodology.

• The net birth/death model component figures are unique to each month and exhibit a seasonal pattern that can result in negative adjustments in some months. These models do not attempt to correct for any other potential error sources in the CES estimates such as sampling error or design limitations.
• Note that the net birth/death figures are not seasonally adjusted, and are applied to not seasonally adjusted monthly employment links to determine the final estimate.
• The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.

Household Data
In October, the number of unemployed persons increased by 558,000 to 15.7 million. The unemployment rate rose by 0.4 percentage point to 10.2 percent, the highest rate since April 1983.

Since the start of the recession in December 2007, the number of unemployed persons has risen by 8.2 million, and the unemployment rate has grown by 5.3 percentage points.

Among the major worker groups, the unemployment rates for adult men (10.7 percent) and whites (9.5 percent) rose in October. The jobless rates for adult women (8.1 percent), teenagers (27.6 percent), blacks (15.7 percent), and Hispanics (13.1 percent) were little changed over the month.

The civilian labor force participation rate was little changed over the month at 65.1 percent. The employment-population ratio continued to decline in October, falling to 58.5 percent.

The number of persons working part time for economic reasons (sometimes referred to as involuntary part-time workers) was little changed in October at 9.3 million. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.

Persons Not in the Labor Force

About 2.4 million persons were marginally attached to the labor force in October, reflecting an increase of 736,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Among the marginally attached, there were 808,000 discouraged workers in October, up from 484,000 a year earlier. (The data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The other 1.6 million persons marginally attached to the labor force in October had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities.Some "Recovery"

In a typical recovery, the participation rate should go up not down. The reason is people hear there is a recovery, hear things are getting better, hear the talk about "green shoots" and think there might be a job if they go looking.

Last month the participation rate dropped by .3% and the civilian labor force drop by 571,00 workers. This month the participation rated ticked down again by .1% while the civilian labor force dropped by 31,000. In normal condition, the civilian labor force ought to be growing by 120,000 a month due to increasing population and immigration.

Is this a "recovery"?

Table A-5 Part Time Status



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The chart shows there are 9.28 million people are working part time but want a full time job. A year ago the number was 6.8 million.

Note the trend in part-time work. It is inching up. In a recovery it should be headed down quickly. The reason is employers increase the hours of part-time workers before they start hiring full-time workers.

The key take-away from this series are the millions of workers whose hours will rise before companies start hiring more workers.

Table A-12

Table A-12 is where one can find a better approximation of what the unemployment rate really is. Let's take a look



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Grim Statistics

The official unemployment rate is 10.2% and rising. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

It reflects how unemployment feels to the average Joe on the street. U-6 is 17.5%. Both U-6 and U-3 (the so called "official" unemployment number) are poised to rise further although most likely at a slower pace than earlier this year.

Looking ahead, there is no driver for jobs and states in forced cutback mode are making matters far worse.

Unemployment is likely to continue rising until sometime in 2011.

Depression Level Statistics

I consider these job losses to be depression level totals. Admittedly conditions are not as bad as the great depression, but this is certainly no ordinary recession by any economic measure including lending, housing, bank failures, jobs, the stock market, commodity prices, treasury yields etc. For more on this idea please see Humpty Dumpty On Inflation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Although I have mentioned the enormous property bubble in Canada on numerous occasions, I have also stated a belief that Canada as a whole was better off than the US.

Not so fast says Jonathan Tonge of the America Canada Blog.

Jonathan pinged me with the following email:
Mish,

Observing the attached August 2009 GDP report you’ll note that Canada’s economy is still receding and it has not escaped recession. Furthermore, the only sectors that are growing are from the result of one of two things: stimulus and a massively inflationary credit environment.

Canadian Real Estate:

Canada’s home prices have skyrocketed in this recession. When the dollar was at 97 cents US a couple weeks ago, average Canadian home prices hit roughly $320,000 US – an all-time high. Residential mortgage debt has over doubled since 2002. We will surpass the US in per capita residential debt within the next year. In 2009 alone, we will add 100 billion in fresh residential mortgage credit (equivalent of about 1 trillion in the US on a per capita basis)

The average price of a detached Toronto home has approached $600,000. I have attached a home listed at $559,000. The home is about a 15 minute drive from downtown in an average location. It is clearly overvalued.

The listing-to-sales ratio in Toronto, the fifth largest city in North America, has surpassed the late 1980’s bubble. Moments after that point Toronto’s housing market crashed losing 25% of its value and the country went into a deep recession. Toronto’s housing market took 12 years to recover, and needless to say its recovery was brought on by a massively inflationary credit environment.

In the greater Vancouver area, our third largest metropolis after Montreal, the average price of a detached home in March 2008 was $921,000. In fall of 2008 the market tanked, but only to find itself growing again in 2009. By September 2009 the average price was back up to $904,000. Average household incomes in Vancouver are lower than average incomes in Toronto. They hover somewhere around the $70,000 mark.

All of these prices are one hundred percent attributable to ultra low interest rates and a government insured credit market. CMHC, the equivalent of Fannie and Freddie, has expanded securitization of mortgage debt to nearly 100% of the credit market in Canada. The government of Canada insures the securities. The healthy banks in Canada, something that gets bragged about internationally, have fewer loans on their books then they did in 2007. This is despite the credit market growing by 30% since then.

The Bank of Canada has already admitted to a real estate bubble in Canada. Mark Carney, head of the BOC, has threatened to manipulate the mortgage market if borrowers don’t come to their senses.

Exports and Buy America:

Exports to the United States have fallen nearly 50%, in part thanks to “Buy America”.



I was just transferred from our Mississauga, ON offices to Hamilton, and I get the pleasure of driving through the steel armpit of Ontario daily. US Steel purchased Stelco, our largest steel manufacturer, two years ago and just after it received hundreds of millions from Ontario’s provincial government to keep operating. Within days of “Buy America”, US steel shut down the Canadian Stelco plant.

A few months ago, as the benefits for the laid off workers dried up, US Steel was notified that they would have to either bring the workers back or pay out their pensions. US Steel decided to bring them back to work. Instead of making steel, they painted all the buildings in a fresh coat of blue paint. If you understand the size of the Stelco plant and buildings, then you can understand what a formidable task this was.

A couple weeks after it now appears that all the buildings are blue and the workers have been laid off again. However the steel mill now sends clouds of pollution miles high in the sky. I have been told by some locals that the US Steel sends its iron ore to the plant to be refined. Once refined it is put back on the ship and sent to one of their US plants – most likely in Gary Indiana – to be turned into steel. So we get the pollution up here but none of the profits or labour. The government of Canada has taken US Steel to court for $10 million per day for breach of contract.

Wait until more Canadians find out about this. “Buy Canada’, or more plausibly, “Do Not Buy America” will gain steam. We’re a free trade country by and far, but “Buy America” has been a hard hit below the belt for most of us.

Deficits:

In Ontario, a province with 1/3 the number of citizens as California, we are running a 25 billion deficit, which is getting revised upwards of 10 billion every two months. On top of that the governments in Canada are in bed with the government unions, and for obvious reasons they truly believe that running massive deficits are good for the economy. They remember nothing of the hardship that Canada went through in the 90’s when our debt-to-gdp topped 100%, our country went into deep recession, and we lost our triple A rating.

As an example of this ludicrous spending, Ontario, despite the record deficit, just passed all day kindergarten. The program, a concoction of the teacher’s union, insisted that the all day program shall be taught by university educated teachers. These teachers can earn almost $100,000 per year. The program is expected to serve up to 100,000 students and cost $1.5 billion per year. That’s $15,000 per year per child to receive an additional half day of kindergarten class.

Between our federal and provincial governments we will run deficits well over 100 billion. On a per capita basis, that is the equivalent of the US running a trillion dollar deficit. This is the fastest and most significant meltdown of our national finances in a single year in history. Last year almost everything was operating in surplus.

Conclusion:

All in, I’d short Canada if it was a stock. This isn’t good news for America. We are by far your largest trading partner. We consume more American made products than any other nation by a long shot (4 times what China consumes). If our economy crashes in the near future, it will impact tens of millions of US workers who depend daily on the free trade of goods between our countries.

Regards,
Jonathan TongeCHMC - Canada's Fannie Mae

Please consider CMHC - Canada's Breaking Point by Jonathan Tonge.Everyone here is probably very well aware of who CMHC is.

For any international visitors, CMHC was formed as a crown corporation in Canada after World War II to address the shortage in housing. It's mandate was to make home ownership accessible to all Canadians. CMHC primary deliverable is mortgage insurance and mortgage backed securities. Think Fannie and Freddie.

In 2001 GE Capital was permitted to join CMHC in the Canadian mortgage insurance industry to provide competition in the marketplace. GE Capital began insuring Canadian mortgages and issuing NHA-MBS (Mortgage Backed securities insured by the Government of Canada). In response to competition, CMHC began its trip down a new road.

In 2002 total outstanding mortgage debt in Canada was still a cool $467 billion. This was predominantly issued to good credit and people with proper downpayments. CMHC insured a small portion of this debt.

In 2003 CMHC decided to remove the price ceilings limitations. That is, it would insure any mortgage regardless of the cost of the home.

In 2007, after years of lobbying, the now defunct AIG found new hope with the newly elected Conservative government. AIG was now permitted to insure high risk Canadian mortgages. It was also permitted to issue mortgage backed securities and exchange these on the open market. At the same time, the Conservative government launched a radical policy that allowed CMHC, AIG & GE to insure 35 year ams and 0% down payments. A few months later this was expanded to 40 year amortizations.

Thanks to this stimulus in 2007 the market radically changed.

Historically high home prices continued to gain steam. High risk borrowers flooded the real estate market. Throughout 2007, the average home buyer who took out a mortgage had only 6% equity in their homes. That's the national average downpayment for all mortgages including buyers who moved up.



CMHC mandate is to help provide affordable housing. Yet it has only served to fuel the credit markets, increasing the price of homes well beyond affordable levels.
Inquiring minds are reading When Home Prices Rise also by Jonathan Tonge.I'm about to offer the absolute best evidence of why Canada's housing market has to crash. It's written into the cards. So here it is in three quick charts.

We can start off by taking a quick snapshot of residential mortgage credit in Canada over the past thirty years.

Total Residential Mortgage Credit



Residential Mortgage Credit as a Percent of Salaries and Wages



Click on the chart for a sharper image. Note that in the past thirty years, home prices have only risen substantially when credit is accelerating.

This summer brought to us record home sales and average prices despite stagnating incomes. This was all caused by government stimulus priming the credit markets - mostly thanks to CMHC and the Bank of Canada.



In 1985 we borrowed 45% of our gross salaries and wages to pay for housing. By April of 2009 we borrowed 110%. This of course is an average of our entire country including those without mortgages.

To the bulls and bears, please put aside your emotions. A real estate correction is written into the cards. It's a mathematical must.
Vancouver Ownership vs. Rental

Here is an Email from "Ian" on the merits (or lack thereof) on owning a house in Vancouver.

Ian Writes:
Mish

I just did a quick comparison to see what the premium to own vs. rent in Vancouver & Toronto looked like, and I thought you may be interested.

Vancouver

Unit 1101-550 beach is available to purchase for $759,000



Unit 2101-550 beach is available to rent for $2300/month

Assuming: The purchaser pays full price, gets a 5 year closed at 4.1% and puts 20% down, the monthly cost to buy (including condo fees) is $3718. Premium to own vs. rent is 62%…..not to mention the additional $72k the Vancouver buyer needs in order to put down 20%.
Ian had Toronto examples as well but unfortunately the listings expired. The bottom line from Ian is Toronto is much more affordable than Vancouver (at least on a comparison of price to own vs. rent).

Ian Continues ....
I guess it’s important to consider a few other differences between the two cities.

Toronto/Ontario has:
A higher rate of population growth 9.2% vs. 6.5% (5 year average)
Higher median income ($78,802 compared to $74,961)
Higher savings rate (3.7% ONT vs. -2.6% for BC)
A bigger and more diverse economy

Vancouver/BC has:
A more aesthetically appealing city
A better hockey team
Way more StarbucksOntario deficits: No one cares

Deficit spending is not just for the US. Canada likes them too (and so does the UK, Japan, China, and everywhere else). Please consider Ontario deficits: No one cares
October 22, 2009 5:09 PM
Bond markets shrugged off news that Ontario will run a larger-than-expected $24.7-billion deficit.

There was widespread anticipation that Canada’s most populous province would overshoot its deficit forecast going into Thursday's economic update. So bond traders said the spread, or premium, on benchmark Ontario bonds widened by just one basis point when Finance Minister Dwight Duncan revealed an additional $6.2-billion in deficit spending.

Ontario is expected to see its total borrowing requirement for this fiscal year increase by $3.2-billion to $42.6-billion. A large portion of that additional borrowing - up to 50 per cent, according to investment banking sources - will be done on international markets.Ontario taxpayers bracing for years of deficits

The Vancouver Sun notes Ontario taxpayers bracing for years of deficitsOctober 21, 2009
Ontario’s finance minister is bracing taxpayers for years of budget deficits, warning Canada’s most populous province could be in for a “long, slow grind” before it swings back to true economic recovery.

The scope of Ontario’s financial crisis is underscored by its sputtering economy, so closely tied to the United States.

The province’s gross domestic product, a key measure of economic health that represents the dollar value of all goods and services produced, stood at $508.9-billion in the second quarter. That’s roughly the same size as it was in 2005, meaning Ontario’s economy has not grown in the four years since. Government revenues are also now back at levels they were that year.

Since peaking in the fourth quarter of 2007, real GDP has shrunk 5%.

Corporate tax revenues have plunged over the past year as the recession took hold. That in turn will make it more difficult for the province to dig itself out of a deficit position by 2015 as promised.

Ontario is not alone however. Based on the most recent estimates compiled by TD Bank Financial, the federal and provincial governments combined are on pace to tally a deficit of $85-billion in fiscal year 2009-2010 on an aggregate basis, representing 6% of GDP.

TD Bank says the real shortfall could top $100-billion as governments revise their estimates higher. Tackling the deficits will be made tougher by the likelihood of a historically slow rate of GDP growth nationwide and age-related spending challenges like seniors’ benefits, the bank said in a report released Tuesday.

Exactly how Ontario intends to sustain its public services while restoring a balanced budget is still unclear. The province spent $4-billion to help rescue General Motors Co. and Chrysler earlier this year. It is running a deficit that’s roughly 20% of total revenues, according to TD -- the highest ratio of any province.Ontario credit downgraded by S&P

The Financial Post is reporting Ontario credit downgraded by S&P after record deficit projection
The Ontario government had its credit rating downgraded one category by Standard and Poor's Ratings Services on Thursday in response to its recent projection of a record deficit and negative prospects for the province's economy going forward.

The province's rating was dropped to AA-minus from AA.

Last week the Ontario government said it expects to run a deficit of $24.7-billion in the current fiscal year, up from its expectation of $14.1-billion in March.

The bigger shortfall is largely a result of more money being spent than earlier expected, including $4-billion that's going toward auto-industry bailouts. As well, it expects now to get $5.8-billion less in tax revenues than previously anticipated as earnings for both companies and individuals alike have taken a hit from the recent recession.Government To The Rescue

In an amazing bit of irony Ontario schools to teach financial literacy. Starting in September, 2011, Ontario students from grade four to 12 will learn how to better manage their money in courses that will be integrated into their overall school curriculum in an effort to improve financial smarts.

“The global economic challenges of the last year have highlighted the need to ensure a financially literate population,” Ontario Education Minister Kathleen Wynne said in a statement. The Globe and Mail had this iStockphoto to go along with its financial literacy article.



The person really needing financial literacy education is ...



Dalton McGuinty, Ontario's 24th Premier.

I have certainly been wrong about when Canada's housing bubble would burst for good. However, burst it will and when it does the pain will be no less than what has happened in the US.

By the way, with reckless spending everywhere, it is no wonder gold is soaring.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I have received a couple more replies to Government and Lender Policies of Fear and Shame Help Keep Homeowners Debt Slaves that are worth sharing.

This one is from "Wells Fargo Madness" who writes:
What a timely and spot-on post....

I can personally attest to the truth of the situation described in your latest missive:

"Given these economic incentives for the lender, a seriously underwater homeowner with good credit and solid mortgage payment history who responsibly calls his lender to work out a loan modification is likely to be told by his lender that it will not discuss a loan modification until the homeowner is 30 days or more delinquent on his mortgage payment.

The lender is making a bet (and a good one) that the homeowner values his credit score too much to miss a payment and will just give up the idea of a loan modification.

However, if the homeowner does what the lender suggests, misses a payment, and calls back to discuss a loan modification in 30 days, the homeowner is likely to be told to call back when he is 90 days delinquent. In the meantime, the lender will send the borrower a series of strongly-worded notices reminding him of his moral obligation to pay and threatening legal action, including foreclosure and a deficiency judgment, if the homeowner does not bring his mortgage payments current. The lender is again making a bet (and again a good one) that the homeowner will be shamed or frightened into paying their mortgage. If the homeowner calls the lender’s bluff and calls back when he is 90 days delinquent, there is a good possibility that he will be told that his credit score is now so low that he does not qualify for a loan modification."

I bought a house back in 2004, having moved halfway across the country for a new job. It was a house I could comfortably afford - I made a little over $70,000 as a senior manager for a newspaper, and my mortgage was a little under $900 a month (including taxes and insurance), fixed at 5.25% for 30 years with Wells Fargo. In spite of the pressure put on me by a broker when I was buying, I avoided the no money down variable option because I wanted to do what I thought was the responsible thing to lock in my payments at a decent rate I knew I could afford and avoid the reset lotto.

In April of 2008, I was notified that the job I had moved across the country for was set to be eliminated, along with the entire staff of my department. The company I worked for was highly levered in an environment where revenues were shrinking, and 'consolidations' were being made across the company. The day I found out that I was going to be out of work, I called Wells Fargo to see if it would be possible to make some alternate payment arrangements until I found work, and was told precisely what the article you reference noted - that they couldn't even discuss the matter with me until I was 30 days in arrears. I was mortified, knowing that being 30 days in arrears would leave me with the dreaded 'mortgage late' on what had been a pristine 800 credit score. I had been prudent and saved a fair sum of money, so I decided to try and keep the plates spinning while I looked for work.

I applied myself to the job hunt, but with nearly 50 positions eliminate from my company and a few hundred at other domestic newspapers who shared my area of specialty, it was a tough task finding work.

Then in August, Gannett, the biggest newspaper company in the world, announced that they would be laying off 1000 workers, and my sources inside Gannett told me that they were going the 'consolidation' route, meaning that in the course of 3 months nearly a third of the total positions in my field had gone *poof*. My prospects for finding work in the industry where I had experience had just gone from tough to Quixotic.

I again called Wells Fargo to see if there was anything they could help me with that didn't involve damaging my credit - I still had a sizable amount of savings to negotiate with - but the answer was the same: 30 days late or no discussion. I decided I'd have to take them up on the offer.

When 30 days had elapsed, I contacted them once again, only to now be told that they couldn't work out any arrangements until I had found work. I was angry, as one might imagine. I decided that they had received the last payment they were going to receive from me. Fourteen months later, I have kept the vow.

I'm not proud of walking away from my 'responsibility', but in light of the situation - nearly 18 months without finding work - it seems that it was the best thing that could have happened. If I had kept paying all along, I'd have depleted a good deal of my savings, and I'd still be facing losing the unemployment benefits that are keeping the other bills paid. As it stands, I've still got that nest egg to see my family through the rough days that lie ahead.

I've been to the housing counselors the state has set up, and the best they were able to do for me was that I could pay off the back payments, penalties and interest, and resume making payments.

My house is set to be sold at auction next week, and due to the rules in the state, the minimum price will be well in excess of what I suppose the market price would be. I expect that the bank will be the buyer by default.

If my experience is representative, walking away might be the best option.

From Wells Fargo's perspective, this was an avoidable situation. I called them when I found out about my joblessness, and I did everything I could to avoid a default. All I wanted was some recognition that I was willing to work with them if they would work with me - maybe only paying interest until I was able to find something.

However, once I felt double-crossed, having been told to let it go into arrears so that they could work with me, and then to be told they still couldn't work with me, I did what I thought was prudent. I decided to see how long I could live rent free. As of today, it's been almost 14 months.

Assuming that the house sells next week and I get an order to vacate the next, I'll be here through the end of January (it takes a minimum of 60 days to affect an eviction here). More likely, I won't get the order to vacate until the bank sells my house as part of a package foreclosure deal for about 20 cents on the dollar. I might get to live here rent-free for a good spell longer. I could have, and probably would have, paid them nearly 50% of the house's value as a cash settlement 14 months ago if they'd been willing to have a conversation.

I've come to the realization that I'm not going to find work in the field to which I'm accustomed and I'm back in school to get another degree. I started in August after the Gannett news came out, as much to avoid a long gap in my resume without an explanation as anything else. I've been doing programming and database work since I minored in computer sciences 15 years ago, but I figured I'd legitimize my skills with a degree - since I have the down time. I've got 8 classes to go and a 4.0 GPA. The big question is: will I find work when I get done this spring?

"Wells Fargo Madness"
Thanks "Wells Fargo Madness". Good luck on your job hunt! You did the smart thing and the moral thing as well, which is to protect your family instead of the piranhas at Wells Fargo. When a significant percentage of those Option ARM holders Wells Fargo start to walk (and I believe they will), Wells is going to be in deep trouble.

Misguided Morality

In a comment on this blog to the original post, Ron writes:
Walking away because you can't make the payments is understandable. Walking away even though you can make the payments tells something about your character and morals.

It does not matter if everyone else in the world is doing it. Justifying something just because others are doing it does not make it right. A person of morals and character knows this and will never be convinced otherwise.

That is what I was taught as a youth by those I respect. No amount of criticism will change my beliefs.Ron and others are entitled to believe what they want.

However, the sad reality is that "misguided morality" perpetuates the problem. The quicker homes fall and the quicker bad debts are written off and the quicker that we kill one-sided morality the better off we will all be.

If there is any morality at all in these situations it consists of two things:

1) Doing the best to take care of one's family
2) Lenders preying on misguided morality

Those waking away are not only doing the smart thing for themselves, they are also helping the economy over the long haul. The Fed criticized Japan for years for not writing off bad debts and making the banks Zombies.

The US has not only Zombified banks, but Zombified consumers, all for the sake of misguided morality that does not stand up to scrutiny if one would simply read and understand Government and Lender Policies of Fear and Shame Help Keep Homeowners Debt Slaves.

Consult An Attorney

If you are considering walking away, please Consult An Attorney Before Walking Away.

Thoughts on Foreclosure Hearings and Deficiency Notes

To tie up some more loose ends, Larry Nusbaum at the Millionaire Now Blog wrote:

I am a RAC (Resolution Assistance Contractor) for the FDIC and wanted to add to what attorney Dan McKillop, J.D stated in the "Consult An Attorney" advice:

• Since Florida is a Judicial Foreclosure state I would attend the Foreclosure Hearing and demand that the foreclosing lender "produce the note", because the may not have it. Also, take the appraisal to the judge.
• The decision to pursue a deficiency is going to be based on the financial picture of the (former) borrowers. In many cases I instruct our attorneys not to bother and simply write it off if the guy has no money.
• However, in many cases, the Deficiency Balance (note) will be sold for cents on the dollar. So, in that case it makes sense for the borrower to make an offer to pay off the now greatly reduced note. But, in that scenario do not settle the deficiency! Buy the note for the agreed upon price so that no 1099 is issued.
• 1099? Yes, if you do a short-sale or foreclosure AND the bank/lender writes off the deficiency you get a 1099.
• Lastly, a judgment, can always be included in a Chapter 7 federal bankruptcy

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

The Senate approved yet another plan to stimulate the economy. It's called throwing $33 billion at homebuilders. This is of course doing nothing but giving money to the greedy pigs that helped create this mess. However, that is the way Washington works.

Senate Majority Leader Harry Reid even had the gall to brag about it. Please consider Senate Approves Extended U.S. Homebuyer Tax Credit.
The U.S. Senate approved a $45 billion plan to expand a tax credit for first-time homebuyers, extend jobless benefits and provide tax refunds to money-losing companies.

Lawmakers voted 98-0 for the measure, sending it to the House, where Majority Leader Steny Hoyer of Maryland said in a statement it will receive a vote as early as tomorrow. The bill then would be forwarded to President Barack Obama for his signature.

The plan would be the first major extension of provisions in February’s economic stimulus plan. The $8,000 homebuyers’ tax credit, slated to expire this month, would continue until April 30 and be expanded to include people with higher incomes and some who already own homes. That would cost about $10 billion in the fiscal year that began Oct. 1, according to Congress’s Joint Committee on Taxation.

The measure includes $2.4 billion to extend unemployment benefits for as many as 20 weeks, enough to aid the jobless through the holiday season. It would loosen tax rules for homebuilders and other money-losing companies to let them claim an estimated $33 billion in tax refunds this year, according to Joint Committee on Taxation estimates.

“Republicans used every trick in the book to slow and stall and ensure we can’t do important work,” Senate Majority Leader Harry Reid, a Nevada Democrat, said today.

Other Stimulus Measures

Lawmakers are still considering whether to extend several other elements of the stimulus package, including subsidies to help the jobless buy health insurance and increased funds for food stamps. Obama has called for sending seniors $250 checks because they won’t get a cost-of-living increase next year in their Social Security checks.

Waste of Money

Senator Christopher Bond, a Missouri Republican, called the tax credit a waste of money, saying studies show that most of those claiming the break would have bought homes anyway.

Goldman Sachs Group Inc. said in a research note yesterday that the credit probably spurred 200,000 home sales that otherwise wouldn’t have occurred.

Extending the credit to people who own homes wouldn’t reduce the excess housing blamed for the slump because “every buyer taking advantage of the move-up credit would necessarily be a seller,” Goldman Sachs said. It said the plan may increase housing prices by 1 percent because “sellers are likely to incorporate a fraction of the credit amount in their sale prices.” Waste Of Money

Of course it's a waste of money. The most galling thing about it is $33 billion of the $45 billion is not going to do anything but pad the pockets of those who helped create this mess. A mere $2.4 billion was given to extend unemployment benefits.

If Goldman Sachs is correct (and I believe they are), then most of the $10 billion in tax credits is a waste as well. Moreover, we have a huge inventory of homes already and we are creating incentives to build more.

The whole thing reeks and the Senate knows it. Note that Senator Christopher Bond called it a waste of money but there was not a single "No Vote". The bill passed 98-0 undoubtedly because the homebuilders padded the pockets of those voting for it with campaign contributions. This is the way Congress "works".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

It's no wonder that gold is soaring with the US, UK, and China all printing money like mad. Throw enough money around and gold is bound to rise regardless of anything else that might happen (all of it bad).

Please consider the latest insanity in the UK: BOE May Expand Bond Plan as Officials ‘Throw Money’ at Economy.
The Bank of England may increase its bond-purchase plan by 50 billion pounds ($83 billion) today as central bankers and politicians scramble to shore up Britain’s banking system and drag the economy out of recession.

Governor Mervyn King’s nine-member Monetary Policy Committee will expand the asset-buying program to 225 billion pounds at 12 p.m. in London, the median of 48 forecasts in a Bloomberg News survey shows. That follows Prime Minister Gordon Brown’s pledge this week to spend almost 40 billion pounds in a second bailout of two the nation’s biggest banks.

Any increase in the Bank of England’s emergency program would be the third since King unveiled the plan in March. Brown’s first bank bailout, the government’s fiscal stimulus measures and an injection of 175 billion pounds in newly printed central bank money have so far failed to end Britain’s longest recession on record.

“They’ve got to throw money at it,” said Neil Mackinnon, an economist at VTB Capital Plc and a former U.K. Treasury official. “The fact of the matter is that the U.K. economy is lagging behind. As to whether quantitative easing is working, the jury is still out.” Quantitative Easing History Lesson

Mackinnon does not know if the strategy is working yet still insists “They’ve got to throw money at it.”

Neil Mackinnon is in dire need of a history lesson. Quantitative Easing was a spectacular failure in Japan, it will prove to be a spectacular failure in the UK as well. For more on the lesson of Japan, please see Is Debt-Deflation Just Beginning?

However, this should not take a history lesson. Common sense alone says you cannot cure a debt problem by throwing still more money at problems hoping something will stick.

It is impossible to have a sustainable recovery based on loose money policies. The global housing bubble should be proof enough of that.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Crain's Chicago Business is reporting Cook County sales-tax receipts plunge.
Suburban Cook County experienced the biggest drop in sales tax revenue during the second quarter relative to the six collar counties, according to a study released Wednesday.

Sales tax revenue plummeted 14.4% during the April-June period from a year ago, based on a study conducted by the Chaddick Institute for Metropolitan Development at DePaul University. That followed a 12.1% drop in the first quarter and compares with a regional average of an 11.8% slump. Suburban Cook County excludes Chicago and Evanston.

The recession has hit the heartland very hard,” says Joseph Schwieterman, director of the Chaddick Institute and professor of public service at DePaul. However, “crossing the 10% threshold has appeared to have changed the consumer’s buying experience.”

For all of 2008, sales tax revenue fell 4.5% in suburban Cook County. That compares with a 4.1% decline for the region on average, the study showed.

Cook County’s second-quarter revenue loss topped a 13.3% drop in tax receipts in Lake County. DuPage was next with a 12.7% decrease.

Just near the edges of Cook County, sales tax revenue has plummeted as well. The village of Barrington Hills, near Lake County, posted the biggest loss, down 34.3%. The village of Barrington followed with a 19.5% loss in sales tax revenue.

The city of Chicago fared better than the rest of Cook County, posting a 9.6% drop in sales tax revenue in the second quarter. That's after an 8.6% decline in the first quarter for the city vs. a 12.1% drop for the suburban county.

The report attributed the relative outperformance of Chicago, in part, to the addition of new big-box stores, which helped improve the quantity and price-competitiveness of the city’s retail sector and reduced the drain of retail dollars to neighboring communities.Outperformance of Chicago

The report Crain cited claims big-box stores helped sales in Chicago. I disagree. Once stores reach a saturation point they actually decrease sales because of competition of lower prices.

Chicago held up better than the Northern suburbs because many in Chicago are spending every dime they have on food, gasoline, clothes, and other day to day living expenses.

Contrast to Barrington, one of the richest areas in the entire state.

The village of Barrington Hills, near Lake County, posted the biggest loss, down 34.3%. The village of Barrington followed with a 19.5% loss in sales tax revenue.

The wealthy can afford to cut expenses far more than the poor who already spend every dime they have. One would (or should) expect to see the poorer suburbs affected less than the wealthier ones.

I believe the Chaddick Institute Study missed the mark in concluding box-stores helped Chicago.

Chicago Raises Property Taxes

Inquiring minds are disgusted with what Chicago and Cook County are doing about revenue shortfalls. Please consider Property taxes going up in Chicago and Cook County.
October 20, 2009
Probably not much of a shock, but it’s now official: Collectively, homeowners and businesses in Cook County are being hit up for 4.2 percent more in property taxes this year than last.

The semi-annual round of property tax bills will be arriving in mail boxes across the county in coming weeks, and most will be bigger than last year. Results will clearly vary from house to house, shop to shop and factory to factory, but the total property tax burden for Chicago taxpayers will rise more than 6 percent over last year, the clerk’s office said. Suburban taxpayers as a group will see a lower increase, but it is difficult to come up with a comparable projection because most communities are comprised of a plethora of taxing districts that apply to some residents and not others.

Despite last year’s housing market crash, tax officials calculate that property values for tax purposes rose 8.23 percent in suburban townships and 9.96 percent in the city. The calculation includes an array of moving parts, not the least of which is the gradual phase out of a program to limit assessment increases that was implemented at the height of the housing market boom earlier this decade. Chicago Proud To Say "We Have The Highest Taxes In The Nation"

On July,1 2008 CBS News reported Taxes In Chicago Now 10.25 Percent, Highest In Nation while asking the question "Sales Tax Hike In Effect; Will Shoppers Revolt?"
Chicago is no longer the "Second City" when it comes to the sales taxes. Thanks to a 1 percent sales tax increase that went into effect Tuesday, we're number one in the nation. Some shoppers are promising to revolt, but will they?

The 1 percent increase hikes the sales tax in Chicago to 10.25 percent. By comparison, the sales tax in Lake and Will counties is 7 percent, and in DuPage County, it's 7.25 percent.

A sales tax of 10.25 percent is also significantly higher than the sales tax in other major cities. New York, Los Angeles and Dallas all have a sales tax of less than 8.3 percent, Phoenix has a tax of 6.3 percent, and Denver's sales tax is only 3.6 percent. Birmingham, Ala., earlier this year passed a sales tax hike--to 10 percent.

It will definitely be cheaper to shop in the suburbs. Buy a $500 TV in DuPage County where the taxes are 6.75 percent and you'll pay $534, in Chicago where the taxes are 9 percent, you'll pay $545 for that same television, and when taxes increase to 10.25 percent, you'll pay $551.

"It's kind of frustrating," Ashmalla said. "I go to Best Buy or something, and high-priced electronics – it adds like $20, $30 to a TV I bought." "I'm not going to be purchasing in Chicago much more – not electronics or anything high-priced," he said.

Cook County Commissioner Tony Peraica (R-16th) was one of the commissioners who led the fight against the tax hike. He says it's not too late to repeal it.

He plans to introduce the measure to repeal the sales tax at the next County Board meeting in mid-July, but he predicts getting his proposal to pass will be a challenge.

Leading a "tax revolt" outside the James R. Thompson Center on Tuesday, across the street from the County Building, Peraica told angry consumers, "This is nothing but a corruption tax ladies and gentlemen. Corruption equals higher taxes..."

At Left: A DuPage County gas station advertises that customers don't have to pay the high taxes of stations in neighboring Cook County.

Businesses are concerned that consumers will leave Cook County to make purchases, and some businesses outside the county are capitalizing on the opportunity already.

Some residents of Palatine have been so upset by the tax hike that they have even talked about seceding from the county.Chicago is driving business away and destroying property values by raising sales taxes and property taxes. It should be reducing taxes and cutting expenses. The fact that Chicago has the highest taxes in the nation strongly suggests it has the most bloated bureaucracy and overpaid workers in the nation to go along.

I wish Palatine would follow through with succeeding from the county. The madness has to stop.

Chicago should be thankful it did not get the Olympics. It would have made a boondoggle out of them.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Californians Against Higher Taxes warns that New Taxes Would Hurt Local Businesses.
Saying the current Legislative special session threatens to open a Pandora’s Box of new taxes, business leaders here came together today to warn of the negative impact higher taxes would have on small and minority-owned businesses struggling to stay alive in this economy.

The special session in Sacramento is considering a slew of tax increase proposals. Speakers today slammed proposed increases in the gas tax, a new tax on oil production and a new tax that would place a levy on services such as dry cleaners, tax preparers and even funeral services for the first time.

”I’m going to have to pass that tax along to my clients at a time when they can’t afford fee increases,” said Velma Union, managing partner of ACV Financial Services. “This has the potential to really hurt my business – either through losing clients that can’t pay more, or keeping them by absorbing thousands of dollars in new taxes I can’t pass along. Since many small companies are service businesses, this will put a lot of us at risk.”

“No matter what the politicians say, a tax on fuel either when it comes out of the ground or when a consumer fills up his tank, means higher gas prices,” said Jovonnie Mabrie, who is a real estate appraiser. “For a small business person like me, every dollar I have to pay in higher gas prices means a dollar less to pay my bills.”

“We’re talking about jobs here, too,” said James Clark of Innovative Contractors. “When your costs go up, you make cuts, and because payroll is one of the biggest expenses, you have to look at laying some people off. There are enough people out of work in California already.”The Tax Man Cometh

Earlier today I noted Chicago Metro Area Sales-Tax Receipts Plunge, Property Taxes Rise Cook County and Chicago raised sales taxes only to see sales tax collections plunge. In response to falling revenues Chicago raised property taxes 4.2% in spite of plunging property values.

"Despite last year’s housing market crash, tax officials calculate that property values for tax purposes rose 8.23 percent in suburban townships and 9.96 percent in the city."

Think that is good for property values or business? I don't.

Pension Crisis Bankrupts Prichard, Alabama

Inquiring minds are reading Prichard Alabama Files Bankruptcy Over Pensions; Wildcat Strike In Philadelphia; Oregon's Financial Gamble
Prichard Mayor Ron Davis released the following statement Wednesday morning:

“I have looked at every opportunity available to obtain money to help fund the retirement plan for the City of Prichard. After careful review of all of our options, bankruptcy protection seems to be the only solution left at this time.

Over the past 50 years, the pension plan was amended by the Legislature more than fifteen times, and always the economic burden on the City was increased. This has been a long term problem that was unfortunately inherited by this administration.

After several lawsuits filed by pensioners, it has forced us to come to this decision, one that will protect the city and its residents.Prichard Meets Thidwick the Moose

Congratulations are in order for Prichard, Alabama otherwise known as Thidwick the Big Hearted Moose. If you do not know the story of Thidwick the Moose, please read Dr. Seuss On The Economy.

I am quite sure you will enjoy it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Inquiring minds are noting another city has been driven to bankruptcy because of pension promises that cannot possibly be met.

Please consider Prichard Alabama Files For Bankruptcy.Prichard Mayor Ron Davis released the following statement Wednesday morning:

“I have looked at every opportunity available to obtain money to help fund the retirement plan for the City of Prichard. After careful review of all of our options, bankruptcy protection seems to be the only solution left at this time.

Over the past 50 years, the pension plan was amended by the Legislature more than fifteen times, and always the economic burden on the City was increased. This has been a long term problem that was unfortunately inherited by this administration.

After several lawsuits filed by pensioners, it has forced us to come to this decision, one that will protect the city and its residents. I hope that a solution can soon be found that will be fair to all. As Mayor, it is my duty to make sure that the City of Prichard continues to move forward by providing essential municipal services and to operate for the benefit of its citizens.”Commuter Strike in Philadelphia

The unions in Philadelphia have not gotten the message there is no money and their over-bloated pension plans are unsustainable.

Proof of the above is in the Philly report SEPTA strike catches commuters off guard.
Tue, Nov. 3, 2009
Hundreds of thousands of commuters scrambled this morning to find a way to work or school after SEPTA's largest union staged a surprise predawn strike, shutting down all subway, bus and trolley service in the city.

The walkout by Transport Workers Union Local 243, which began at 3 a.m. and caught commuters off guard, also affected Frontier Division buses in Bucks, Montgomery, and Chester counties.

The walkout even caught some members of the striking union unaware. Sly Wagner, a train operator for 17 years, showed up at the Fern Rock station ready to go to work. "I'm like everybody else," he said. "The only way I found out was when I went to the station and the gates were locked."

In the end, it was a difference over wages that sparked the walkout. Earlier Monday, transit officials disclosed that both sides had reached a tentative agreement on health care and were reportedly close on wages.

"Nobody wants to leave something on the table," U.S. Rep. Bob Brady, who had been involved in the negotiations since last week, said during yesterday evening's break.

But union president Willie Brown, in a telephone interview, painted a different picture early today.

"They wouldn't provide the proper numbers" during negotiations, Brown said. "When it comes right down to it, they've underfunded our pension for years."

Governor Rendell said the union chose to walk away from an "excellent" contract offer that includes 11 percent in wage increases over five years, and 11 percent increase in pension contributions, and no increases in workers' contribution for health care.

"Think about that," Rendell said. "Whose pension has been increased in this day and age?"

SEPTA's 5,100 unionized bus drivers, subway and trolley operators earn from $14.54 to $24.24 an hour, reaching the top rate after four years. Mechanics earn $14.40 to $27.59 an hour.I would offer the unions a take it or leave it pay cut to $12.00 an hour. The city would be flooded with workers willing to take that wage. Pensions need to be cut, not added to. It is nearly unbelievable that unions would walk out that way when so many are unemployed begging for any job.

Lorain Ohio Budget Woes

Please consider Lorain asks unions to take pay cut in order to avoid layoffs.
As many as 39 employees could be laid off if Lorain city unions do not agree to take a 7 percent pay cut or City Council does not find ways to quickly bring cash into the city.

Mayor Anthony Krasienko's administration sent letters to bargaining unit presidents Wednesday afternoon asking them to consider pay cuts in order to avoid layoffs. Layoff notices will be sent Monday if the units decline to accept the pay cut. The layoffs will most likely be made based on seniority, according to the administration.

The Lorain Ohio Patrolmen's Benevolent Association Telecommunications and Fraternal Order of Police Lodge 3 declined to take a pay cut. The International Association of Firefighters Local 267 will not even respond to the request, union president Jonathon George said.

"As far as Local 267 is concerned, we are currently under an agreement that prohibits the city from laying off any of our members," George said. "Therefore, there is no need for us to entertain, much less respond to, any threats of such action from the administration. Until written notification of the city's intention to opt out of the current agreement is received, it would be inappropriate to enter into any discussions of layoffs for the remainder of 2009."

Buddy Sivert, president of FOP Lodge 3, said the city improperly asked his group to take a pay cut and he will not take the request to his membership. Instead, he said he hopes City Council will find ways to generate the income necessary to keep the police force at its current level.The article does not detail the budget shortfall but if it is severe enough (and I suspect it is both severe and growing), I recommend the city to declare bankruptcy.

The unions can then see what they can get out of bankruptcy court. Please see Judge Rules Vallejo Can Void Union Contracts for a synopsis of the situation in Vallejo, California.

Alternatively or in addition to bankruptcy, the city just ought to privatize everything it can, including the fire department.

Houston Is Bankrupt

In case you missed it, Bob Lemer, CPA, Retired Partner at Ernst & Young; Aubrey M. Farb, CPA, Retired Partner at Grant Thornton; and Tom Roberts, CPA, Retired Partner at Fitts Roberts have combined to declare the City of Houston is Bankrupt.

The culprit is pension benefits.

Gambling Over Pensions In Oregon

Inquiring minds are concerned about Oregon's Financial Gamble.
A financial investment that has helped fill gaps in pension funding since 2002 quickly turned sour with the stock market's misfortunes last year, losing $1.9 billion for nearly 140 government agencies in the state, according to a Statesman Journal analysis.

The investment strategy called for selling bonds and investing the proceeds. It was backed by the financial companies that stood to profit from the investment move.

That financial gamble might force school districts, cities and counties to consider layoffs or service cuts in 2011, when pension contribution rates reset. That amount will reflect 2008-09 investment returns, including 27 percent losses in 2008.

In 2001 and 2002, state legislators passed laws that essentially allowed, for the first time in Oregon, the majority of public agencies to "refinance" their pension obligations by making a financial move called arbitrage.

Here's how arbitrage play works: Cities, counties and school districts took advantage of low interest rates at the time and issued pension bonds. They then deposited bond proceeds into "side accounts" with the state pension system. The side account created a way to invest bond proceeds with other pension assets in the investment portfolio.

If the rate of return on the investments (say, 8 percent) is higher than the bond interest rate (say, 5 percent), the agency makes money on the difference (in this example, 3 percent). That translates into a savings to an agency's pension costs, as the difference helps an agency pay its pension contributions.

PERS, Oregon's Public Employees Retirement System, aims to earn 8 percent return on its investments. Historically, pension investments earned 10.25 percent from 1970 to 2008, said PERS actuarial-services manager Dale Orr.

Since 2002, agencies have issued pension bonds with interest rates of 4.7 percent to 7 percent, according to a Statesman Journal analysis of bonds issued in Oregon.

A handful of agencies issued bonds with a 7 percent interest rate, according to bond data from the state treasurer's office — a smaller margin than most for the arbitrage play.

"If everything goes right … but of course, there's risk," Orr said. "There is risk that our portfolio won't earn 8 percent."

'Caught up in the … mania'

In Oregon, more than 90 percent of the 140 agencies that issued pension bonds did so from 2002 to 2005, according to a Statesman Journal analysis of pension bonds in Oregon. The time frame is significant because it coincides with the housing market boom, Thoma said.

"There's an exact parallel," Thoma said. "It's the same things that were happening in housing: People were convinced that there were these riskless ways to make money. It turns out it wasn't risk-free. People wanted to believe that housing prices would always go up. They wanted to believe that this time was different."

'Looming crisis'

In a year, the economy unraveled and the arbitrage play showed signs of running into problems.

The housing boom busted. Financial giants failed. Lending tightened and borrowing stalled. Investments nose-dived. Unemployment soared.

As a result of one investment year, Oregon's unfunded actuarial liability in the pension system skyrocketed. In 2008, pension investments lost 27 percent, the largest loss in the agency's history.

"Our investment strategies are for the long term, and we recognize that the market is going to be volatile," Orr said. "Twenty-seven percent is a lot to try and recoup. Most likely, it will not be recouped in one year or even two years."Borrowing Money At 5-7% Betting On The Stock Market Is Madness

It is economic madness to think risk-free returns of 8% can be had when 2-year treasuries are yielding .9% and 10-year treasuries are yielding a mere 3.4%. The years 1980 to 2000 are NOT the norm. In 1980 one easily could have locked in 12% returns just by throwing it all into the 30 year long bond.

Moreover, pension funds cannot count on dividends. Please consider the Dividend Yield for Stocks in the S&P 500.

139 S&P 500 stocks do not have any dividend. The average yield for the group is a mere 1.84%.

I think pension plans will be lucky to average 5% a year for the next 5 years. Indeed it is quite likely the bottom in equities is not even in. If that pans out we might see negative returns for the next 5 years.

Even IF the bottom is in, the best one can hope for in a buy and hold index strategy is 5-7% The pension plans need 8% in a 3%-5% world. It cannot be done.

Expect More City Bankruptcies

Expect to see many plans blow up betting the bottom is in or chasing risk because they need 8%. We are in a major pension crisis and this one is not going to blow over. Meanwhile the unions in Philadelphia are on a wildcat strike asking for more.

The mayor needs to show them the door. Unless he does, I can predict the future. The future is Prichard. It's already too late for Houston and Detroit. It's probably too late for Baltimore as well. Please see Time for Baltimore to "Pull a Vallejo" and Declare Bankruptcy for details.

Look for more city bankruptcies over wage and pension benefits. They are without a doubt coming.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Money is a difficult subject. There is much confusion as to what it is. There is even more confusion as to the best way to measure it. Yet, before we can measure it, we have to define it.

Here is a description I pieced together from a few re-ordered sentences of Rothbard's classic text: What Has Government Done to Our Money?
Money is a commodity used as a medium of exchange.

Like all commodities, it has an existing stock, it faces demands by people to buy and hold it. Like all commodities, its “price” in terms of other goods is determined by the interaction of its total supply, or stock, and the total demand by people to buy and hold it. People “buy” money by selling their goods and services for it, just as they “sell” money when they buy goods and services.

Money is not an abstract unit of account. It is not a useless token only good for exchanging. It is not a “claim on society”. It is not a guarantee of a fixed price level. It is simply a commodity.What Is The Proper Supply Of Money?

Continuing from the book ...
Now we may ask: what is the supply of money in society and how is that supply used? In particular, we may raise the perennial question, how much money “do we need”?

Must the money supply be regulated by some sort of “criterion,” or can it be left alone to the free market?

All sorts of criteria have been put forward: that money should move in accordance with population, with the “volume of trade,” with the “amounts of goods produced,” so as to keep the “price level” constant, etc.

But money differs from other commodities in one essential fact. And grasping this difference furnishes a key to understanding monetary matters.

When the supply of any other good increases, this increase confers a social benefit; it is a matter for general rejoicing. More consumer goods mean a higher standard of living for the public; more capital goods mean sustained and increased living standards in the future.

[Yet] an increase in money supply, unlike other goods, [does not] confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices—i.e., dilutes its own purchasing power. The reason for this puzzle is that money is only useful for its exchange value.

[Thus] we come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold-unit [monetary-unit].The online book is a great read and I highly recommend reading it in entirety.

The key point above is that an increase in money supply confers no overall economic benefit. Over time, money simply buys less and less.

At any point in time, however, when demand for money increases (people want to hold it as opposed to buy goods and services) prices of goods and services decline decline. This can happen even as money supply increases. It is happening now.

Money vs. Credit

In a gold based economy, a measure of money would be a measure of the supply of gold. However, in a fractional Fractional Reserve system (even one based on gold) more credit can be extended (more gold lent out via paper receipts supposedly "as good as gold") than their is actual gold.

Clearly this is fraudulent.

Even in a fiat system where money is amazingly backed by nothing, more credit can be extended than there is actual fiat currency. This is fraudulent as well, and sooner or later a credit crisis erupts caused by inability to pay back with interest what has been lent.

Indeed the entire banking system in insolvent right now. It is physically impossible to pay back all the credit that has been extended on the fiat base money supply that actually exists.

How Does One Measure Money?

The mainstream monetary measurements are:
Base Money Supply
M1
M2
M3 (discontinued in 2006)
MZM

Base Money Supply



M2



Clearly we can see from the above charts there is a huge difference between base money supply and M2. There is an even larger difference between base money supply and M3.

Do any of the above measures represent "money"?

Money AMS and True Money Supply

Hoping to clarify the distinction between money and credit, Austrian economic followers have two additional measures, one called True Money Supply, the other Money AMS (Austrian Money Supply). I have a monetary measure called M Prime (M') but that is a representation (as best as I can put together) of Money AMS.

At the heart of the entire debate is the question "How Does One Distinguish Credit Transactions From Money?"

Please consider Money, Credit, Inflation and Deflation by Steve Saville.

In an article posted earlier this week, Mike "Mish" Shedlock weighed in on the TMS vs. M3 discussion. Mish's article supports our view that TMS (the "True Money Supply" developed by Murray Rothbard and Joseph Salerno) is a more appropriate measure of money supply than M3, although he prefers a measure called "M Prime". The main difference between TMS and M Prime is that TMS includes savings deposits whereas M Prime does not.

Our view is that savings deposits must be included in any measure of the total money supply, for the reasons spelled out on pages 2 and 3 of Joseph Salerno's article at http://www.mises.org/journals/aen/aen6_4_1.pdf. According to Salerno:

"Savings deposits, whether at commercial banks or thrift institutions are economically indistinguishable from demand deposits and are therefore included in the TMS. Both demand and savings deposits are federally insured under the same conditions and, consequently, both represent instantly cashable, par value claims to the general medium of exchange. The essential, economic point is that some or all of the dollars accumulated in, e.g., passbook savings accounts are effectively withdrawable on demand by depositors in the form of spendable cash. In addition, savings deposits are at all times transferable, dollar for dollar, into "transactions" accounts such as demand deposits or NOW accounts."

Mystery of the Money Supply Definition

The above argument by Saville might sound convincing. However, let's consider what Austrian economist Frank Shostak has to say in Mystery of the Money Supply Definition, also in a Mises Journal.
According to popular thinking, the inclusion of savings deposits into the money supply definition is justified on the grounds that money deposited in saving accounts can always be withdrawn on demand. But the same logic should also be applied to money placed with an MMMF [Money Market Mutual Fund]. The nub, however, is
that savings deposits do not confer an unlimited claim. The bank could always insist on a waiting period of thirty days during which the deposited money could not be withdrawn.

Savings deposits should therefore be considered credit transactions with depositors relinquishing ownership for at least thirty days. This fact is not altered just because the depositor could withdraw his money on demand. When the bank accommodates this demand, it sells other assets for cash. Buyers of assets part with their cash, which in turn is transferred to the holder of the savings deposit. The same logic is applicable to fixed-term deposits like CDs, which are credit transactions. Shostak goes on debunking MZM, MMMFs, and other measures of money. He settles on this definition: Money AMS = Cash + demand deposits with commercial banks and thrift institutions + government deposits with banks and the central bank.

I concur with Shostak in regards to savings accounts.

Think of it this way: Savings accounts are really lending accounts. You deposit money in a bank (transferring the claim on the money to the bank) in return for an agreed upon interest rate.

With demand deposits (checking accounts) there is no transfer of claim. Nonetheless, thanks to Greenspan's allowing of banks to "sweep" customers' checking accounts into savings accounts nightly, money that should be available on demand isn't.

What are Sweeps?

Sweeps are automated programs that "sweep" funds from one type of account into another type of account automatically. In this case we are talking about programs that allow banks to "sweep" funds from checking accounts to other types of accounts such as savings accounts that allow money to be lent out.

There are no reserve requirements on savings accounts.

Sweeps were initiated by Greenspan in 1994. Take a look at the following chart to see what has happened since then.



Except for the monetary stimulus of the Fed fighting the last two recessions, demand deposits have generally been in decline since 1994. It is the only monetary component in a sustained (albeit artificial) downtrend. The point being, in measuring demand deposits, one must add in sweeps.

It has been a long time since I have updated M Prime, but thanks to my friend "TC" I have a couple of new charts.

M Prime



M Prime consists of all money that is readily available on demand.
Here are the components:

• Currency
• Demand Deposits at Commercial Banks
• Sweeps
• US Government Demand Deposits and Notes
• Demand Deposits due Foreign Commercial banks
• Demand Deposits due Foreign Official Institutions
• US Government Demand Deposits at Commercial banks

The last 4 components are so minor they barely register, appearing as a single line at the bottom of the chart.

M Prime CPI Adjusted




Money AMS

Here is a chart of Shostak's Money AMS:

M Prime is nearly an exact match of Money AMS. I cannot account for the few subtle differences. One can construct M Prime from the components I mentioned above.

The Fed hides sweeps data in an obscure online publication called swdata.

Note that sweeps data is seldom less than two months old. I have no idea why it takes the Fed 2-3 months to post this data. I suppose we should be grateful they publish it at all. For the missing months, we simply extrapolate forward.

A quick look shows that nearly $800 billion dollars that should be in checking accounts is missing in action. Money, supposedly available on demand, is just not there.

Given there are no reserves on savings accounts, as much as $4.5 trillion people think is in their savings accounts is not there either. Moreover, the duration mismatch on savings accounts, sweeps, and likely even CDs is massive.

If even 20% of the people tried to get their money out the system would freeze up.

The banking system is clearly insolvent. Such is the folly of fractional reserve lending.

For a further discussion of money, derivatives, and invisible debt, and the monetary crisis we are facing, please see Janet Tavakoli on Financial Meth Labs.

This concludes the first half of the discussion. Thanks again to "TC" for the charts, and a huge thanks to Frank Shostak for Money AMS and also to Steve Saville for their parts in the discussion.

In the second component we will take a look at which, if any money supply measures are a valid measure of inflation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Here is a lengthy but well worth listening to 59 minute interview of Janet Tavakoli on C-Span. The interview is from April 20, 2009 but given that Tavakoli's name is just now on everyone's radar, most will have missed it.



Interview Topics

• Money
• Transparency
• Job security
• Banking crisis
• Credit derivatives
• Invisible Debt
• How and why credit derivatives came into existence
• Mortgage lending, Countrywide, New Century, etc
• Investment banks churning money to collect fees
• Bipartisan problem of promotion of home ownership to buy votes
• Crony capitalism

Select Quotes

• Democracy has been diluted by the actions we have taken to get out of this crisis.
• The government is willing to willy nilly print money to prevent any bank from going into receivership which I think is a galacticly bad idea.
• Credit derivatives added to the problems by providing leverage and opacity. They increased people’s ability to borrow in hidden ways.
• There is a lot of debt in the system that is invisible. And banks themselves were often running invisible hedge funds. The legacy investment banks were running invisible hedge funds, but so were our major banks, and that includes JPMorgan, and Citigroup Bank of America.
• Collateralized Debt Obligations (CDOs) were overrated and overpriced the minute they came to market. If that wasn’t enough, investment banks were creating these things in their financial meth labs , knowingly selling things they knew or should have known were overrated and overpriced.
• In 2007 when it was clear that this activity should be shut down, because we had mortgage lenders failing throughout the country, instead of shutting down the financial meth labs, the investment banks sped up, they accelerated the bad deals they were bringing to market. Many of them were just phony secutritizations with no other purpose than to hide losses.
• I was hopeful that when someone like Obama came in, there would be meaningful change. If anything, the situation has gotten worse. But this is bipartisan. You’ll notice that President Bush when he was in office, he elevated Roland Arnold who was the head of Ameriquest, that had been involved in alleged mortgage fraud, massive, sued by almost every state in the union, and he was elevated to the position of Ambassador to the Netherlands. The Netherlands did not even like it.
• This was not a model issue. This was a management issue. We had people who knew or should have known they were selling things that were value destroying securitizations, and their sale provided money to lenders were originating fraudulent loans, overrated by complicit rating agencies.

Janet Tavakoli is a straight shooter and an equal party basher. You have to like that.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I have sided with Nadler on gold issues in the past, but his claim that gold is not in a bull market is just plain nonsense. Please consider Gold Is Not in a Bull Market
Recently, gold appears to have entered The Mother of All Bull Markets. Even though gold has backed off of its $1,072/oz record from two weeks ago, as of Thursday's close, the market was still up 18 percent for the year and climbing. Interest in the yellow metal—from both individual and institutional investors—has never been higher.

But don't be fooled, says Jon Nadler, metals market analyst and PR head for Kitco Metals, Inc. The precious metals expert says the current bull market in gold is all an illusion—one that the fundamentals can't support for long.

Recently, HAI associate editor Lara Crigger discussed gold fundamentals with Mr. Nadler, including what investors should look for in a gold bull market, why gold supply and demand are so out of whack with prices, and what two events should kick off a price correction.

Lara Crigger: You've written before, "Gold is not in a bull market. The dollar is in a bear market." How do you know? What telltale signs indicate a gold bull market?

Jon Nadler: This phenomenon here has largely been a dollar-driven, dollar-based story, but the requirements for a bull market in gold extend beyond a simple anti-dollar relationship. There are four factors that truly make a gold bull market.

First and foremost, you have to have demand that far outstrips supply. Like any commodity in higher demand than supply makes available, you'd obviously see a price reflection.

Secondly, you'd have to have a falling stock market. The old adage is that gold is an inverse asset to currencies, stocks and other assets—so where's the bear market in stocks? Stocks have been up 50 percent-plus this year.

Third, you'd have to have an actual, tangible inflation level, and the threat of much higher inflation on the horizon as well. We don't see that either, which we'll talk about later.

And fourth, you'd need an increase in the price of gold across all major currencies—no exceptions. You can't have Aussie dollars and the South African rand going one way, while the euro and U.S. dollar is going the other.

Crigger: But isn't gold supposed to be this ideal anti-dollar play?

Nadler: It's not that simple. In fact, statistically speaking, if you look at the correlation between gold and the dollar since 1971-72, it's -0.27. In plain English, that means if you are betting gold as an anti-dollar play, you're likely to lose money 73 percent of the time.

......
Statistically Speaking

Let's start with a look at two claims made by Nadler, back to back.

Nadler Claim #1: "Gold is not in a bull market. The dollar is in a bear market."

Nadler Claim #2: "Statistically speaking, if you look at the correlation between gold and the dollar since 1971-72, it's -0.27. In plain English, that means if you are betting gold as an anti-dollar play, you're likely to lose money 73 percent of the time."

Somehow gold is rising because the dollar is in a bear market, while statistically speaking there in a negative correlation.

Peculiar Definition of Bull Market

Nadler has a mighty peculiar definition of a gold bull market with four stringent conditions.

1) "Demand has to exceed supply"

The plain fact of the matter is the intersection of supply and demand determines price. Supply and demand will always find equilibrium. Right off the bat one can determine Nadler's definition is complete silliness.

2) "To have a bull market in gold the stock market has to fall"

That is like saying to have a bull market in soybeans the price of paper clips must fall.

3) "You'd have to have an actual, tangible inflation level, and the threat of much higher inflation on the horizon as well"

Nadler does not say why we have to have inflation for gold to be in a bull market; we just have to take his word for it. It would make about as much sense to suggest that to have a bull market in gold, sea turtles must lay a record amount of eggs.

Historically speaking, gold does well in times of credit stress, not in times of inflation. There was inflation every step of the way from 1980 to 2000 and gold fell every step of the way.

However, take a look at periods of credit stress. Nixon closing the gold window was arguably a period of credit stress, and gold certainly did well. We are clearly in a period of global credit stress right now, not just in the US, and gold is doing well.

The great depression was a period of credit stress and a period of deflation as well, and gold did well. This point alone disproves Nadler's contention that gold needs inflation to rise.

4) "You'd need an increase in the price of gold across all major currencies—no exceptions. You can't have Aussie dollars and the South African rand going one way, while the euro and U.S. dollar is going the other."

While there is some merit to suggest the price of gold needs to rise in other than dollar terms, it is another to say it has to be rising against every currency, and still another to define the South African Rand a "major currency".

Gold In Euros, $US, $A, Yen



Click on chart for sharper image
Chart courtesy of The Privateer

Nadler can believe what he wants, but that looks like a bull market to me.

Indeed the only long term bull markets with no broken trendlines that I can find are gold and US Treasuries. After 30 years, treasuries do not have much left to give, although they will likely be a safe haven against the next stock market collapse.

Conclusions

• I find it peculiar that the PR head for a metals firm has managed to define bull markets in such a way that gold can never be in one.
• Nadler's definition is so preposterous that my conclusion is his definition is purposely preposterous.
• I will leave it to others to hypothesize why that is the case.

The Stock Market, Gold, the US Dollar, Sideline Cash, China

I was on King World News with Eric King discussing Gold, the Stock Market, the US Dollar, Sideline Cash, China, and US real estate. Inquiring minds will want to listen in.

To hear the podcast please click on King World News Mish Podcast.

That is part 1. Part 2 will be coming this Friday.

To hear Eric King's interview with Ron Paul, Rick Rule, Ted Butler and others, please click on the King World News Home Page.

By the way ...

I will be on the panel of speakers at the appropriately misnamed Chicago Natural Resources Conference in Rolling Meadows, Illinois on November 6th & 7th.

For all you deflationists, I would like to point out there is no cost for those who preregister for the conference. Click on the link for details about the exhibitors, speakers, and to register. See ya there.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Janet Tavakoli forwarded to me, a PDF of Representative Issa's Letter to William Dudley Requesting AIG Bailout Disclosure. Inquiring minds might be interested in reading it.
Mr. William C. Dudley
President
Federal Reserve Bank of New York
33 Liberty Street
New York, NY 10045

Dear Mr. Dudley:

As Ranking Member of the Committee on Oversight and Government Reform, I
am deeply concerned by news reports that the Federal Reserve Bank of New York (“FRBNY”) may have unnecessarily cost the American taxpayers billions of dollars.1

As you know, in late 2008 American International Group (“AIG”) was attempting to negotiate a haircut for banks that held $62 billion in credit default swaps (“CDS”) from AIG. AIG was reportedly seeking to persuade the banks to accept haircuts of as much as 40 cents on the dollar in order to retire these CDS contracts.

On September 16, 2008, the FRBNY extended AIG an $85 billion line of credit,
effectively nationalizing it. According to news reports, late in the week of November 3, then-FRBNY President Timothy Geithner, along with the U.S. Department of the Treasury and the Federal Reserve Board in Washington, took over negotiations with AIG’s counterparties.

News reports indicate that Mr. Geithner’s team circulated a draft term sheet to set the terms under which AIG would settle its CDS obligations, including a blank space in which the haircut for creditors was to have been inserted. However, the haircut provision was reportedly crossed out and, after less than a week of secret negotiations between the FRBNY and the banks, FRBNY ordered AIG to pay its creditors at par – 100 cents on the dollar – not 60 cents as AIG had been attempting to negotiate.

Thus, behind closed doors and with no approval from Congress, the FRBNY may have added an additional $13 billion of debt on the backs of taxpayers.

These allegations, if true, amount to nothing less than a backdoor bailout of AIG’s creditors, including Goldman Sachs, Merrill Lynch, Société Générale and Deutsche Bank.

The lack of transparency and accountability in this transaction is disturbing enough. However, there is evidence that this $13 billion expenditure was entirely unnecessary. According to Janet Tavakoli of Tavakoli Structured Finance, “There’s no way they should have paid at par. AIG was basically bankrupt.”

Another expert has said that the typical outcome in cases like this involves counterparties being forced to accept haircuts of anywhere from 30 to 50 cents on the dollar.

This suggests that the FRBNY may have paid AIG’s counterparties at par to surreptitiously provide another bailout for large financial institutions. According to Donn Vickrey of Gradient Analytics, “Some of those banks needed 100 cents on the dollar or they risked failure.”

However, another source close to the transaction suggested the FRBNY may have paid AIG’s counterparties at par out of pure expediency: “[S]ome counterparties insisted on being paid in full and the [FRBNY] did not want to negotiate separate deals.”

Furthermore, many of AIG’s counterparties reportedly hedged their exposure to the troubled insurance giant, obviating any need for a taxpayer bailout of these large financial institutions. According to Goldman Sachs’ Chief Financial Officer, “There would have been no credit losses [at Goldman Sachs] if AIG had failed.”

All of this begs the question why the FRBNY would not drive a better bargain for the American taxpayer. If the FRBNY thought it was necessary to provide another taxpayer bailout of AIG’s counterparties, it should have come to Congress and made its case that this action was necessary. However, if the FRBNY simply paid AIG’s counterparties at par out of expediency, it raises serious questions about its judgment and motives.

It is also disturbing that, at the time this secret deal was made, FRBNY Chairman Stephen Friedman, a member of the board of Goldman Sachs, purchased more than 50,000 shares of Goldman Sachs before knowledge of the FRBNY’s bailout of Goldman Sachs and other AIG counterparties became public knowledge.

According to news reports, this transaction has earned Mr. Friedman over $5 million in profit.

Finally, according to one AIG executive quoted in news reports, the FRBNY may have attempted to manage public disclosure of its decision to pay AIG’s counterparties at par by pressuring the company not to file pertinent documents with the U.S. Securities and Exchange Commission (“SEC”):

They’d tell us that they don’t think that this or that should be disclosed. They’d say, “Don’t you think your counterparties will be concerned?” It was much more about protecting the Fed.

These allegations raise serious questions about the transparency, accountability and wisdom of the FRBNY’s actions. The American people have a right to know the full details behind the FRBNY’s decision to stop negotiations with AIG’s counterparties and pay them billions of dollars of taxpayer money.

To assist the Committee with its investigation of this matter, please provide the following information no later than close of business on Friday, November 13, 2009:

All records and communications referring or relating to the FRBNY’s negotiations with AIG’s CDS counterparties, including but not limited to:

a) Emails, phone logs and meeting notes of the following people: Timothy Geithner, Stephen Friedman, Tom Baxter, and Sarah Dahlgren;

b) Term sheets, including drafts, relating to AIG’s payments to its CDS counterparties;

c) Emails, phone logs and meeting notes referring or relating to public disclosure of AIG’s payments to its CDS counterparties including disclosure to the SEC.

Please note that, for purposes of responding to this request, the terms “records,” “communications,” and “referring or relating” should be interpreted consistently with the attached Definitions of Terms.

Thank you for your cooperation in this matter. If you have any questions regarding this request, please contact Christopher Hixon or Brien Beattie with the Committee staff at (202) 225-5074.

Sincerely,
Darrell E. Issa
Ranking Member
cc: Hon. Edolphus Towns, ChairmanGoldman Sachs: Reasonable Doubt

In case you have not yet seen it, please read Goldman Sachs: Reasonable Doubt by Janet Tavakoli. Here is the beginning:
In August 2007, I publicly challenged the fact that AIG took no write-downs whatsoever for its credit default swaps on underlying mortgage related “super senior” positions. I used the example of its aggregate $19.2 billion in credit default swaps on super senior positions backed by BBB-rated tranches of residential mortgage backed securities. I spoke with Warren Buffett, but only about what I had already told the Wall Street Journal (Dear Mr. Buffett Pp. 164-165, 246).

I met with Jamie Dimon, CEO of JPMorgan Chase, adding that the difference was material. JPMorgan Chase’s credit derivatives positions exceeded those of all other U.S. banks combined at the time. JPMorgan was not a participant in the problematic deals, and it was not a recipient of AIG’s settlement payments, but stability in the credit derivatives markets was an important issue. Dimon was dismissive of my concerns. In August of 2007, a potential implosion of AIG was too horrible to contemplate.

Unbeknownst to me, in July 2007, Goldman Sachs and AIG began a prolonged battle over prices and collateral payments for pre-2006 vintage deals on which Goldman had bought protection.

Fraud Audit

Was the risk that Goldman hedged with AIG as bad as Goldman Sachs Alternative Mortgage Products’ GSAMP Trust 2006-S3? Any risk manager worth their salt would have reasonable doubt about this deal and conduct a fraud audit. A fraud audit doesn’t mean you are accusing anyone of fraud, only that the audit will be thorough, because there are indications of grave problems. If there is fraud, however, the audit should be rigorous enough to uncover it.

If the aggregate $19.2 billion CDS position were derived from BBB rated tranches similar to one from GSAMP Trust 2006-3, the supposedly super safe “super senior” tranche would be worth zero. Every underlying BBB tranche would have permanent value destruction and zero value. AIG would owe a credit default swap payment for the full amount $19.2 billion. Since there is doubt about the collateral of every deal of this ilk, super senior tranches of mezzanine CDOs in the secondary market are currently valued at zero.

No wonder Goldman Sachs bought protection from AIG on mortgage backed deals—and then bought protection on AIG. .... Janet Tavakoli is kicking ass. It's good to see someone do it.

It would be nice to see her publicly comment specifically on how Ron Paul's bill has been gutted by Mel Watt, a Democrat from North Carolina, whose district includes Charlotte, headquarters of Bank of America Corp., the biggest U.S. lender.

For more details please see Audit the Fed Bill Gutted: What You Can Do.

I will email her to see what if anything she can do. It can't hurt.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

This should come as no surprise but Ron Paul says Federal Reserve Policy Audit Legislation ‘Gutted’
Representative Ron Paul, the Texas Republican who has called for an end to the Federal Reserve, said legislation he introduced to audit monetary policy has been “gutted” while moving toward a possible vote in the Democratic-controlled House.

The bill, with 308 co-sponsors, has been stripped of provisions that would remove Fed exemptions from audits of transactions with foreign central banks, monetary policy deliberations, transactions made under the direction of the Federal Open Market Committee and communications between the Board, the reserve banks and staff, Paul said today.

“There’s nothing left, it’s been gutted,” he said in a telephone interview. “This is not a partisan issue. People all over the country want to know what the Fed is up to, and this legislation was supposed to help them do that.”

Paul, a member of the House Financial Services Committee, said Mel Watt, a Democrat from North Carolina, has eliminated “just about everything” while preparing the legislation for formal consideration. Watt is chairman of the panel’s domestic monetary policy and technology subcommittee.

Keith Kelly, a spokesman for Watt, declined to comment and said Watt wasn’t immediately available for an interview. Watt’s district includes Charlotte, headquarters of Bank of America Corp., the biggest U.S. lender.
Call The Capital Switchboard

Conservative For Change has this advice in Ron Paul's Audit the Fed Bill Gutted.
It is time to get on the phone with everyone in Washington...Congressman and Senators and demand action against the illegal Federal Reserve. Call the Capitol Switchboard 202-224-3121 and speak with everyone you can! Call Democratic Central Committee

On October 8, in Audit The Fed Revisited Jacob Dreizin offered this advice.Without a flood of citizen lobbying, they will most likely water down H.R. 1207 into something meaningless, or else ignore it altogether.

The committee Democrats' central phone number is (202) 225–4247, and the fax is (202) 225-6952. Alternately, and perhaps more effectively, you can politely email some or all of the committee's most senior Democrat staff directly, as follows:

Committee staff director and chief counsel: Jeanne.Roslanowick@mail.house.gov

Committee deputy chief counsel: Lawranne.Stewart@mail.house.gov

Committee communications director: Steven.Adamske@mail.house.gov (or possibly Steve.Adamske@mail.house.gov)Phone Your Own Representative

For a list of phone and fax numbers for Congress please see Speak Out - Audit the Fed, Then End It!

Oppose Debt Slave Bait

As long as you are phoning (you are phoning aren't you?), you may as well make it double duty.

Patrick at the Housing Crash Forum says Please oppose the $8000 debt-slave bait!

The U.S. Senate will be voting on an amendment this week that would extend the first-time mortgage-slave tax credit.

The NAR is supporting the Dodd-Lieberman-Isakson amendment because they hope to get commissions for ruining more lives with debt.

This amendment would:

–Provide the $8,000 tax credit to ANY buyer (not just first time) so realtors can take more commissions at taxpayer expense.
–Set income limits absurdly high at $150,000/$300,000 for single/married buyers.
–Make the credit available until June 30, 2010, rigging the housing market to postpone affordable house prices.

The NAR is distributing “Legislative talking points” on the Dodd-Lieberman-Isakson Amendment $8,000 “Homebuyer” Tax Credit so realtors know how to spin the issue in public.

Patrick.net is asking for your help in generating phone calls to your senators in Washington, DC.

Please request to speak to each Senator’s Tax Legislative Assistant and ask them to OPPOSE the Dodd-Lieberman-Isakson amendment. We need to generate as many calls as quickly as possible. Here is a list of the phone numbers for our Senators:

http://www.senate.gov/general/contact_information/senators_cfm.cfm

Those wishing to see the 10-15 best housing related stories of the day (I subscribe - it's free) may wish to sign up for housing crash news.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Michael Mandel at BusinessWeek claims that By overlooking cuts in research and development, product design, and worker training, GDP is greatly overstating the economy's strength.

Please consider The GDP Mirage.
Here's a riddle: If a scientist or engineer is laid off, does it affect gross domestic product?

The third-quarter GDP figures, released on Oct. 29, showed the economy growing at a 3.5% annual pace, breaking a string of four consecutive negative quarters.

The trouble is that those GDP and productivity growth figures could be significantly overestimated—perhaps by one percentage point or even more.

That's because the official statistics are not designed to pick up cutbacks in "intangible investments" such as business spending on research and development, product design, and worker training. There's ample evidence to suggest that companies, to reduce costs and boost short-term profits, are slashing this kind of spending, which is essential for innovation. Without investment in intangibles, the U.S. can't compete in a knowledge-based global economy. Yet you won't see that plunge reflected in the GDP and productivity statistics, which are still too focused on more traditional sectors, such as motor vehicles and construction.

Here's a sobering sign that companies are robbing the future to pay for short-term profits: Over the past year, U.S. employment of scientists and engineers—the people who create the next generation of products and make the U.S. more competitive over the long term—has fallen by 6.3%, according to a BusinessWeek tabulation of unpublished data. Yet overall employment has fallen only 4.1%. "There are really bright people who are struggling to find a job," says Josh Albert, managing director at Klein Hersh International, an executive search firm for life scientists.

The Bureau of Economic Analysis, the government agency that compiles the GDP figures, is taking steps to deal with the new realities. Software has been treated as investment since 1999, and the BEA plans to include R&D in the official GDP statistics in 2013, four years from now. But the agency acknowledges that other areas of intangible investment still need to be worked into the numbers. "We think it's important not to ignore the fact that R&D is only part of broader innovative activity," says BEA Director J. Steven Landefeld. For now, though, the U.S. is navigating through the downturn with fragmentary information.

While the statistics don't account for it, there's good reason to suspect intangible investments are falling. Companies are under pressure to cut costs by reducing R&D expenditures and deferring other crucial intangibles, notes Hulten. "Because these are expensed, it looks like a pure win," he says. "You are not seeing the benefits of the intangibles in the financial statements—only the costs."

One clear-cut sign that GDP growth is being overestimated: the sharp drop in venture capital investment, which goes directly to new businesses. VCs invested about $12 billion in the first three quarters of 2009, barely half the $22 billion plunked down during the first three quarters of 2008. Some of this shortfall would have been spent on computers and other physical equipment, which would have been picked up in GDP. But most of the drop in VC money would have gone to pay for scientists, engineers, and new product development—all valuable intangible investments that show up nowhere in the published stats.

Adding to the uncertainty, companies report their R&D only on a global basis, not broken out by country. As a result, even though some companies are adding to such spending, there's no way to know how much of those increases are taking place in the U.S.Counting Production Before There Is Any

There is much more in the article. Please take a look.

I have met Mandel. He is a smart guy. However he is counting chickens before they are hatched, better phrased as counting production before there is any. Research may pay off, or it may not. When it does pay off it may be 5 years from now or 20 years from now. It may pay off a little or it may pay off a lot.

Attempting to count what does not exist, and may never exist is simply wrong. Compounding the problem is the last paragraph in the blockquote above. Are we supposed to give the US GDP a boost because the thinking takes place here rather than the UK or Japan?

The reality is that it does not matter where the thinking or the research occurs. All that matters is that a product is created that people want to buy. That is what GDP is and should be.

Mandel is correct in one aspect: That cutbacks in R&D are highly likely to affect future GDP. However, one just does not know when or by how much or even what country will benefit.

GDP is hugely overstated, but not for the reasons Mandel suggests. GDP is distorted by hedonics, imputations, and government spending.

Imputations

Imputations are a part of GDP that the government decides to estimate value, where no cash actually changed hands. In other words, if I scratch your back and you scratch mine but no one gets paid, then back scratching is undercounted in the GDP.

One such imputation is the value of "free" checking accounts. The reality is bank checking accounts are not free. Banks are sweeping out nearly every penny every night and lending the money out. What's "free" is the fact that banks have free access to your money.

Nonetheless the BEA assigns a value to those free checking accounts and adds it to the GDP.

Imputations go far beyond that into other absurdities. For example: If you own your own house, the government recalculates your income as if you were renting your house from yourself and thus paying yourself rent.

Imputed rent just happens to be one of the most frequently asked questions of the BEA. Please consider Why does GDP include imputations?
In the GDP, the purchase of a new house is treated as an investment; the ownership of the home is treated as a productive activity; and a service is assumed to flow from the house to the occupant over the economic life of the house. For the homeowner, the value of that service is measured as the income the homeowner could have received if the house had been rented to a tenant.

Another important imputation measures financial services provided by banks and other financial institutions either without charge or for a small fee that does not reflect the entire value of the service. Examples are checking-account maintenance and services provided to borrowers. For the depositor, this “imputed interest” is measured as the difference between the interest paid by the bank and the interest that the depositor could have earned by investing in “safe” government securities. For the borrower, it is measured as the difference between the interest charged by the bank and the interest the bank could have earned by investing in those government securities.

Since the mid-1990s, the shares of GDP accounted for by some imputations have increased as the activities measured have grown faster than other activities.

• From 1996 to 2006, the share of GDP accounted for by the imputation for owner-occupied housing increased from 6.0 percent to 6.2 percent.
• From 1996 to 2006, the share of employer contributions for private health and life insurance grew from 3.2 percent of GDP to 4.2 percent of GDP.
• From 1996 to 2006, the share of all imputations in GDP grew from 13.8 percent to 14.8 percent.
• In 2006, imputed financial services represented 1.7 percent of GDP, the same as in 1996.

Imputed rent makes about as much sense as the idea we rent cars or lawnmowers from ourselves.

Hedonics

Hedonics is a way of accounting for the changing quality of products when calculating price movements. For example, today's computers are many times faster and have more memory than models produced just a few years ago.

The BEA adjusts prices for the improved quality as noted in The Role of Hedonic Methods in Measuring Real GDP in the United States.

I believe prices are prices. The way to measure productive output is simple: goods times real prices paid, not goods times what the government thinks the value of the product is.

Definition of GDP

Wikipedia gives several Formulas for GDP.GDP can be defined in three ways, all of which are conceptually identical. First, it is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time (usually a 365-day year).

Second, it is equal to the sum of the value added at every stage of production (the intermediate stages) by all the industries within a country, plus taxes less subsidies on products, in the period.

Third, it is equal to the sum of the income generated by production in the country in the period—that is, compensation of employees, taxes on production and imports less subsidies, and gross operating surplus (or profits).

The most common approach to measuring and quantifying GDP is the expenditure method:

GDP = private consumption + gross investment + government spending + (exports − imports).The problem is that government spending, no matter how useless, unproductive, or overpriced it may be, adds to GDP. That is likely the biggest problem, not hedonics or imputations.

GDP Stall Rate

If it seems like the economy is at the stall rate when it is growing at 2.00 or even 2.5% it is because it is.

Inquiring minds are taking another look at the Incredible Shrinking Boomer Economy.
In his Town Hall Meetings Bernanke said:

"It takes GDP growth of about 2.5 percent to keep the jobless rate constant. But the Fed expects growth of only about 1 percent in the last six months of the year. So that's not enough to bring down the unemployment rate."
Inquiring minds might be asking: Why does it take 2.5% growth to keep the jobless rate constant? The answer is the first 2.5%+- of GDP is fictional. When the economy is growing at 2%, it feels like a recession because it probably is, even though no one will admit it.

GDP has grown 3.2% a year since 1965. In a recent study, McKinsey forecast GDP growth of 2.4% over the next three decades as boomers ratchet back.

If Bernanke is correct that it takes 2.5% GDP growth just to keep the unemployment rate constant, and McKinsey is also correct in its 2.4% forecast, we will be stuck with 10% unemployment for decades.

One can believe the reported GDP numbers or not. I don't. And if GDP slips back to 1.5% to 2% don't expect any jobs to come out of it because they won't.

Yes, GDP is a mirage, but not for the reasons Mandel suggested.

Let's now answer Mandel's riddle "If a scientist or engineer is laid off, does it affect gross domestic product?"

The answer by now should be clear: Is does not affect current GDP but it may affect future GDP in an unknown, impossible to predict way, in terms of the time it will take to see any products, as well as the present and future value of those products.

I have two questions for Mandel:

1) Do we really want some bureaucrat at the BEA figuring out the present value of research and training (especially government research and training) and adding that to current GDP?

2) Isn't GDP distorted enough already?

Addendum:

Chris Martenson has an article on GDP and other Fuzzy Numbers that inquiring minds may wish to read.

The reality is GDP ought to stand for Grossly Distorted Procedures, not Gross Domestic Product.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Last Thursday I received an email from David Meier, Associate Advisor at the MotleyFool concerning Debt-Deflation.

David asked if I had any comments on his article Debt-deflation: Just the beginning? Here is a partial listing:
The debate rages on.

Is inflation or deflation the bigger threat? There are lots of people -- lots of smart people -- on both sides of the debate and they present lots of good arguments. One thing that I have not seen -- and maybe I just missed it -- was an analysis using Irving Fisher's debt-deflation framework. So I decided to put one together myself and to inject my understanding of what Bernanke is try to do to stop deflation from taking hold.

The question I keep coming back to, especially as I read more about the situation Japan faced (I'm reading everything I can by Richard Koo, including his book "The Holy Grail of Macroeconomics."

And just to make sure I am not being one-sided, I am countering my fears of deflation with "Monetary Regimes and Inflation" by Peter Bernholz, which should arrive next week.

Without further ado, below is my research on debt-deflation.

Dave
Dave's research is a 70 page Slideshow On Debt-Deflation that is easy enough to read or download from Scribd.

Here is my response ....

You should not be afraid of deflation.

You should be afraid of policies attempting to fight it.

Deflation (rather price deflation) is actually the natural state of affairs. As productivity increases, more goods and services are produced relative to the population and prices would therefore be expected to drop.

It is the Fed, along with misguided Keynesian and Monetarist economists who think falling prices are a bad thing. Who amongst us does not like falling prices (except of course on things we own like houses, but even then who is not sick of higher property taxes that result)?

The reality is inflation benefits those with first access to money. Guess who that is? The answer is easy: banks, government, and the already wealthy. Inflation is actually a tax on the middle class and the poor who get access to money last. During the housing bubble, by the time the poor could get access to to money easily, it was far too late to buy.

Given that inflation benefits those with first access to money, any targeted inflation at all is morally wrong.

Note that Congress has passed 300+ affordable housing measures over the years and all of them failed. The irony now is Congress has simultaneously passed measures hoping to prop up the price of homes while seeking still additional money to create affordable housing.

Home prices need to fall (and will fall) to levels of affordability based on wages and wage growth regardless of what the Fed does. Thus, efforts to prop up prices are triply stupid: They are costly; They they will not work (prices will fall to where they are headed anyway); and they will delay a recovery.

Deflation is only bad in the context of the short-term pain it will involve. Moreover, it is important to remember that the pain of deflation is relative to the inflation party that preceded it. That party must be paid for either in terms of time or price.

Following the Footsteps of Japan

The irony is Greenspan and Bernanke repeatedly criticized the Bank of Japan for not writing off bad bank debts. So what do we do?

We are Following the Footsteps of Japan even though we have proven without a shadow of a doubt it is economic insanity.

Psychology of Deflation Revisited

In January 2007, someone on the Motley Fool told me "Too even compare the citizens of Japan to the US is stupid, stupid, stupid Forest Gump!"

I was also told "Fannie Mae can revive the housing bubble" and that I "ignore an enormous amount of 1990s monetary theory by Bernanke and co about how they would have dealt with Japans deflation."

Inquiring minds can read Q&A on the Psychology of Deflation to see my replies.

It now seems that Things That "Can't" Happen, did happen.

Indeed Economic Madness Is Repeatedly Endless

Bernanke's Deflation Preventing Scorecard

In case no one is keeping track, Bernanke has now fired every bullet from his 2002 “helicopter drop” speech Deflation: Making Sure "It" Doesn't Happen Here.

Misunderstanding Japan's Lost Two Decades

Richard Koo of Nomura Research Institute Ltd. says U.S. Risks Japan-Like ‘Lost Decade’ on Stimulus Exit.

I say U.S. Faces Second Lost Decade "Because" of Misguided Stimulus

Real Lesson of Japan's Lost Decades

The real lesson is no matter how much money you throw around, economies cannot recover until uncollectible debts and malinvestments are written off. That is why you have “zero interest rates and still nothing’s happening.”

The moment fiscal stimulus stops economies are virtually guaranteed to relapse until asset bubbles deflate, and malinvestments and bad debts are written off.

Bailing out the banks did nothing to fix these problems. Consumers are still saddled in debt, in underwater mortgages, with no job. Moreover, there is no driver for jobs given rampant overcapacity in nearly every sector.

Banks do not want to lend in this kind of environment so they don't. Businesses do not want to expand in this kind of environment so they don't. Meanwhile the Obama administration is making matters worse by increasing taxes on small businesses and proposing everyone pay for health insurance, with businesses forced to offer a plan or pony up part of the cost.

This too is giving small businesses an incentive not to hire. Housing prices are too high yet the Administration and Congress are hell bent on propping up prices. The solution is to let prices fall until they are affordable.

Illusion of Stimulus

Recoveries based on stimulus are nothing but an illusion. Here is a snip worth reading from U.S. Faces Second Lost Decade "Because" of Misguided Stimulus written by my friend "HB" about Christina Romer, chair of Obama's Council of Economic Advisers.
I know Christina Romer best for her misinterpretation of what happened in 1937-38. She believes that the fallback into full-scale depression from 'depression light' (as evidenced by unemployment in 1938 almost returning to the highest levels of the depression trough 32/33) is proof that it was a mistake to tighten policy (fiscal and monetary) too early.

In other words, according to her, if the Fed had continued pumping as furiously as possible, then everything would have been alright.

In reality, the entire inflationary mini-boomlet-within-the-depression was simply an illusion. 'GDP growth' that is bought with monetary pumping and feckless fiscal spending only misdirects and ultimately consumes even more scarce capital.

Fiscal stimulus may temporarily give the impression of a recovery, but it is not a genuine recovery. It makes things worse. The moment the pumping is abandoned, the true state of affairs is simply unmasked. That is what happened in 37/38 - a slight tightening of monetary policy revealed the fact that the mini-boomlet was as unsound as its predecessor boom in the years prior to the '29 crash.

It would not have been possible to hide this reality forever. There is nothing, absolutely nothing, that government intervention can achieve in terms of 'fixing' the economy. The choice was in either abandoning the unsound policy and the unsound investments it produced, or careen toward a complete destruction of the currency system.

Once again, I stand amazed at how people can look at this, and look at Japan, and look at the housing bubble/bust sequence, and still believe that monetary pumping and deficit spending are viable tools of economic policy when a bust occurs. It really boggles the mind, reminding me of Einstein's definition of insanity, 'doing the same thing over and over again and expecting a different result'.Understanding Velocity

David had several slides on velocity. The important point he missed is that velocity of money is a result not a cause of anything to come.

Velocity is falling because the Fed is printing hoping to stimulate the economy but banks are not lending because

1) credit risks are high
2) there is rampant overcapacity everywhere, thus businesses have no reason to expand
3) credit worthy consumers do not want to borrow

The attitudes of lenders and potential borrowers have changed. Under these conditions, the more Bernanke prints, the lower velocity will go.

Spending Collapses In All Generation Groups

Please consider Spending Collapses In All Generation Groups

It's no secret that boomers fearing an underfunded retirement have sharply cut spending. However, it's not just boomers cutting back. Consumer attitudes toward debt have changed across all age groups.

Bernanke can flood the world with "reserves" and indeed he has. However, he cannot force banks to lend or consumers to borrow.

Here is a simple analogy that everyone should be able to understand: You can lead a horse to water but you cannot make it drink. And if the horse does not want to drink, it was a waste of time and energy to lead the horse to the water.

In a debt-based economy, it is extremely difficult (by monetary policy) to produce inflation if consumers will not participate. And as noted above, demographics and attitudes strongly suggest consumers have had enough of debt and spending sprees.

Government bodies like Congress can theoretically produce inflation but Japan tried and failed for years.

Uncharted Territory

In the US and globally we are in uncharted territory. Odds are we will see many things we have never seen before as stimulus after stimulus fails to produce desired results.

I ask you to consider Twelve Reasons For A Job Loss Recovery.

Humpty Dumpty On Depression Conditions

The conditions now are very similar to what happened in the great depression, discounting for the moment this reflationary effort by the Fed that is doomed to fail.

For more on the conditions one would expect to see in deflation please consider
Humpty Dumpty On Inflation.

Some of those conditions have changed since December. However, bank failures, total bank credit, and short term treasury yields near 0% have not. Moreover, long term yields have ticked up but they are still at historic lows compared to anything but the lows last December.

It is important not to confuse a recovery in the stock market with an economic recovery.

Don't just take my word for it. Please consider Leading indicators and the shape of the recovery by Paul Krugman?

Michael Shedlock has an awesome takedown of ECRI’s claim that its indicators (a) have successfully predicted turning points in the past (b) point to a sold recovery now. I’d add that this is a really, really bad time to be relying on conventional indicators.

Why? Basically, because in a zero-interest rate world — the three-month rate was .066% last I looked — especially one that’s suffered from a collapse of the shadow banking system, conventional indicators don’t mean what they usually mean. Increases in the monetary base aren’t especially expansionary. The yield curve more or less has to slope up, even if no recovery is expected. And so on.

So historical correlations, to the extent that they exist — and as Shedlock points out, ECRI is claiming a much better record than it really has — can’t be counted on to prevail. There’s really no alternative to making fundamental analyses of the macro situation.

One important point to note is this is a credit bubble bust, similar to the Great Depression, not an earnings scare recession, or a routine business cycle recession.

This is a once in several generational event. I bet the ECRIs leading indicators applied in April of 1930 would have looked quite similar.

One thing is for sure, is that Krugman does not hold any grudges. I sure have to give him credit for that. I also happen to agree with Krugman when it come to free trade for which we are both strong proponents.

Unfortunately however, there is a rising tide of protectionism in Congress and this Administration. Note that the Smoot-Hawley Tariff Act is one of the things that made the Great Depression much worse.

States are repeating another mistake by raising property taxes.

Keynesian Model Broken Beyond Repair

The Keynesian and Monetarist models are broken beyond repair.

It is amazing that so much love exists for a man whose ideas have been thoroughly discredited on many occasions. Here is a little blurb from the American Journal of Economics and Sociology.
The crisis policy devised by John Maynard (Lord) Keynes, which seemed to work well during World War II and in postwar reconstruction, met its nadir in 1975. Contrary to Keynesian theory, formalized in the Phillips Curve argument that inflation and mass unemployment are mutual trade offs, double digit inflation and record unemployment made further deficit spending an impossible policy.In case you fail to understand the implications, Keynes is arguing one cannot have a recession and inflation at the same time.

Did The Keynesian Economists Give Up Their Theories Confronted With Japan?

The answer is no. Stagflation in the 70's discredited Keyensian theory as did Japan's building bridges to nowhere.

Keynesian economists now say the problem was Japan simply did not act fast enough.

The amount of global monetary stimulus thrown at curing the deflation problem is staggering. Yet here we are with the same debt overhang, no jobs, and no way to pay off that debt. Deflation looms larger than ever because of Central Bank efforts to fight it.

Let's return to the beginning. It's important to remember that inflation and deflation about not about prices but rather about the expansion of money supply and credit. Concern over prices is putting the cart before the horse.

Fantasizing In Academic Wonderland

Keynesian academic models do not work in a real world, with real people, where attitudes and global forces such as global wage arbitrage are in play. The Fed cannot force consumers to borrow or banks to lend. Nor can the Fed create jobs. Congress can create makeshift jobs but as we have shown above, makeshift jobs cannot possibly create a solid economic foundation.

In response to the above someone is sure to tell me how negative interest rates could be used to force banks to lend. My response is forcing banks to lend cannot and will not work in actual practice.

One reason Bernanke wanted to pay interest on reserves was to slowly recapitalize them over time. One cannot achieve that while forcing them to lend. Moreover forcing banks to lend will do nothing but increase further writeoffs.

Again, it is important to look at how things operate in a real world model, with real consequences, as opposed to fantasizing in academic wonderland about how to force banks to lend.

Fiat World Mathematical Model

Logically speaking, when the problem is debt is to high, it is insane to think a spending spree will fix the problem. Even a 6th grader would be able to understand this, but Keynesian and Monetarist academic wonks just cannot manage the task.

Greenspan stimulated the economy in 2002 and all we have to show for it is a collapsing housing bubble and still more debt.

Instead of following a Keynesian model that does not work, please consider a Fiat World Mathematical Model.

I believe Steve Keen and I have it correct. In a credit-based, fiat-currency model, deflation will always manifest itself as debt-deflation. Price deflation is a meaningless sideshow.

I am not sure how far along we are with debt deflation given that much depends on how far and how long the Fed and Congress attempts to fight it. The preliminary results however, do not look very good. I expect a second lost decade in the US, just as happened in Japan.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post ListMike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

In an On My Mind segment of Forbes Ron Paul says Be Prepared for the WorstAny number of pundits claim that we have now passed the worst of the recession. Green shoots of recovery are supposedly popping up all around the country, and the economy is expected to resume growing soon at an annual rate of 3% to 4%. Many of these are the same people who insisted that the economy would continue growing last year, even while it was clear that we were already in the beginning stages of a recession.

A false recovery is under way. I am reminded of the outlook in 1930, when the experts were certain that the worst of the Depression was over and that recovery was just around the corner. The economy and stock market seemed to be recovering, and there was optimism that the recession, like many of those before it, would be over in a year or less. Instead, the interventionist policies of Hoover and Roosevelt caused the Depression to worsen, and the Dow Jones industrial average did not recover to 1929 levels until 1954. I fear that our stimulus and bailout programs have already done too much to prevent the economy from recovering in a natural manner and will result in yet another asset bubble.

By attempting to cushion the economy from the worst shocks of the housing bubble's collapse, the Federal Reserve has ensured that the ultimate correction of its flawed economic policies will be more severe than it otherwise would have been. Even with the massive interventions, unemployment is near 10% and likely to increase, foreigners are cutting back on purchases of Treasury debt and the Federal Reserve's balance sheet remains bloated at an unprecedented $2 trillion. Can anyone realistically argue that a few small upticks in a handful of economic indicators are a sign that the recession is over?

What is more likely happening is a repeat of the Great Depression. We might have up to a year or so of an economy growing just slightly above stagnation, followed by a drop in growth worse than anything we have seen in the past two years.

Government intervention cannot lead to economic growth. Where does the money come from for Tarp (Treasury's program to buy bad bank paper), the stimulus handouts and the cash for clunkers? It can come only from taxpayers, from sales of Treasury debt or through the printing of new money.

The Fed has already overseen a 95% loss in the dollar's purchasing power since 1913. If we do not stop this profligate spending soon, we risk hyperinflation and seeing a 95% devaluation every year.Fake Recovery

I agree with most of what Ron Paul says except for the likelihood of hyperinflation. While theoretically possible, concern should be more over what legislation Barney Frank and Congress comes up with rather than what Bernanke is going to do next.

On every other point I agree.

• This is a fake recovery that will die as soon as stimulus stops. It will die eventually whether stimulus stops or not.
• The policies of Hoover and Roosevelt certainly caused the Depression to worsen.
• Government intervention cannot lead to economic growth and the policy responses out of the Fed and Congress are simply making matters worse.

Ron Paul vs Michael Moore on Larry King CNN 10/29/2009

Inquiring minds are listening to Ron Paul on Larry king.



Partial Transcript
I dislike the health care system as much as Michael Moore does. But he is complaining about this being a part of capitalism. It has nothing to do with capitalism. This is corporatism. ... Pumping money into as system does not improve quality; it increases prices.

When a country embarks on deficit financing and inflationism you wipe out the middle class ad wealth is transferred from the middle class and the poor to the rich.

The problem isn't the fact that we don't have enough government, we have way too much government. Government crated this monster. If he [Moore] doesn't like what we have, he has to look at what we have been doing for 30 or 40 years. It's called interventionism; it's called Keynesianism; it's called inflationism, and it's called big government. That's the problem.

[On Afghanistan and Iraq] My position is we shouldn't have gone in and we should just come home. There has been a token effort at bringing some troops home from Iraq. Iraq is a mess. But at the same time we are sending in contractors to replace the troops, paying them a lot more money, subsidizing the military industrial complex and Obama ought to be condemned for that.

We just marched in we can just march home. Besides, I will win this argument. We are bankrupt and cannot afford it.

Let's quit this militarism around the world. We are in 130 countries and 700 bases around the world and we cannot sustain these. It's pumped out by the left and the right. There is conservative Keynesianism and liberal Keynesianism which always fails and gives us the financial crisis we are in.I have no quibbles with what Ron Paul says in that interview. Please listen to it. Moore is also criticizing our policy in Iraq.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Government, lenders, and various lender-sponsored "help" agencies have acted in unison, using fear mongering tactics and shame to manage the housing crisis for the sole benefit of lenders.

Thanks to Brent T. White at the James E. Rogers College of Law and the Sacramento Bee and for a fascinating called Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.

Note: The PDF is 54 pages long and worth reading in entirety but I have condensed the discussion down to a very readable 3-4 pages of so. There is little sense in putting such a lengthy snip into a huge blockquote that will take up a lot of space. Instead, I will make it clear below when the article ends.

Abstract

Despite reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners choose not to strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to encourage homeowners to follow social and moral norms related to the honoring of financial obligations - and to ignore market and legal norms under which strategic default might be both viable and the wisest financial decision. Norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse.

II. Underwater and Staying Put

As further evidence that relatively few homeowners strategically default solely because they are underwater, housing markets with a sharply higher percentage of underwater homeowners as compared to the national average do not have sharply higher default rates.

As the chart below illustrates, this pattern of relatively low default rates compared to the percentage of underwater mortgages holds true almost universally across the hardest hit markets, with the default rate much more closely resembling the unemployment rate than the percent underwater:



III. The Financial Logic of Walking Away

Before examining why more underwater homeowners are not strategically defaulting, it might be helpful to explore why they should. A textbook premise of economics is that the value of a home, even an owner occupied one, is “the current value of the rent payments that could be earned from renting the property at market prices.”

In other words, when the net cost of buying a home exceeds the net cost of renting, one is better off renting. The equation is not as simple, however, as comparing total mortgage payments to rent payments because home ownership carries certain benefits including tax breaks and the potential for appreciation. Additionally, assuming a non-depreciating market, the portion of the mortgage payment that goes to principle rather than interest will eventually inure to the homeowner at the time of sale. On the flip side, homeownership carries significant costs that renting does not, including maintenance, homeowner’s insurance and substantial transaction costs upon selling.

In calculating whether to buy or rent, a potential homebuyer should compare the net cost of owning to the net cost of renting a similar home over the expected period of occupancy. The costs of owning include the interest-only portion of the loan payment, property taxes, maintenance, homeowners insurance, and transaction costs upon selling, minus the expected appreciation and cumulative tax savings over the planned period of ownership. As a rule of thumb, a potential homebuyer is generally better off renting when the home price exceeds 15 or 16 times the annual rent for comparable homes.

For example, a homeowner who bought an average home in Miami at the peak would have paid around $355,400. That home would now be worth only $198,00038 and, assuming a 5% down payment, the homeowner would have approximately $132,000 in negative equity. He could save approximately $116,000 by walking away and renting a comparable home. Or, he could stay and take 20 years just to recover lost equity – all the while throwing away $1300 a month in net savings that he could invest elsewhere.

The advantage of walking is even starker for the large percentage of individuals who bought more-expensive-than-average homes in the Miami area – or in any bubble market for that matter - in the last five years. Millions of U.S. homeowners could save hundreds of thousands of dollars by strategically defaulting on their mortgages.
Homeowners should be walking away in droves. But they aren’t.

V. The Social Control of the Housing Crisis

Alarmed by the possibility that foreclosures may reach a tipping point, formal federal policy has aimed to stem the tide of foreclosures through programs designed to “reduce household cash flow problems,” such as the Making Home Affordable (MHA) loan modification program and Hope For Homeowners.

In other words, federal policy assumes that homeowners are – for the most part - not “ruthless” and won’t walk away from their mortgages simply because they have negative equity. Most homeowners walk only when they can no longer afford to stay. As evidence of this fact, only 45% of homeowners would walk even if they had $300,000 in negative equity. This percentage drops to 38% among the subset of individuals who believe it is immoral to strategically default on one’s mortgage (a subset to which 87% of homeowners belong).

These numbers suggest that the “moral constraint” is a powerful one indeed – and that, for most people, only the complete inability to afford their mortgage would push them to default. On the other hand, the fact that 63% of “amoral” individuals would default at $300,000 in negative equity, and 59% would do so at $200,000, suggests that federal policy can only proceed on the premise that affordability is the prime consideration as long as the moral and social constraints on foreclosure remain strong.

The government thus has an incentive, along with certain other economic and social institutions interested in limiting the number of foreclosures, in cultivating guilt and shame in those who would contemplate walking away. Similarly, knowing that guilt and shame alone are not enough to prevent many individuals from defaulting once negative equity is extreme, these same institutions have an interest in increasing the perceived cost of foreclosure by cultivating fear of financial disaster for those who contemplate it.

At the political level, government spokespersons, including President Obama, have repeatedly emphasized the virtue of homeowners who have acted “responsibly” in “making their payments each month”. The worst criticism has been reserved, however, for those who would walk away from mortgages that they can afford.

Such individuals are portrayed as obscene, offensive, and unethical, and likened to deadbeat dads who walk out on their children, or those who would have “given up” and just handed over Europe to the Nazis.

Indeed, a homeowner contemplating a strategic default would be hard pressed to avoid the message that doing so would place them among the most despicable members of society.

Moreover, a homeowner who turned to any number of credit counseling agencies would also find little sympathy - and much moralizing - should they announce their plan to walk on their “affordable” mortgage. Gail Cunningham of the National Foundation for Credit Counseling declared for example in an interview on NPR: “Walking away from one's home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities."

Indeed, the uniform message of both governmental and non-profit counseling agencies (which are typically funded at least in significant part by the financial industry) is that “walking away” is not a responsible choice and should be avoided at all costs.

Social control of would be defaulters is not limited to moral suasion, however. Predominate messages regarding foreclosure also frequently employ fear to persuade homeowners that strategic default is a bad choice. Indeed, almost every media story on those who “walk away from their mortgages” condemns the behavior as immoral and enlists some “expert” to explain that foreclosure is, despite any claims to the contrary, a devastating event.

Similar warnings of disaster pervade the information given to homeowners by HUD-approved housing counseling agencies, such as the following from the Anaheim Housing Counseling Agency:

Losing your home can be the worst and most devastating event to you personally, and your credit history. This is a scenario that you don’t want to occur if you can avoid it! Not only will you lose the comfort of your home and your investment, but a Foreclosure will stay pending on your credit history for as long as 10 years. This will jeopardize your ability to qualify for any future home loan purchases, it may affect your ability to access loans for car purchase and other needed purchases, and loan costs are likely to be higher both in fees and interest paid.

As discussed above, fear alone is a powerful motivator. But guilt and fear in combination are even more potent.

This may be because most individuals have a deep-seated, if ill-defined, sense that if they do “bad things,” bad things will happen to them. Whatever the psychological underpinnings, most people simply do not believe they will escape punishment for their moral transgressions. Guilt and fear of punishment go together.

As explored above, however, there is in fact a huge financial upside to strategic default for seriously underwater homeowners – an upside that is routinely ignored by the media, credit counseling agencies, and other political and economic institutions in “informing” homeowners about the consequences of default. Moreover, the costs of default are not nearly as extreme as these same institutions typically misrepresent them to be. In reality: homeowners face no risk of a deficiency judgment in many states or, regardless of the state, for FHA loans or loans held by Fannie Mae or Freddie Mac; even in recourse states, lenders are unlikely to pursue a deficiency judgment because it is economically inefficient to do so; there is no tax liability on “forgiven portions” of home mortgages under current federal tax law in effect until 2012; defaulting on one’s mortgage does not mean that one’s other credit lines will be revoked; and most people can expect to recover from the negative impact of foreclosure on their credit score within a two years (and, meanwhile, two years of poor credit need not seriously impact one’s life).

VI. The Asymmetry of Homeowner and Lender Norms

One obvious response to the above discussion is that society benefits when people honor their financial obligations and behave according to social and moral norms, rather than strictly legal or market norms. This may be true if lenders behaved according to the same social and moral norms. In the case of lender-borrower behavior, however, there is a clear imbalance in placing personal responsibility on the borrower to honor their “promise to pay” in order to relieve the lender of their agreement to take back the home in lieu of payment. Given lenders generally superior knowledge and understanding of both mortgage instruments and valuation of real estate, it seems only fair to hold them to the benefit of their bargain. At a basic level, sound underwriting of mortgage loans requires lenders to ensure that a loan is sufficiently collateralized in the event of default.

As such, historical home prices have hewed nationally to a price-to-annual-rent ratio of roughly 15-to-1. At the peak of the market, however, price-to-rent ratios reached 38-to-1 in the most inflated markets, and the national average reached 23-to-1.

If personal responsibility is the operative value, then lenders who ignored basic economic principles (of which they should have been aware) should bear at least equal responsibility to homeowners for issuing collateralized loans that were far in excess of the intrinsic value of the home.

Moreover, since lenders generally arrange the appraisal (which home buyers must pay for) and home buyers rely upon the lender to ensure the home is worth the purchase price, one might argue that lender should bear much more than 50% responsibility for the bad investment of the homeowner and lender.

Indeed, lenders’ mortgage default risk models have long shown that the loan-to-value ratio is a critical factor in default risk. Lenders relaxed this requirement, however, as credit default models showed that few borrowers were “ruthless,” meaning that few borrowers default as soon as the loan value exceeds the market value of the home.

This is not to say that lenders are solely responsible for the housing run-up and bust, but that they do in fact bear a substantial portion of the blame – and thus should thus bear a substantial portion of the cost. One might argue, in fact, that the value of personal responsibility would require lenders to own up to their share of the blame, and work with underwater homeowners by voluntarily writing off some of the negative equity.

But lenders, of course, do not operate according norms of personal responsibility, and seek instead to maximize profit (or minimize losses). Appealing to this duty, it has been suggested that, given the great cost to lenders of foreclosure, they have an economic incentive to modify loans for homeowners in danger of default.

Recent studies seeking to explain this apparently irrational behavior have shown that lenders are simply operating to maximize profit and minimize losses, just as they would be expected to do.

First, lenders know that borrowers with high credit scores are unlikely to default even at high levels of negative equity. To modify loans for these homeowners would be to throw money away – and to encourage more homeowners to ask for modifications. Second, a significant number of homeowners who temporarily default on their mortgages “self-cure” without any help from their lender – though self cure rates have dropped precipitously in the last two years. Again, to modify the loans of individuals who would otherwise self cure would be to throw away money. Third, homeowners with poor credit, or who end up in arrears because of “triggering events” such as unemployment, divorce, or other financially devastating circumstances are likely to default on the modified loan as well. To modify loans for these individuals is to waste time and risk housing prices falling further before the lender eventually has to foreclosure and sell the property anyway.

Given these economic incentives for the lender, a seriously underwater homeowner with good credit and solid mortgage payment history who responsibly calls his lender to work out a loan modification is likely to be told by his lender that it will not discuss a loan modification until the homeowner is 30 days or more delinquent on his mortgage payment.

The lender is making a bet (and a good one) that the homeowner values his credit score too much to miss a payment and will just give up the idea of a loan modification.

However, if the homeowner does what the lender suggests, misses a payment, and calls back to discuss a loan modification in 30 days, the homeowner is likely to be told to call back when he is 90 days delinquent. In the meantime, the lender will send the borrower a series of strongly-worded notices reminding him of his moral obligation to pay and threatening legal action, including foreclosure and a deficiency judgment, if the homeowner does not bring his mortgage payments current. The lender is again making a bet (and again a good one) that the homeowner will be shamed or frightened into paying their mortgage. If the homeowner calls the lender’s bluff and calls back when he is 90 days delinquent, there is a good possibility that he will be told that his credit score is now so low that he does not qualify for a loan modification.

Most lenders will, in other words, take full advantage of the asymmetry of norms between lender and homeowner and will use the threat of damaging the borrower’s credit score to bring the homeowner into compliance. Additionally, many lenders will only bargain when the threat of damaging the homeowner’s credit has lost its force and it becomes clear to the lender that foreclosure is imminent absent some accommodation. On a fundamental level, the asymmetry of moral norms for borrowers and market norms for lenders gives lenders an unfair advantage in negotiations related to the enforcement of contractual rights and obligations.

*** END OF ARTICLE SNIP ***

There is more in the article including a discussion as to what to do about it all. I do not agree with many of the proposed solutions and indeed the article points out flaws in most of the solutions that have been proposed.

However, I do agree with the basic idea that asymmetry is a huge problem, that the playing field needs to be leveled.

Moreover, I will add that the real moral hazard is attempting to keep people debt slaves by purposely overstating the costs of walking away while ignoring all of the benefits. These "help" agencies are designed to do one thing and one thing only: help the lender regardless of the cost to the homeowner.

If these "help agencies" actually gave a realistic assessment of the advantages of walking away, we would see more willingness for voluntary cooperation between lenders and homeowners to negotiate a mutually beneficial arrangement. Instead we have a one sided winner-take-all approach whereby the only way for the homeowner to win is to walk away.

The current system of offering lenders a few thousand dollars to refinance a loan making the loan "more affordable" does nothing to address the fundamental problem of too much debt that will act as a drag on the economy for a decade to come.

The article concludes ...
Regardless of the precise policy prescription, it is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible. To the contrary, walking away may be the most financially responsible choice if it allows one to meet one’s unsecured credit obligations or provide for the future economic stability of one’s family.

Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices.

The current housing bust should be viewed for what it is: a market failure – not a moral failure on the part of American homeowners. That being the case, it is time to take morals out of the picture and search for an equitable solution to the negative equity problem.Other than a single sentence about "market failure" that was a brilliantly written piece by Brent T. White. The market did not fail, government policies to promote housing in conjunction with loose monetary policies at the Fed is what failed. Fannie Mae, Freddie Mac, HUD, the FHA, and the Fed all failed. Every one of those agencies should be abolished.

In the meantime, morality and fear mongering is not the solution. Instead, a rational look at the costs and benefits of walking away will encourage market solutions involving renegotiating debt levels to affordable levels rather than concentrating on affordable payment levels. A focus on the latter will act as a drag on the economy for a decade.

Addendum:

Walking away may be a good thing but laws vary state by state.

This is very important: Please do yourself a favor and Consult An Attorney Before Walking Away. The link will explain why.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I have received a couple of replies to Government and Lender Policies of Fear and Shame Help Keep Homeowners Debt Slaves that are worth sharing.

This one is from Michael Becker, a mortgage consultant in Maryland. Michael writes ...Hello Mish,

I wanted to let you know that I deeply appreciate your post on strategic defaults. I get people calling me all of the time looking to refinance and when I find out how underwater they are I tell them it might be wise to walk away from the property.

I also tell them the consequences of walking away. Like the article said, a foreclosure will stay on your credit report for 10 years. However, if you walk away it will only be 3 years before you can buy a home again. (It used to be 2 years but Fannie, Freddie, and the FHA made it longer to discourage people from walking away.)

I tell them if they choose to walk away they need to make sure they have a decent car, and at least one credit card. The reason for the car is that it may be hard to get a decent rate on a car loan for a while if they have a recent foreclosure, and the credit card is needed to help you re-establish your credit after the foreclosure. One of the biggest mistakes people make after a bankruptcy or foreclosure is not re-establishing their credit.

I do believe that in the future the guidelines will be changed to allow people who have re-established their credit to purchase a home 2 years after a foreclosure. This because there will be thousands such potential borrowers and it would be stupid to prevent them from re-entering the market.

The other night I meet some friends for dinner. When a got there a lady I used to work with came up to me and told me her situation. In 2007 she bought a condo in Arlington, Va. for $300,000 and its value had dropped to $200,000. She still owed $295,000 on it. She told me she could afford the payment, but was considering walking away. I asked her what was her mortgage payment and condo fees were. It came to $2,300/month. Then I asked how much would it cost to rent a similar apartment. Her answer was $1,200-1,300.

I said the answer was easy, walk away. In fact, I told her I would stop paying the mortgage and see how long it took them to foreclose. She might be able to live there 6 months or more rent free.

Her fiancé was there and he didn't agree with my answer. He said that her credit would be ruined for ten years and that the value would come back. I responded that a foreclosure would stay on a credit report for 10 years, but if you work hard at re-establishing your credit, the score can come back in a year or two.

I have seen people plenty of people with credit scores over 700 within one year of a bankruptcy or foreclosure. As far as the value coming back, I told him that it would take 10 years or more before that value comes back.

More people need to know that foreclosure is not the end of the world and that their credit can come back in a couple of years or sooner, especially if they take the right steps prior to the foreclosure.

Thanks for the post, and keep up the good work.

Michael BeckerWalking Away is not the end of the world. Indeed, for most it will be a new beginning.

Addendum:

Walking away may be a good thing but laws vary state by state.

This is very important: Please do yourself a favor and Consult An Attorney Before Walking Away. The link will explain why.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.