Today's Markets

On the two day chart, notice there are two upward sloping trend lines, which prices broke at the end of the day today. Also note that prices moved through the 200 day SMA and the shorter SMAs are moving lower. Finally, look at the heavy volume at the end of the trading day traders were definitely looking to get out.



Pulling the camera back, notice there was a big gap down on Monday at the open, caused by the GM situation. Prices formed a downward sloping channel for the entire trading day yesterday, rebounded a bit today with a gap up but then fell through all the upward sloping support lines mentioned above.



On the daily chart, notice that prices are moving up the 38.2% Fibonacci level.

We're Nowhere Near a Bottom in Housing

From Bloomberg:

Home prices in 20 U.S. cities fell 19 percent in January from a year earlier, the fastest drop on record, as demand plummeted and foreclosures rose.

The S&P/Case-Shiller index’s decrease was more than forecast and compares with an 18.6 percent decrease in December. The gauge has fallen every month since January 2007, and year- over-year records began in 2001.

A glut of unsold properties may keep prices low, shrinking household wealth and damping spending. Still, sales of new and previously owned homes rose in February, indicating the housing slump, now in its fourth year, may ease as policy efforts to unclog credit and aid borrowers begin to take hold.

“At this point it doesn’t look great for the near term,” Robert Shiller, chief economist at MacroMarkets LLC and a co- creator of the home price index, said today in a Bloomberg Radio interview. Still, he said, prices “can’t keep declining at this rate forever.”

In order for housing to bottom, we need to see prices drop in the 3%-5% year over year range. That's when we'll know the decline in housing is ending. Until that time, we're nowhere near a bottom in housing.

MZM/M2 Post

Some things just can't be resisted -- such as using Pink Floyd's money to begin a discussion about money supply (note two things about the track. First, the main riff is in 7/4 which is a metrical oddity for pop music, and David Gilmour's always great guitar playing.)

This post will be discussing MZM which is:

A measure of the liquid money supply within an economy. MZM represents all money in M2 less the time deposits, plus all money market funds.

.....

MZM has become one of the preferred measures of money supply because it better represents money readily available within the economy for spending and consumption. This measurement derives its name from its mixture of all the liquid and zero maturity money found within the three "M's."

In essence, what we're looking for is money that we can spend right now if we wanted to. First here's a chart of the absolute liquid amount of money in the system:


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Note that the Federal Reserve has been pumping money into the system in order to stimulate demand. Notice this did not happen in the recessions of the early 1980s because the Fed was raising interest rates at that time. However, the Fed did pump liquidity into the system in the last recession (2001) as they are now.

Here is a chart of the year over year rate of change:



We are seeing a positive rate of year over year growth between 10% and say 16%. However, note the rate of year over year change that occurred in this recession compared to the last recession and you see a major difference. The last recession saw an increase in the year over year rate of increase in MZM whereas this recession is seeing a more controlled year over year rate of change. Interesting, to say the least.

But the tale becomes more interesting here:


This is a graph of the year over year change in M2, which is:

A category within the money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.

M1 is

A category of the money supply that includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order of Withdrawal (NOW) Accounts.

First, notice the year over year increase in M2 -- which is spiking to around 10%. But let's ask ourselves why that is happening. Liquid money as represented by MZM is showing a year over year increase, but not at the same rate as we have seen in previous recessions. That means non-currency money is probably the primary reason for the increase in M2. And when we look at the spike in savings:


We get our probable answer as to what is causing the spike in M2 -- people putting money into demand deposits.

Let's ask ourselves a final question: will people spend this money or will they keep it in their accounts as a financial cushion? The answer is extremely important from an inflationary perspective. If the money is more prone to stay put then it will not add as much inflationary pressure or growth. If people are going to rush out and blow it then we'll have an increase in MZM, which will increase monetary velocity and thereby inflation and overall growth.

Bottom line: we don't know the answer to the preceding question. There has been a tremendous amount of wealth destruction over the last 6 quarters which would indicate people are more inclined to keep the money where it is. However, we've also seen weak personal consumption expenditures over the last two quarters indicating there might be some pent-up demand that will kick in when people feel a bit more confident in spending.

In other words -- we get to wait and see. What fun.

Treasury Tuesdays

The main issue in the Treasury market right now is the Fed's purchase of Treasury debt. That has placed a de facto floor underneath Treasury prices for the foreseeable future. The long bar (you can't miss it on this chart) occurred when the Treasury announced the plan. Since that announcement, prices have sold off to the 10 day SMA but are now using the 10 day SMA as technical support. In addition, the 10 day SMA has crossed over the 50 day SMA and the 20 day SMA has also crossed over the 50 day SMA.

It's important to remember that SMAs are coincidental indicators, meaning they occur at the same time as the event they are describing. If you want a moving average that is more predictive -- or at least more important relative to the current prices, use the exponential moving average:


Notice that on the EMA chart, the 10 and 20 day EMAs have already moved through the 50 day EMAs.

Today's Markets

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The market sold-off today on news of GM's president being fired and amid concern that an auto bail-out was not on the way. However, notice there are still plenty of support levels below current levels. In addition, a sell-off was inevitable. What we need to watch for now is what happens when prices hit various support levels.

A Sucker is Born Every Minute

From the WSJ:

Some investors haven't quite given up the ghost of "decoupling," the notion that emerging markets can ignore recessions in developed economies. Yes, growth rates in China, India and Brazil likely will outpace those in the U.S., Europe and Japan this year. And emerging-market banks largely have avoided contagion by the West's toxic assets.

That's right -- countries that extract raw materials don't need to sell those materials to anybody who then develop then into products which are sold in the developed world. That's just a figment of my imagination.....

Mortgage Delinquencies Continue to Rise

From the WSJ:

Defaults on home mortgages insured by the Federal Housing Administration in February increased from a year earlier.

A spokesman for the FHA said 7.5% of FHA loans were "seriously delinquent" at the end of February, up from 6.2% a year earlier. Seriously delinquent includes loans that are 90 days or more overdue, in the foreclosure process or in bankruptcy.

Since the collapse of the subprime mortgage market in 2007, most home loans for people who can't afford a sizable down payment are flowing to the FHA. The agency, which is part of the U.S. Department of Housing and Urban Development, insures mortgage lenders against the risk of defaults on home mortgages that meet its standards. FHA-insured loans are available on loans with down payments as small as 3.5% of the home's value.

The FHA's share of the U.S. mortgage market soared to nearly a third of loans originated in last year's fourth quarter from about 2% in 2006 as a whole, according to Inside Mortgage Finance, a trade publication. That is increasing the risk to taxpayers if the FHA's reserves prove inadequate to cover default losses.

Let's coordinate this data with the following charts from the FDIC:

The non-current rate has increased for the last two years. The chart indicates the trend is solidly up.

Credit quality of residential mortgage loans has continually decreased


And the non-current rates on loans on 1-4 residential properties has been increasing as well.

Market Monday's

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Let's take the last few year's price action apart in order to place the current rally in perspective.

1.) The market has been in a confirmed downtrend since the beginning of 2008. Since that time it has rallied 4 times -- March - mid-May, early July to the end of August, November to January 2009 and the current rally which started in March of this year. All the rallies formed upward sloping triangles, sometimes referred to as wedges.

2.) The first rally ran into upside resistance at the 200 day SMA while the others ran into resistance at or just beyond the 50 day SMA. Currently, prices are at or near similar areas around the 50 day SMA

3.) The rallies have varied in strength from (roughly) 8.3% t0 25%. The current rally is over 20%, but is still below the bigger gain of the November-January rally


Notice the following on the 6 month chart:

-- Prices have moved though the downward sloping trend line that connected several points

-- Prices have moved through several previous lows

-- The 10 day SMA has moved through the 50 day SMA

-- The 20 day SMA has now turned positive

-- In other words, there are now several important technical areas of support for prices should they fall


Above is a chart that shows more of the support areas in the event of a pullback.

Who Will Borrow?

From IBD:

The Treasury and the Federal Reserve are throwing trillions of dollars at financial firms to prod them to lend more. But even if those programs succeed, debt-strapped families probably won't want to borrow hand over fist.

This is the key question to ask regarding the credit crisis: once banks are back on their feet, who will take out loans.

Let's start with this:

Consumers are saving more to make up for a 20% drop in the median U.S. home price and a nearly 50% decline in stock prices from their peaks.

Since the second quarter of 2007, households have seen their net worth drop from $64.361 trillion to $51.476 in the 4Q08. This is a drop of 20%. Most importantly, the two most important asset classes are -- stocks and houses -- are falling. In other words, there is no place to hide.

In addition there is already a ton of household debt in the system. Total household debt in 4Q08 stood at $13.8 trillion while total GDP stood at $14.2 trillion. In other words, there as nearly as much household debt as there was GDP.

As a result of all the debt and drop in two primary assets, households are saving more:



What will change this behavior from an increase in savings to an increase in spending? I'm not sure. There are some who are arguing that we are moving into a "return to frugality" where consumers can't be counted on to provide 70% of GDP growth, I think this is entirely possible. However, if the following happens this "return to frugality" could be thwarted:

1.) Meaningful job growth returns for an "extended" period of time. My meaningful, I'm thinking at least 125,000 for 4-6 months.,

2.) There is meaningful increase in incomes.

3.) Stocks return to profitability.

4.) Real estate starts to steady.

Weekend Weimar and Beagle

The market is almost closed. It's been a good week. So -- relax and don't think about anything related to the market or the economy for the next few days.

To that end

Underground Economy Thrives In Recession

From Bloomberg:

Carlos Cruz has a strategy for surviving the worst global recession in 60 years: pay less in taxes and pass the savings along to customers.

“I’m declaring half as much as I used to,” said Cruz, 29, who runs a painting business in Madrid. “Prices have fallen by 30 percent and customers will choose you for a difference of as little as 50 euros ($67.70),” said Cruz, an Ecuadorian who has lived in Spain since 2001.

Even as the U.S., Japan and Europe weather the first simultaneous recessions since World War II, some types of activity are expanding worldwide -- just below government radar. The production of goods and services that are lawful, though not declared, may grow the most as a proportion of total output since 2000, according to Friedrich Schneider, a professor at Austria’s Johannes Kepler University of Linz.

.....

In 21 of the 30 countries in the Organization for Economic Co-operation and Development, Schneider estimates the informal economy will equal 13.8 percent of official gross domestic product in 2009, up from 13.3 percent last year. On that basis, its value will climb by $200 billion to $5.59 trillion in those nations from $5.39 trillion, using constant 2008 GDP because data for this year isn’t yet available.

I've always wondered how you counted an economy that by definition is not trying to be found. But that's neither here nor there at this point.

A Closer Look At the Latest Rally

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All of the charts below have important technical information. In all three, prices have broken through both a downward sloping trendline that acted as upside resistance and lows established over the last few months. Both of these developments are technically very positive. In addition, now all three are above the all their respective SMAs -- another bullish technical development.

Forex Fridays

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On the weekly chart, notice the dollar is clearly in a double top pattern and has now fallen from the second top. The MACD and RSI have followed, confirming the trend. Prices have fallen through the 10 and 20 week SMA which will pull those numbers lower. Although the long-term trend is still up (as evidenced by the increasing 50 week SMA) the fact that prices are now between a group of SMAs indicates the markets will probably be taking a breather right now.


The daily chart shows the sell-off in more detail. Prices have clearly broken the upward sloping trend line that started in mid/late December of last year. The MACD and RSI have also dropped, confirming the trend. The 10 and 20 day SMA are both moving lower, and the 10 day SMA has now moved through the 50 day SMA -- a bearish development.

Today's Markets

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The rally continues. Prices are now above all the SMAs. in addition, the 10 day SMA is about to move through the 50 day SMA, which would be a very bullish event. Also note the 20 day SMA is moving higher and the 50 day SMA has lost its several downward sloping trajectory.

Bottom line: this rally is looking very good right now.

GDP Contracts by 6.3%

From Marketwatch:

The U.S. economy experienced its most violent contraction in a generation during the fourth quarter, with real gross domestic product plunging at a 6.3% annualized seasonally adjusted rate, the Commerce Department reported Thursday in its third estimate of quarterly growth.

GDP hadn't fallen so much since the first quarter of 1982. It was the third largest decline in GDP in 50 years.

Economists believe the current quarter, which ends March 31, was nearly as bad.
Current projections look for GDP to fall at a 5.1% annual pace. Since 1947, GDP has never fallen by more than 4% for two quarters in a row.

Some have a more extreme view: "The economy will contract by a staggering 7% to 8% in the first quarter, before the economy begins to stabilize,"wrote Nariman Behravesh, chief economist for IHS Global Insight.

GDP is expected to fall 2% in the second quarter, according to a suvey of economists conducted by MarketWatch.

Commercial Real Estate Looking Terrible

The Wall Street Journal posted a Deutsche Bank study on commercial real estate today. It's really ugly. Here is a link to the article, which also has a link to the study. Here are some relevant graphs (click on all for a larger image):

British Bond Auction Fails

From Bloomberg:

Bank of England Governor Mervyn King says Gordon Brown should be “cautious” on public spending while the official in charge of U.K. bond sales says the central bank is undermining demand for government debt.

For the first time in almost seven years, the U.K. couldn’t find enough buyers for one of its debt sales when it offered 1.75 billion pounds ($2.55 billion) of bonds yesterday. The yield on 10-year gilts rose after the sale by as much as 20 basis points, or 0.2 percentage point, to 3.53 percent, the highest since March 5.

The failure came a day after King said the government needs to be “cautious about going further in using discretionary measures” to expand government deficits as it tries to pull the economy out of a recession. Robert Stheeman, head of the U.K.’s Debt Management Office, which runs the bond auctions, says it wasn’t able to attract enough bids partly because of the Bank of England’s efforts to lower yields through debt purchases.

“Yields at these levels are not at all attractive,” Stheeman, chief executive officer of the Debt Management Office, said yesterday in an interview in London. “Yields have shifted downward. Why have they shifted down? It’s partly because of the Bank of England’s announcement about quantitative easing.”

Investors say both are to blame for the failed debt sale.

‘Buying or Selling?’

Gilts have “only one buyer and that’s Mervyn King,” said John Anderson, a money manager who oversees about $3 billion in pound-denominated assets at Rensburg Fund Management in London. “You don’t need to look anywhere beyond that. Make your mind up, please, government. Do you want to buy gilts or do you want to sell them? You can’t do both.”

First, I have to admit I have not been keeping up with UK economic events. Right now the US is challenging enough. That being said ...

This is an interesting -- and partially scary situation. Like the US, the British are buying their own debt. But in doing so, they are artificially deflating the price relative to current demand. Because of the level of government spending, investors are concerned about repayment. As a result, the current interest rate provides insufficient risk compensation which led to the latest auction failure.

Some attributed the failure to simple confusion:

Although some experts attributed the failure to confusion in the market, rather than concern over Britain’s solvency, it was highly embarrassing for Mr Brown coming just days before world leaders are due to meet in London for the G20 summit to discuss the economic crisis.

Frankly, the Bloomberg explanation makes more sense: there is now increased risk in purchasing government debt. Investors want to be compensation for this risk. But the government buying debt and thereby keeping it artificially low is keeping private capital out of the market.

Thursday Oil Market Round-Up

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Oil prices -- which have been consolidating in a triangle consolidation pattern for the better part of 5 months -- have now broken out of that pattern. Prices are alos above the 10 and 20 week SMA, which will now provide technical support for sell-offs. Also note the MACD and RSI are rising with plenty of room to move higher. This is a very bullish set-up.


The daily chart shows more detail of the above actions. Notice that prices and the SMAs have now aligned in a very bullish configuration -- prices are above all the SMAs, all the SMAs are rising and the shorter SMAs are above the longer SMAs. In addition, the MACD has been rising for 5 months and the RSI has been rising for the last month and a half. This is also a good looking chart.

Today's Markets

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The main takeaway from the daily chart is the rally is still intact; the upward sloping trendline is still providing support for the rally.


On the daily chart, notice we've had two "inside days" -- days there the candle's bodies are inside the preceding day. This is similar to a triangle or situation where there is price consolidation. Also notice the following:

-- The 10 day SMA has moved through the 20 day SMA

-- The 20 day SMA has now turned positive

-- Prices are still above the 50 day SMA

-- Prices have not retreated to any of the above printed support levels yet

About the Durable Goods Number

There seems to be a fair amount of hoopla about the durable goods number. Let's go to the data as opposed to the spin:

New orders for manufactured durable goods in February increased $5.5 billion or 3.4 percent to $165.6 billion, the U.S. Census Bureau announced today. This increase follows six consecutive monthly decreases, including a 7.3 percent January decrease. Excluding transportation, new orders increased 3.9 percent. Excluding defense, new orders increased 1.7 percent.

-- This is the first increase in 7 months.

-- January's orders dropped hard -- 7.3%

In other words, if we're looking for a trend, it's down. This would be the equivalent of a bear market rally.

In addition, the non-seasonally adjusted numbers for total year to date new orders are down 28.4% -- hardly a great situation. Excluding transportation, that number is -22.4%. In other words, transportation isn't the problem; manufacturing as a whole is.

The uptick is of course welcome news. However, after placing it in context, we learn we have a long way to go before we've seen an industrial rebound.

Fed Wants Broader Powers

From Marketwatch:

Treasury Secretary Timothy Geithner and Federal Reserve Board Chairman Ben Bernanke called for broad new powers to regulate the nation's financial system on Tuesday, arguing that the $170 billion rescue of AIG and the outcry over its bonuses would have never happened if the government had the right regulatory system.

Called before the House Financial Services Committee to answer for the $165 million in bonuses paid to employees of a unit of American International Group (AIG:
American International Group Inc Geithner and Bernanke tried to change the subject to a more elevated topic: How to avoid the next mess. They said Congress should broaden the authority of financial regulators to cover institutions, such as AIG, that can pose systemic risks but that aren't regulated very well.

If AIG had failed last September, the result could have been "a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs," Bernanke said.

The broader powers would give regulators tools to close down financial firms in an orderly manner and avoid a cascading collapse of financial market firms, the two officials told the committee.

Geithner said the decision to seize a financial company deemed "too big to fail" would have to have the agreement of the White House, the Fed and other top regulators.

There are several important points made above.

1.) AIG is catching a large amount of flack -- as well they should. But a central point is often lost in the stories: an AIG failure would have sent the financial system into a death spiral. What Bernanke and company want to avoid is the 1929 - 1933 period where a wave of financial failures sent the US economy into a 25% drop in GDP over a four year period. An AIG failure would have done that. As a result, they had to be saved.

2.) There is no national insurance regulator. Instead, regulation is left up to the states. This is a really stupid idea and needs to change pronto.

3.) This leads to the larger question: overall regulation of the financial industry. We're already seeing some bits and pieces of various proposals emerge:

The Obama administration is preparing an overhaul of U.S. banking rules that would force financial companies to keep more cash on hand in case their trading bets go wrong.

The bottom line is the US financial system is going to be overhauled over the next few years -- as well it should.

Shadow Inventory Threatens Housing Recovery

From IBD:

Even as a few rays of hope peek out for housing, a dark cloud of unlisted and unsold foreclosed homes threatens to further delay a recovery and undermine lenders' financials.

The government is riding in with new programs almost every week, including Monday, that may rescue lenders. But they also cause paralysis in the short term.

Lenders are holding "between 600,000 and 700,000 residential properties that are not on the multiple listing service (MLS)," said Rick Sharga, senior vice president at RealtyTrac, a foreclosure listing firm in Irvine, Calif.

This shadow supply isn't counted as part of the housing inventory. There were 3.8 million existing homes on the market in February, equal to 9.7 months' worth at the current sales pace.

Add in the shadow supply and selling all the available homes will take even longer, and that suggests prices have even further to fall.

This is a really big issue with the housing market -- and one that is woefully underreported.

A Note on the Comments

Although I'm a bit behind on "hip" internet lingo, I think I have been dealing with posting "spam". So, here are some rules for posting on this blog.

1.) No stock tips.

2.) No "I'm accurate 89% of the time" on my stock tips

3.) No postings strictly in Chinese

4.) No offers for link exchanges

Everything else is fair game.

I'm now approving all postings which I do several times every day. Sorry for this, but frankly the spam was getting really annoying.

BD

Wednesday Commodities Round-Up

Notice the following on the agricultural prices chart

-- Prices are consolidating in a triangle consolidation pattern, and have been for between 4-5 months

-- Prices and the SMAs are still in a tight pattern, indicating overall indecision

-- The MACD is rising

-- The RSI is sort of rising, but it's not as strong as we'd like to see

-- There's upward room for the stochastics.


Notice the following on the industrial metals chart:

-- Prices have been consolidating since the end of last year

-- Prices and the SMAs are still in a tight range, indicating indecision

-- The MACD is rising

-- The RSI is rising

-- There's a touch of upward room left on the stochastics

Bottom line: both charts are still consolidating.

Today's Markets

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It's been a long time since I've seen a 5 minute chart that looked like this. Boy does it look good. This is a solid rally. Notice that prices have been rallying for the entire period, but have engaged in solid moves followed by profit-taking and consolidation areas.



On the daily chart, it's important to point out possible levels where prices could sell-off to in the eventual sell-off. Therefore, take note of all the Fibonacci levels along with the moving averages because these are possible support levels. Also note there are plenty of support levels out there, which should help everybody breath more of a sign of relief right now.

Transportation Not Looking So Rosy

From Reuters:

World airlines are set to lose $4.7 billion this year as a result of the global recession that has shrunk passenger and cargo demand, industry body IATA said.

The International Air Transport Association had estimated in December the industry would lose $2.5 billion in 2009.

"The state of the airline industry today is grim. Demand has deteriorated much more rapidly with the economic slowdown than could have been anticipated even a few months ago," Director-General Giovanni Bisignani said on Tuesday.

"The relief of lower fuel prices is overshadowed by falling demand and plummeting revenues. The industry is in intensive care."

IATA, which represents 230 airlines including British Airways (BAY.L), Cathay Pacific (0293.HK), United Airlines (UAUA.O), and Emirates (EMIRA.UL), also raised its estimate of international airline losses in 2008 to $8.5 billion, from its previous $8 billion estimate.

And consider this table from the Association of American Railroads:



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We'll need better news from the transportation sector before we can say the economy is moving at top speed.

We're Nowhere Near a Bottom in Housing

From Bloomberg:

Purchases rose 5.1 percent to an annual rate of 4.72 million from 4.49 million in January, the National Association of Realtors said today in Washington. The median price slumped 15.5 percent from a year ago, the second-biggest drop on record, and distressed properties accounted for 45 percent of all sales.

.....

Home sales have been falling since 2005 and prices peaked in 2006. The S&P/Case-Shiller home-price index of 20 metropolitan cities was down 18.5 percent in December from a year earlier, a record decline, the group said last month.

Frankly, the only statistic I need to see right now is the year over year price number. So long as we're seeing double digit declines we're nowhere near a bottom in housing. When we start to see YOY price declines slow to 5% or so, then we'll be able to start talking about a bottom -- but not until then.

However, there are technically some signs that a bottom could occur:

The realtor group’s affordability index reached a record high in January.

That tells us that home buying is far more feasible right now. In addition, we can expect mortgage rates to remain low for sometime:

Fed policy makers last week announced the central bank will buy as much as $300 billion in long-term Treasuries and more than double mortgage-debt purchases to $1.45 trillion. The central bank had already committed to buying $600 billion of mortgage-backed securities and bonds sold by government- sponsored housing agencies.

Regarding the "first time home buyer tax credit is spurring demand" argument, the tax credit itself is really an interest free loan from the government rather than a real tax credit.

Treasury Tuesdays

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Just to remember where we are, Treasury prices spiked at the end of last year in response to the credit crisis. However, prices have come down since then, although they are still above the 200 day SMA and the line of support established from the high in September of last year.



On the three month chart, we see the rally that occurred after the Fed's last policy statement where they essentially said they would be purchasing Treasuries. Since then, prices have sold off. However, the Fed essentially put a floor in Treasury prices with it's announcement.

Today's Markets

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The was one heck of a rally today:



The market opened with a big gap up and moved higher until lunch and then sold off a bit. Then prices continued their move higher, closing at session highs on strong volume.



On the daily chart, notice that prices moved above the 50 day SMA today. That's incredibly important from a technical level right now.



Also note that prices moved though key technical resistance levels today.

Bottom line: this is a nice looking chart. In addition, I'm expecting prices to pull back to technically important levels over the next few weeks.

The Negative Response to Geithner's Plan

We all know that Krugman is against the plan. However, Galbraith offers some great observations.

The Geitner Plan

From the WSJ:

However, the financial system as a whole is still working against recovery. Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions -- so-called legacy assets -- are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

.....

Today, we are announcing another critical piece of our plan to increase the flow of credit and expand liquidity. Our new Public-Private Investment Program will set up funds to provide a market for the legacy loans and securities that currently burden the financial system.

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

.....

We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession. The rule of law gives responsible entrepreneurs and investors the confidence to invest and create jobs in our nation. Our nation's commitment to pursue economic policies that promote confidence and stability dates back to the very first secretary of the Treasury, Alexander Hamilton, who first made it clear that when our government gives its word we mean it.

Let's move through this paragraph by paragraph:

1.) First -- I like the term "legacy assets". It's a nice and polite way of saying, "we're stuck with some really old garbage".

Now -- let me back up a bit further and provide a bit of a history lesson here. Securitization -- the process of taking single loans, pooling them with other loans of similar qualities (same interest rate, maturity date etc..) has been around for about 30 years now. For anyone who wants to really delve into this process, read any of the fixed income books by Frank Fabozzi. In other words, the problem hasn't been the system of securitization. Instead the problem has been the "lend to securitize" market of mortgage lenders that sprung up over the last 15 years like weeds. These lenders had no incentive to make quality loans because they sold the loans off faster then the loans would go bad.

These are essentially mortgage related assets who's value is depressed right now thanks to the housing market. There are a lot of questions related to these assets. Let's start with the big one: what are they worth? The problem is most of these assets are "thinly traded" -- meaning there aren't enough trades to determine an "average price". And therein lies the real problem with most of these bonds -- we can't figure out what they are worth.

Secondly, is their price unrealistically low right now because of the problems in the housing market? That is, are prices unrealistically depressed? There is no answer to this question. Most owners would say yes -- which explains why they are arguing for a relaxing of the mark to market rules. In general I would agree with this sentiment, but only by adding this very important caveat: prices are depressed if the owner's intention is to hold the asset to maturity. Finally, will these assets increase in value over time to where a profit can be made? No one really knows the answer to this question either, although assuming the maturity date is far away enough (say 10+ years) the answer is probably yes.

Here are the underlying principles:

Three Basic Principles: Using $75 to $100 billion in TARP capital and capital from private investors, the Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time. The Public-Private Investment Program will be designed around three basic principles:

* Maximizing the Impact of Each Taxpayer Dollar: First, by using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.

* Shared Risk and Profits With Private Sector Participants: Second, the Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.

* Private Sector Price Discovery: Third, to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

Here are the advertised merits:

The Merits of This Approach: This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly. Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience. But if the government acts alone in directly purchasing legacy assets, taxpayers will take on all the risk of such purchases – along with the additional risk that taxpayers will overpay if government employees are setting the price for those assets.

So -- the government provides some funding, to be matched by the private sector. The plan states this will "maximize the impact of each taxpayer dollar" and "share the risk", both of which are fundamentally true assuming, of course, there is a desire by the private sector to participate. Assuming that is true, then the two propositions are true.

Here's how it would work:

* Banks Identify the Assets They Wish to Sell: To start the process, banks will decide which assets – usually a pool of loans – they would like to sell. The FDIC will conduct an analysis to determine the amount of funding it is willing to guarantee. Leverage will not exceed a 6-to-1 debt-to-equity ratio. Assets eligible for purchase will be determined by the participating banks, their primary regulators, the FDIC and Treasury. Financial institutions of all sizes will be eligible to sell assets.

* Pools Are Auctioned Off to the Highest Bidder: The FDIC will conduct an auction for these pools of loans. The highest bidder will have access to the Public-Private Investment Program to fund 50 percent of the equity requirement of their purchase.

* Financing Is Provided Through FDIC Guarantee: If the seller accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee.

* Private Sector Partners Manage the Assets: Once the assets have been sold, private fund managers will control and manage the assets until final liquidation, subject to strict FDIC oversight.

All of this hinges on two points:

1.) The banks wanting to sell an asset, and

2.) Private bidders arriving at a price the banks are willing to take.

These two points are critical. There is nothing forcing banks to participate in the program. And that is the real problem. And there is a big reason keeping the banks from participating: finding out that various assets aren't worth anything.

However, assuming banks are willing to play this isn't bad. I would change a few things -- the most important being the government provided leverage. I think the private sector should pony up a whole lot more. But that's just my opinion which is completely unsolicited.

In addition, no plan is perfect. There are no guaranteed solutions to any of our problems right now. Specifically, nationalization has a ton of problems associated with it. However, overall I think this is workable.

Market Monday's

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With the one month chart, notice the following:

-- The market has enjoyed one heck of a run, moving from roughly 67 to 76.

-- Prices moved over the 50 day SMA but couldn't keep above it.

-- The 10 day SMA has crossed over the 20 day SMA

-- The 20 day SMA has moved into a horizontal position

-- The 50 day SMA is still moving lower

-- Notice there have been some incredibly strong bars during this rally.


The chart from last week shows a two and a half day rally that ended near the end of trading on Thursday when prices fell through the upward sloping trend line. Notice that during the rally prices formed numerous bull market flags to consolidate gains. The sell-off lasted for most of Friday and is most likely the result of natural before the weekend profit taking; no one wants to hold a position in this market over a two day weekend.

Weekend Wiemer and Beagle

The market is closed. That means it's time to do anything except think about the market or the economy. To that end...

About that Nationalization Idea....

From Marketwatch:

The Federal Deposit Insurance Corp. said late Thursday that it has completed the sale of IndyMac Federal Bank FSB, the firm it took over last year, and that it took a $10.7 billion loss on the deal, far more than originally expected.

The FDIC said OneWest Bank, FSB, a newly formed Pasadena, California-based federal savings bank organized by IMB HoldCo LLC, would assume IndyMac's deposits.

"As of January 31, 2009, IndyMac Federal had total assets of $23.5 billion and total deposits of $6.4 billion. OneWest has agreed to purchase all deposits and approximately $20.7 billion in assets at a discount of $4.7 billion. The FDIC will retain the remaining assets for later disposition," the FDIC said in a press release.

I mention this for the following reasons:

1.) Nationalization advocates seem to think it's the best thing since sliced bread (at least to my ears). Yet three are no panaceas -- no easy answers to the questions faced by the financial sector right now.

2.) This is in line with the Swedish experience. While advocates point to the Swedish model as one to emulate Sweden still lost approximately 2% of thier GDP on the deal.

3.) I still think the best idea is to use the remaining TARP money to make one giant bank, transfer good assets to it and let the bad assets sit in the remaining shells.

A Closer Look At Inflation

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From the BLS:

The Producer Price Index for Finished Goods advanced 0.1 percent in February, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This rise followed a 0.8-percent increase in January and a 1.9-percent decline in December. At the earlier stages of processing, prices received by manufacturers of intermediate goods decreased 0.9 percent in February after falling 0.7 percent in the previous month, and the index for crude materials declined 4.5 percent following a 2.9-percent decrease in January. (See table A.)

There has been a some virtual ink spilled over the question of deflation -- that is, are we going into a period of deflation somewhat like that of the Great Depression. So far the evidence is a bit mixed. First, The change from the preceding month in core PPI has only been negative once in the last 12 months. This was November's -.1 decline. This tells me that so far the decline has to do with the commodity deflation over the last 9 months as this chart shows:



However, we have seen one of the biggest drops in overall PPI in an incredibly long series of data:



In addition, the year over year number is still scary:



But also note in the above chart that prices have dropped at this level before -- in 2001 -- without the fear of deflation emerging.

In addition, so far the rate of decline in both intermediate and crude goods as decreased over the last two months. Intermediate goods decreased at a roughly 4%/month clip in the October, November and December of last year, but fell at a .7% and .9% clip in January and February of this year. Crude goods show a similar pattern: they fell at (approximately) 16%, 14% and 5% in October, November and December of last year but at a 3% and 4.5% clip in January and February of this year.

In other words, from the PPI perspective, I'm leaning towards the "there isn't a deflation problem" conclusion.

From the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in February, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The February level of 212.193 (1982-84=100) was 0.2 percent higher than in February 2008

Like the PPI data, the CPI data shows drop in 4Q of 2004 and increases so far this year. For October, November and December of last year there were drops in overall CPI of -.8%, -1.7%, -.8%, respectively, but in January and February of this year we saw increases of .3%, .4% respectively. More importantly, this appears to be a commodity related situation. The month over month rate of increase in core CPI for October - February was .0%, .1% , .0%, .2%, .2% respectively.

That does not mean there shouldn't be cause for concern. Consider this chart of CPI data


That's one of the largest drops in CPI the data has seen over the last half century. In addition,



The year over year chart of CPI is ugly, and its far too early to tell if we're at the beginning of an upswing or not.

In general, it looks to me as though the price drops of the last 5 months are related and confined to the energy/commodity drops of the last 9 months. That does not mean we shouldn't keep an eye on these numbers. But the latest upticks in overall data and the lack of spreading to core numbers gives me the impression the "deflationary spiral" argument is losing steam.