Dr. John Rutledge Blog: March 2008 Archives

March 28, 2008

Fed Policy

Posted by John Rutledge at 11:15 PM | Comments (5) | TrackBack

India World's Second Largest Mobile Phone Market

(March 28, 2008) - This is important. India has crossed the 250 million mark with the addition of 8.53 million mobile phone subscribers in February. India will become the second largest wireless network in the world after China in the first half of April 2008. (Hint: That makes the U.S. #3.) Click here to read the full article in the Economic Times.

Future growth of income, productivity and jobs will depend on who has the best information and communications technology, because high-speed communications allows the economy to perform as a massive parallel-processing information network. Hats off to China and India for making R&D and investment in new networks a priority. Wouldn't hurt if the U.S. government were a positive force for investment here too.

According to telecom regulator Trai, a total of 8.49 million telephone connections were added during February as compared to 8.74 million connections in January 2008.
The total number of telephone connections hit 290.11 million at the end of February 2008 as compared to 281.62 million in January 2008, taking the overall teledensity to 25.31 per cent at the end of February 2008 as against 24.63 per cent in January 2008.

In the wireless segment, 8.53 million subscribers were added in February 2008 as against 8.77 million subscribers added in the month of January 2008.
The total wireless subscribers base stood at 250.93 million at the end of February 2008.

The US currently has 256 million subscribers and adds about two to three million subscribers every month while China adds around six to seven million subscribers a month.

India's monthly wireless subscriber addition of 8 million to 9 million a month is the highest.

With this performance, India will surpass US in terms of wireless subscribers during the first half of April to become the second largest wireless network in the world. India's total subscriber base will also cross the 300 million mark in April, analysts said.

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Instructional Technology

We need to do more to use the fact that high-speed communications networks can distribute top quality educational materials at zero incremental cost. Here is an article that shows how it helps. College Students Score Higher In Classes That Incorporate Instructional Technology Than In Traditional Classes

Posted by John Rutledge at 8:05 PM | Comments (1) | TrackBack

Bank Loans Still OK

(March 28, 2008) - I have written lately that the reason the banking crisis has not killed GDP and jobs--at least not yet--is that the infarction has not spread to business lending. More than 50% of GDP is produced by small, private companies that have no access to the public markets. They get the working capital they use to buy raw materials, make payroll and tread water until their customers pay from banks and private equity firms. As you can see in the latest data in the chart below, so far so good. Bank Commercial and Industrial Loans

You can also see, however, by clicking on the link below that the big banks pretty much pooped out last fall; most of the burden since then has fallen on the shoulders of small and medium-sized commercial banks.

This is the reason I have been so critical of the Fed's heroic lending arrangements to keep the big brokers, investment banks and banks liquid. Providing adequate liquidity is a great idea, but the Fed has combined these new credit lines with sterilization measures that keep total bank reserves and the monetary base from growing when the big firms tap the credit lines. That means the Fed is sucking one dollar of reserves out of small and regional banks for every dollar it makes available to JPMorgan or Goldman Sachs. That is very destructive to the business lending we need to keep the real economy afloat.

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March 27, 2008

Initial Claims Down 9,000 to 366,000

(March 27, 2008) - Like Randy says on American Idol, this number is just OK for me, Dog. Just not a memorable number. The Department of Labor reported in its Initial Claims Report, announcing that in the week ending March 22, the advance figure for seasonally adjusted initial claims was 366,000, a decrease of 9,000 from the previous week's revised figure of 375,000. The 4-week moving average was 358,000, an increase of 1,750 from the previous week's revised average of 356,250.

This week's number is further support for the view that we are stuck in a range of low but positive growth. Bet this goes on for a while.

Posted by John Rutledge at 7:35 PM | Comments (0) | TrackBack

How to smite Smoot

(March, 28, 2008) - Here is a great article in the current issue of the Economist that gives measures of the amount of GDP at stake in today's battles over global trade and immigration. The numbers are huge! Worth thinking about. Click here to read the full article.

IN JUNE 1930 the Smoot-Hawley tariff act turned a stockmarket collapse into a crippling, decade-long Depression. Now, politicians seem to be preparing for protectionism even while financial meltdown is going on. Barack Obama and Hillary Clinton vie with each other to be nasty about the North American Free-Trade Agreement. Last year the European Union dropped the principle of “free and undistorted competition” from its Lisbon treaty.

All the more reason, then, to welcome a study* by two eminent trade economists, Kym Anderson of the University of Adelaide and Alan Winters of the University of Sussex. They estimate the losses from such protectionism as already exists; calculate the potential gains that might accrue if—a big if—protectionist temptations were ignored and, more intriguingly, estimate the possible benefits if further migration were encouraged as well.

If you look just at merchandise trade barriers and farm subsidies, the authors reckon, the costs of trade distortion are running at almost $300 billion a year (that figure is the difference between what trade could be by 2015 without distortions and what it actually is, using 2005 as a baseline). This figure is sometimes bandied about at the Doha round of trade talks. It is, the authors reckon, a conservative one.

It assumes all industries respond to liberalisation in the same way, and that competition is perfect, which it is not. The authors show that if you use more realistic assumptions, estimates of the cost of protection actually rise from anywhere between $460 billion a year to over $2.5 trillion. (The wide range is the result of using “computable general-equilibrium models”, which are only as good as the assumptions you feed into them.) Whatever the exact amount, these are large sums and far greater than once-fashionable alternatives, such as bilateral deals.

But more trade in goods is only part of economic liberalisation. Another is trade in “factors of production”—like labour. The authors look at what might happen if the share of foreign workers grew to 3% of the labour force of rich countries. This would involve an increase, they say, of 14m people over 25 years (roughly 500,000 a year). The global gains, the authors reckon, would be $675 billion a year by 2025. Even if you subtract the cost of moving to the host country for immigrants and the social-welfare benefits they may get when they arrive, the net benefits are at least twice as much as a Doha agreement (and could be reaped by rich countries unilaterally, if they wanted).

Posted by John Rutledge at 6:11 PM | Comments (0) | TrackBack

March 26, 2008

Rice Prices Forcing Cuts in Refugee Aid

(March 26, 2008) - The law of unintended consequences strikes again. The U.S. mandated ethanol requirements have forced a huge spike in corn, grain and meat prices; they have done tremendous damage to the poorest people in the world. Read the latest example here, Rice Prices Forcing Cuts in Refugee Aid.

Soaring rice prices on world markets and a battered U.S. dollar are forcing cuts in already meager food aid to more than 140,000 refugees who have fled military-ruled Myanmar into Thailand.
Part of a surge in worldwide food prices, rice has increased by 50 percent in the past two months and some experts predict further hikes of up to 40 percent. Meanwhile, the U.S. dollar continues to slide against the Thai baht currency. (Tell me that's not embarrassing.)

If the gap is not filled, refugees could be issued with just 26 pounds of rice a month and no other food items - less than half of their daily protein and calorie needs, he said. Nursery school feeding and health projects would have to be slashed or terminated.

The irony, as I wrote about recently, is that on net ethanol increases CO2 levels and uses more fossil fuel than it saves. Unfortunately, it has now become a political institution as members of Congress wrestle for subsidies and mandates.

There is a serious energy problem. This is not the right way to solve it. In addition to the obvious moral issues, hungry people are very hard to get along with.

Starving people is not good policy, regardless of your political views.

Posted by John Rutledge at 10:23 PM | Comments (1) | TrackBack

Advance Report On Manufacturers' Shipments (-2.8%), Inventories (+0.5%), and Orders (-1.7%)

(March 26, 2008) - Another ugly one. The Census Bureau released their Advance Report On Manufacturers' Shipments, Inventories, and Orders this morning, announcing that new orders for manufactured durable goods in February decreased $3.6 billion or 1.7% to $210.6 billion. This was the second consecutive monthly decrease and followed a 4.7% January decrease.

Shipments of manufactured durable goods in February, down three of the last four months, decreased $6.0 billion or 2.8% to $210.5 billion following a 2.3% January increase. Unfilled orders for manufactured durable goods in February, up thirty-three of the last thirty-four months, increased $6.1 billion or 0.8% to $820.6 billion, following a 0.8% January increase.

Inventories of manufactured durable goods in February, up seven of the last eight months, increased $1.6 billion or 0.5% to $323.7 billion. This was at the highest level since the series was first stated on a NAICS basis in 1992 and followed a 0.6% January increase.

JR

Posted by John Rutledge at 9:22 PM

U.S. Chamber Report - Strengthening U.S. Capital Markets

(March 26, 2008) - Here is the link to the U.S. Chamber of Commerce report on Strengthening U.S. Capital Markets that I wrote about earlier today.

Equity Raised in U.S. and Non-U.S. Public Markets

And this is the chart from the report that we need to put on the back of milk cartons. the chart speaks for itself. Read this report. It's important.

Posted by John Rutledge at 9:12 PM | Comments (1) | TrackBack

Jim Dorn on Sovereign Wealth Paranoia

(March 26, 2008) - Jim Dorn and I were in graduate school together at the University of Virginia. In addition to being a great guy, he is China specialist at the Cato Institute. Jim's article in the South China Morning Post on Sovereign Wealth Paranoia is a good antidote to the things we read in the press. Enjoy.

The most recent example of sovereign wealth fund paranoia is the 3Com deal, in which China's Huawei was denied the ability to make a minority investment in the company. I had the chance to spend a day at Huawei's headquarters in Shenzhen--impressive company. Similar things are happening in Australia now where the new government is likely to restrict proposed investments in mining companies. This is protectionism in another form.

This is a tricky issue that will be in the headlines for a long time. I think the answer is disclosure, not the straightjacket. What do you think?

Posted by John Rutledge at 8:46 PM | Comments (1) | TrackBack

Cardiac Plasticity

(March 26, 2008) - An article in the current issue of the New England Journal of Medicine titled Cardiac Plasticity is worth thinking about. The concept of plasticity--especially neural plasticity--plays an important role in recent microbiology research. I think there are important applications in economics, finance, and policy that may help us to avoid, or mitigate, future conflicts among cultures and nations.

Plasticity is a property of a system that allows it to improve its efficiency by adapting to changes in its environment by altering its structure. Columbia's Eric Kandel won a Nobel Prize for showing that repeated environmental stimuli (electric shocks, etc.) lead to physical growth of neurons that dramatically alter the number of synapses, or contact points, between neighboring neurons. Read Kandel's In Search of Memory: The Emergence of a New Science of Mind for more on his work.

In one result, for example, Kandel showed that repeated negative events (electric shocks) produced a tripling of the synapses which transmit negative sensory information to other neurons--making the entire system hyper-sensitive to negative stimuli.

Even more interesting, when the bad events stop happening the number of synapses declines to roughly double their original levels. They never again fall to the original number. The system, or organism, remains in a hyper-vigilant state for the rest of its life.

I also recommend reading Seymour Benzer's Time, Love, Memory. Benzer won a Nobel Prize for work on the development of the link between genetics and behavior.

Real world examples? In recent years, Americans were subjected to a long string of fear stimuli--the dotcom bust, 9/11, Enron, anthrax, Iraq, $100 oil, the mortgage crisis, .... That string of experiences has produced a fearful and hypervigilant group of people, including voters and investors, who behave differently as a result. That makes us more belligerant and more likely to make errors of commission than we would otherwise be. And it makes people more willing to bail out of investments at the first sign of trouble.

This dynamic co-evolution of an organism and its environment--called epigenesis--is very important. In particular, Bruce Wexler's Brain and Culture: Neurobiology, Ideology, and Social Change details research showing that children's brains exhibit a high degree of plasticity up until about 1 years old but a dramatic loss of plasticity after that.

Essentially, children re-wire their brains to fit comfortably in the environment they see (which is why we all want to go back to our childhoods). If the environment does not change much, they will function efficiently. But if the environment changes to a dramatically different one after they lose plasticity, they experience cognitive dissonance, a permanently fearful and anxious state. Adults in this condition are not easy to get along with. They also violently resist seeing their children morph to fit the new environment. The result is conflict.

The rapid change brought on by improvements in communications technology and globalization has placed many people in this state. Fundamentalism, terrorism, genocide, protectionism, immigration, and outsourcing battles all reflect its cost. But attempts to stop change are futile. The answer is finding ways to reduce its cost by reducing the frictions that transform rapid change to turbulence. More on this to come.

Posted by John Rutledge at 8:21 PM | Comments (0) | TrackBack

U.S. markets seen losing ground to global competitors

(March 26, 2008) - This is a big problem. The world's companies are increasingly avoiding the US and raising capital in other markets. Today the U.S. Chamber of Commerce's held their second annual capital markets conference to examine the issue. You can read about it by clicking here.

The United States received only 6.9 percent of the funds raised in global initial public offerings in 2007 and did not participate in any of the top 20 global IPOs, Harvard Law School Professor Hal Scott said at the conference.In comparison, in 2000, about half of the value of global IPOs was raised in the United States.

U.S. capital markets again lost ground against global competitors last year, highlighting the need to streamline regulation and crack down on excessive securities litigation.

Also, many foreign companies in 2007 took advantage of a U.S. regulatory change that let them delist from U.S. exchanges. About 15 percent of U.S.-listed foreign companies left the U.S. markets in 2007, about three times the historical rate

The world is going through a major capital re-deployment, as investors move capital from high-cost, low-return situations to more attractive opportunities. The home of such capital market activities will enjoy major advantages over other countries. Increasingly, that is London, Hong Kong and Singapore.

This is a good but sad example of what systems theorists call path-dependence. Enron and other scandals happened for one set of reasons. That led to Sarbanes-Oxley--the small public company prevention act. That, and other issues, are driving our capital markets offshore. Problem is, these changes are hard (sometimes impossible) to reverse once they happen--a property known as hysteresis.

When it happened in the UK we called it the British disease. What will they call this?

Posted by John Rutledge at 7:18 PM | Comments (0) | TrackBack

Parental Controls & Online Child Protection

(March 26, 2008) - My friend Adam Thierer at the Progress and Freedom Institute has just released a new report on Parental Controls & Online Child Protection Report. It is a great review of the market for parental control tools, rating schemes, education efforts, and initiatives aimed at promoting online child safety. You can read the full report by clicking here.

Posted by John Rutledge at 1:59 AM | Comments (1) | TrackBack

March 25, 2008

Goldman sees $1.2 trillion global credit loss

(March 25, 2008) - Okay, here's a big number for you. A new number from Goldman Sachs forecasts that global credit losses stemming from the current market turmoil will reach $1.2 trillion, with Wall Street accounting for nearly 40 percent of the losses. Click here to read the report, Goldman sees $1.2 trillion global credit loss.

That's real money, even in Washington.

U.S. institutions, including banks, brokers-dealers, hedge funds and government-sponsored enterprises, have reported $120 billion in write-offs since the credit crunch began last summer and will account for $460 billion in net credit losses before it is done. Home mortgages will make up half, commercial mortgages 15-20%, and the rest will come from credit cards, car loans, business loans lending and corporate bonds.

Before we light our hair on fire, I should point out that we have tons and tons of assets here. The most recent Flow of Funds report from the Federal Reserve Board shows the composition of U.S. assets. At the end of 2007, Americans owned $141.9 trillion worth of financial assets (deposits, stocks, bonds, pension assets, etc.).

Americans also are responsible for $107 trillion in total liabilities (every loan has a borrower and a lender), including $14.6 trillion worth of mortgage securities. That makes the net financial asset figure $34.6 trillion.

But Americans also own real, or tangible, assets like homes, farms, cars, collectibles and vintage refrigerators, for which there are no offsetting liabilities. Households owned $26.8 trillion of them at the end of last year, including $22.5 trillion in real estate, and $4.0 trillion worth of used cars, boats, furniture and other durable goods. In addition, corporations owned another $14.5 trillion worth of tangible assets--real estate, plant and equipment, software, inventories, etc. Mom and pop companies owned another $7.9 trillion of real assets. (So far, that's $49.2 trillion of tangible assets.)

But that leaves out all the other sectors--farms, financial companies (banks, S&Ls, brokers, insurance companies, money managers, etc.), and all levels of government (local, state, federal and of course the UN and the dreaded Trilateral Commission). All those trucks and cars you see that say government property are tangible assets too and should be counted in the balance sheet. Unfortunately, the Fed does not report these numbers (they did until 1994 but stopped). Since about 1/3 of people work for some level of government and government makes up about 1/3 of GDP it might make sense to guess that governments own roughly one-third of total tangible assets, which would add another $25 trillion to our numbers.

Once these tangible assets are factored in, the household and nonprofit sector alone has a net worth of $57.7 trillion--equal to 5.6 years worth of personal income.

But wait! The government also owns a butt-load (technical expression) of land. Last time I looked (and I am working from memory here (lazy SOB) which is not so good as it used to be), the GAO reported that the Federal government owned about 700 million acres of land, including about half of all the land west of the Mississippi River. I have no idea what that land would be worth if valued at market prices. To count the zeroes, however, let's make a guess. At $10,000 per acre, the Feds alone own about $7 trillion worth of land. That is larger than total government debt in the hands of the public, i.e., the Federal government actually has a positive net worth.

Sidebar: Before 1994, the Fed reported these assets on the government's published balance sheet. They don't do that any more. Today, the GAO does not include land as an asset owned by the government. It is reported in a footnote as land held in trust for the American people. I'm not sure why they decided to do that (I have an idea) but the net result is they report a huge negative net worth for the government and asset sales are quietly taken off the table.

Before the nature-lovers (several of whom live in my house) get mad at me and accuse me of wanting to sell the national forests, I am not saying we should do that. I would just like to see the numbers on the table where we can understand them.

In the meantime, I am going to revise my balance sheet to refer to my house, my car and all my other stuff as assets held in trust for the Internal Revenue Service and, if there is any left over, the Rutledge children. That seems a more accurate description anyway.

So what does all this mean? It means that, although there are very painful things going on in the real estate and securities markets, the $1.2 trillion in global losses the Goldman guys write about is not the end of the world. We have at least $200 trillion in assets just in the United States and there are lots more abroad. Household net worth is $57.7 trillion--total net worth is approaching $100 trillion.

This is a big country and it would take a lot of killing to bring it down. Don't give up on America or the American economy. And at today's prices, don't sell your house or your stock.

Posted by John Rutledge at 5:27 PM | Comments (1) | TrackBack

February Used Car Prices - My Favorite Measure of Pressure on Consumer Balance Sheets

(March 25, 2008) - I love the Manheim Index. Manheim runs used car auctions all over the place and collects the actual sales prices of 5 million used car transactions every year. (Way better than any government agency collects data.) They report the index about the 5th business day of every month. It is absolutely, hands down, the single best measure of household balance street pressure and liquidity I have ever seen.

As you can see in the chart on the left, above, when people get pinched for cash they harvest the assets in their driveway. And the chart on the right shows that, although prices have fallen every month since last September when the mortgage crunch hit, they have not fallen as much as they did in 2002-2003 when the employment numbers were falling.

The monthly data, above, show that prices are still falling. Used car prices have fallen by about 6% since their peak last September. When the Manheim Index turns the corner and starts to rise again, that will be the all clear whistle. Until then, people are still being squeezed.

Posted by John Rutledge at 5:05 PM | Comments (0) | TrackBack

Case-Shiller Home Price Indices

(March 25, 2008) - The new Case-Shiller home price numbers are out today showing that home prices in January were still dropping like, uh, something real heavy . They are so bad that I had to ask my daughter what to call them. She says uber-butt-ugly is the appropriate term. You can read the full report by clicking here, Case-Shiller Home Price Indices. The Case-Shiller numbers are the best source of price information because they work hard to deal with the price/mix problem by actually matching consecutive sales for specific properties.

Home prices have now fallen by substantially more than in 1991-92. In that episode, triggered by massive RTC sales, commercial property, not residential, was the heart of the problem.

The eye of the hurricane this month is Las Vegas, where prices fell 5.1% in one month, and 19.3% over the last year. Seattle and Portland are saying "what crisis?"

Incredible, even after the recent price drops, real estate has still outperformed the stock market since the mid 1990's. I think there are going to be huge fortunes made by picking up the (illiquid) pieces after this crisis has passed. I don't think that is many months away. This is the time to be a shopper, not a seller.

Posted by John Rutledge at 4:52 PM | Comments (0) | TrackBack

Rich Karlgaard on Korea

(March 25, 2008) - My friend Rich Karlgaard at Forbes--a staunch defender of freedom and growth and a very nice man to boot--wrote about Korea's new President is taking to energize small businesses. You can read Rich's blog entry by clicking here, Forbes.com: Digital Rules By Rich Karlgaard.

Rich and I normally appear together on the Forbes on Fox show, which airs Saturday mornings. I missed last week's show and will miss the next one. Am home after a minor surgery to get 2 basal cell skin cancers removed. (Thank you Maui sunshine. Be smarter than me. Wear your sun screen!) Bandages off now; down to 2 bandaids. (Today it is Mickey Mouse.) Will be back on the air in a week. Be there or be square.

Rich mentions investing in Korean growth. I have owned the South Korea exchange traded fund (EWY) for some time as a bet on China growth. China's capital markets are still too risky for most investors. But when China grows it needs to buy all sorts of things from other countries where the securities law, contract law, court system and financial reporting is more understandable for American investors. They buy raw materials from South Asia (especially Australia, New Zealand, Indonesia and Malaysia). They get equity capital in Singapore and Hong Kong. And they get technology from Korea, Taiwan and Japan. I like the Korea story better than Taiwan because Korea is focused on communications technology (think Samsung), the heart of China's new economic growth program. I expect to own the Korea shares for a long time. Korea's new president makes me even happier to own them.

America Should Be So Lucky
Wouldn’t it be cool if America elected a president in November who said things like this:

"Business is the foundation of the economy, and the economy will recover only when business activities are re-energized," Mr. Lee said in a wide-ranging interview over the weekend. "And business here means big and small companies--and the workers and management of the companies."

Unfortunately, this guy is not available. He is South Korea’s President Lee Myung-bak, the former CEO of Hyundai Construction...

Posted by John Rutledge at 3:06 PM | Comments (1) | TrackBack

March 24, 2008

That's What I'm Talking About - Banks allowed to lift MBS holdings

(March 24, 2008) - Today a good thing happened. To help thaw the frozen mortgage markets, the Federal Housing Finance Board will allow regional U.S. banks in the Federal Home Loan Bank system to increase their holdings of agency MBS--mortgage-backed securities issued by Fannie Mae and Freddie Mac--by $150 billion for a period of two years. This roughly doubles the $150 billion of mortgage-backed securities that banks can already buy under existing rules. This should improve liquidity in the $4.5 trillion market for agency MBS that is the ultimate home for the bulk of mortgages. You can read the full story by clicking here.

As I am sure you have noticed, I have been whining about the stimulus package since it was first announced. The package is old-religion fiscal stimulus, straight out of the textbooks. It is designed to fix a problem that we don’t have--people who won’t spend their money. The textbook remedy is to give them some more money to spend. This time it’s $600. Problem is, it never works.

If there’s one thing that Americans know how to do it is spend money, which is the flip-side of our legendary low savings rate. (I have personally witnessed my children spend $600 per hour with gusts to $1000.) This time the problem is not lack of spending, it is frozen capital markets. Investors have temporarily lost their ability to peer into the future to identify and value the cash flow streams embodied in mortgage-backed securities, asset-backed securities, corporate debt and equities. If the pension funds, endowments, insurance companies and other long-term investors are reluctant holders of our existing stock of securities there will be no home for the new securities that are created when lenders make new mortgages or new corporate loans. The supply of new financing for homes and businesses dries up. That’s when economic activity gets choked off.

Capital markets support GDP the same way a volcano on the ocean floor supports a tropical island. Without a functioning capital market the economy does not produce the goods and services we refer to as GDP.

So what should a policy maker do? Do things that burn through the fog, making future cash streams more visible and secure for investors. And do things to improve the depth and liquidity of the capital markets. Today’s actions were just that.

Maybe even more important, what should a policy maker not do? They should not do anything to make it even more difficult to understand the future cash streams embodied in a security. That includes granting special powers to sue investors, granting bankruptcy judges the right to change the terms of contracts and Congressional committees that conduct public lynchings for political gain.

Finally, don’t do temporary things. Temporary things don’t work in capital markets. When you buy a mortgage security you need to feel comfortable about looking 5, 15, or 30 years into the future. Security prices are present values of the entire cash flow stream. Temporary measures can increase uncertainty and make things worse. For example, in the original stimulus package there was a one-year, temporary increase in the size of a mortgage loan that can be packaged and sold by the agencies, after which the limit would return to its former, lower level. That means for one year mortgage lenders will be selling a product to investors--MBS comprised of large loans--that is already scheduled to be discontinued, leaving an illiquid orphan basket of securities in the market that would be very difficult to price. Increasing the limit of conforming mortgages is a very good idea but it should be done permanently, not temporarily. When I pointed this out to White House officials they didn’t think it would be a problem because markets are efficient. I think it is a problem.

All in all, however, recent actions directed at capital markets are having a good effect. Example: last Wednesday’s easing of Fannie Mae and Freddie Mac’s capital requirements, allowing them to buy an additional $200 billion in mortgage securities. That’s why the stock market is starting to smell a bottom. There are huge long-term values at today’s prices.

Posted by John Rutledge at 5:47 PM | Comments (0) | TrackBack

February Existing Home Sales +2.9% but Prices Still Falling

(March 24, 2008) - The NAR released the February Existing Home Sales report this morning, showing that sales of existing homes increased 2.9% to a seasonally adjusted annual rate of 5.03 million units in February, but remain 23.8% below the 6.60 million-units one year ago.

Home prices fell again in February. The median existing-home price was $195,000 in February, down 2.0% from January and 8.2% from the February 2007 figure of $213,500. Over the year, prices fell most in the West (13.4%), by 8.6% in the South and 7.1% in the Midwest. Prices rose by 0.4% in the Northeast. In the coming months, however, I believe the eye of the hurricane will shift to the Northeast where investment banks, commercial banks and other financial firms will be busy reducing headcount. Less heads, smaller bonuses, fewer starter mansions, lower home prices--do the math.

(click tables to enlarge in a separate window)

Single-family home sales increased 2.8% to a seasonally adjusted annual rate of 4.47 million in February from 4.35 million in January, but are 22.9% below the 5.80 million-unit level a year ago. The median existing single-family home price was $193,900 in February, down 8.7% from February 2007.

The most interesting part of the report is that the inventory of unsold homes fell 3.0% to 4.03 million from 4.16 million in January. (Inventory peaked at 4.56 million last July.) It's too soon to get excited (inventory was 3.45 million in 2006 and 2.85 million in 2005) but things are heading in the right direction.

At this point I can firmly predict that the world will not end--again.

Posted by John Rutledge at 2:58 PM | Comments (0) | TrackBack

Hey, I Knew That - Coffee Keeps Your Brain Happy

(March 24, 2008) - An interesting article in the current issue of the journal Neuroscience shows that if you want to keep your mouse happy, you have to give him coffee all the time. Read the abstract here: Neuroscience : Chronic but not acute treatment with caffeine attenuates traumatic brain injury in the mouse cortical impact model

I show you this article only half in jest. I am convinced that cognitive science has more to offer than any other field over the next 20 years. I am especially interested in the way brains encode repeated doses of fear and how that plays into conflict. If you want a sneak preview read Wexler's Brain and Culture.

Abstract Caffeine, the most consumed psychoactive drug and non-specific adenosine receptor antagonist, has recently been shown to exert a neuroprotective effect against brain injury in animal models of Parkinson’s disease (PD) and stroke. However, the effects of caffeine on traumatic brain injury (TBI) are not known. In this study, we investigated the effects of acute and chronic caffeine treatment on brain injury in a cortical-impact model of TBI in mice. Following TBI, neurological deficits, cerebral edema, as well as inflammatory cell infiltration were all significantly attenuated in mice pretreated chronically (for 3 weeks) with caffeine in drinking water compared with the mice pretreated with saline. Furthermore, we found that chronic caffeine treatment attenuated glutamate release and inflammatory cytokine production, effects that were correlated with an upregulation of brain A1 receptor mRNA. By contrast, acute treatment with caffeine (i.p. injection, 30 min before TBI) was not effective in protecting against TBI-induced brain injury. These results suggest that chronic (but not acute) caffeine treatment attenuates brain injury, possibly by A1 receptor-mediated suppression of glutamate release and inhibition of excessive inflammatory cytokine production. These results highlight the potential benefit of chronic caffeine intake for preventing TBI and provide a rationale for the epidemiological investigation of the potential association between TBI and human caffeine intake.

Posted by John Rutledge at 2:00 PM | Comments (0) | TrackBack

March 22, 2008

The Secret to Happiness? Giving.

(March 22, 2008) - Here's a great article to read on Easter weekend. The Secret to Happiness? Giving. It reports a recent study by social psychologist Elizabeth Dunn of the University of British Columbia showing that people who donate their dollars to charities or splurge on gifts for others are more content than those who squander all the dough on themselves.

The real question is why this is such a hard lesson for all of us to learn--and remember. I know it's true for myself. When people ask what I did last year that gave me the most joy, the answer is easy. 1) Being with my daughter Manda the day she had her first child and meeting granddaughter, Isabela for the first time, and 2) helping a group of student build a library in a school for disabled orphans in Llasa, Tibet. (I will write more on both later.) Good days in the market and fancy dinners don't seem to hold their value.

This is good because there is so much work to do to help other people, both at home and far away from home.

I have been reading a lot of articles in Behavioral (or experimental) Economics and Evolutionary Economics, as well as Cognitive Science, System Theory and Nonequilibrium Thermodynamics. All are much more interesting than so-called modern economics and finance (the neoclassical synthesis). Economics has largely become a church to worship increasingly irrelevant equilibrium theorems rather than challenge old ideas.

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IMF to boost transparency of sovereign wealth funds

In China, the Xinhua News Agency reported today on the work the IMF is doing to establish a best practice blueprint for sovereign wealth funds. Currently 36 countries or regions have SWFs, with assets worth some 2.5 trillion U.S. dollars. You can read the full article by clicking here.

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March 21, 2008

This is a good thing - Abu Dhabi US sovereign fund accord

(March 21, 2008) - Transparency is a good thing. Arabianbusiness.com reported today that Abu Dhabi signs landmark US sovereign fund accord.

In very much a quid pro quo agreement the US receives assurances that foreign governments will not use their funds for political ends, while countries receiving investment from such funds accept any protectionist barriers to foreign direct investment should be dismantled.
There is also an acknowledgment that funds should disclose more information, particularly financial information, while recipient countries should also have predictable investment frameworks and should not discriminate among investors.

This issue comes up all the time on TV. How should we think about sovereign funds? Well, for one thing they are very big. (When the elephant gets in the bathtub we all get wet.) Also, they have very long investment horizons--considerably longer than pension funds. In recent months I have had the opportunity to visit with the people that manage 5 of the big sovereign funds. In general, they are financial professionals consumed with the same sorts or risk, return worries that we all think about. They have a very difficult investment problem to solve. We need to take the time to get acquainted; we will be dealing with them for a long time.

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Goldman, Lehman outlooks cut to negative by S&P

(March 21, 2008) - Here's a wild idea. Why don't we come up new ratings agencies that actually tell you whether the company will be able to pay its debts in the future instead of the past? Read this article for an example of what I mean.

Although they look pretty good on a chart, rating changes issued after something has already happened (e.g., last week's earnings figures) are of no use at all to investors.

Worse, they can do serious damage. Published ratings are often baked into loan documents in the form of covenants, or triggers, that lead to material, discontinuous changes in price or other terms for the borrower. These can sometimes trigger death spirals of covenant defaults, penalties and fees leading ultimately to insolvency.

It is a well-known rule of thumb in the complex adaptive systems literature that nonlinearity (step-up terms triggered by ratings changes) plus delayed feedback (publishing after the fact) equals chaotic change.

Institutions matter. We can do better than this.

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This is Cool! Reverse Genetic Problems Before They Happen.

(March 21, 2008) - There is a cool article in today's ScienceDaily reporting a successful attempt to prevent Menkes Disease by reversing a genetic defect before birth. You can read the full article by clicking here, Deadly Genetic Disease Prevented Before Birth In Zebrafish.

By injecting a customized "genetic patch" into early stage fish embryos, researchers at Washington University School of Medicine in St. Louis were able to correct a genetic mutation so the embryos developed normally.
The research could lead to the prevention of up to one-fifth of birth defects in humans caused by genetic mutations, according to the authors.
Erik C. Madsen, first author and an M.D./Ph.D. student in the Medical Scientist Training Program at Washington University School of Medicine, made the groundbreaking discovery using a zebrafish model of Menkes disease, a rare, inherited disorder of copper metabolism caused by a mutation in the human version of the ATP7A gene. Zebrafish are vertebrates that develop similarly to humans, and their transparency allows researchers to observe embryonic development.

Children who have Menkes disease have seizures, extensive neurodegeneration in the gray matter of the brain, abnormal bone development and kinky, colorless hair. Most children with Menkes die before age 10, and treatment with copper is largely ineffective.

The development of organs in the fetus is nearly complete at a very early stage. By that time, the mutation causing Menkes disease has already affected brain and nerve development.

The genetic mutations Madsen and the researchers worked with are caused by splicing defects, or an interruption in genetic code. The morpholinos prevent that interruption by patching over the defect so the gene can generate its normal product.
"Consider the genetic code as a book, and someone has put in random letters or gibberish in the middle of the book," Madsen said. "To be able to read the book, you have to ignore the gibberish. If we can make cells ignore the gibberish, or the splicing defect, the fetus can develop normally."

Up to 20 percent of genetic diseases are caused by splicing defects, Madsen said, so this treatment method could potentially be used for many other genetic diseases.

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Investment Firms Tap Fed for Billions

(March 21, 2008) - On Monday I wrote about the Achilles heel of the Fed's new loan facilities. Every dollar they lend to troubled banks through the new facilities sucks one dollar of existing reserves out of healthy banks through offsetting open market operations. Total reserves do not go up at all. Reserves in the hands of healthy institutions actually decline.

Declining reserves at healthy institutions is a problem because it will force them to either call in existing loans or tighten non-price lending standards. Either way it runs the risk of shrinking the availability of the business loans that comprise the working capital for the private companies that make up all job growth. Translation, local and regional banks and their business customers shrink.

Of particular issue--the Fed's new facility they announced last Sunday to mainline reserves directly to the big New York investment banks. Yesterday we got the first numbers on the size of the borrowings. Click here to read the full article.

Big Wall Street investment companies are taking advantage of the Federal Reserve's unprecedented offer to secure emergency loans, the central bank reported Thursday. Those large firms averaged $13.4 billion in daily borrowing over the past week from the new lending facility. The report does not identify the borrowers.
The Fed, in a bold move Sunday, agreed for the first time to let big investment houses get emergency loans directly from the central bank. This mechanism, similar to one available for commercial banks for years, got under way Monday and will continue for at least six months. It was the broadest use of the Fed's lending authority since the 1930s.

On Wednesday alone, lending reached $28.8 billion, according to the Fed report.

Thursday's report offered insight on how much credit was extended to Bear Stearns via JP Morgan through the transaction the Fed approved last Friday. Average daily borrowing came to $5.5 billion for the week ending Wednesday.

Separately, the Fed said it will make $75 billion of Treasury securities available to big investment firms next week. Investment houses can bid on a slice of the securities at a Fed auction next Thursday; a second is set for April 3. The Fed will allow investment firms to borrow up to $200 billion in safe Treasury securities by using some of their more risky investments as collateral.

On its face, the program sounds like a good idea. But by simultaneously reducing reserves--bleeding the healthy banks to support the sick ones--the Fed will transform a capital market problem into shrinking employment. This is sad, because all they have to do to fix it is to suspend the operations to offset the reserve impact, which would keep the reserves of the healthy banks intact. As it is, we should view the new lending facility as a contractionary policy.

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Shocking Story - South Korea Lifts Tariffs to Fight Inflation

(March 20, 2008) - In a shocking move today, the South Korean government broke step with almost every other government in the world, including ours, and decided to move away from protectionism by reducing tariffs. You can read the story by clicking here.

Starting April 1, President Lee Myung-bak's government will reduce import tariffs on about 70 grains and raw materials, including wheat, corn, soybean cake and coffee cream, while cutting tariffs on 18 other items.

When asked about the move, Senator Schumer responded, "It's sad, really. These guys obviously don't understand how the political game is played."

In separate news, Korea today reported its GDP increased 5% in the last year.

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March 20, 2008

Initial Claims +22,000

(March 20, 2008) - This week's initial unemployment claims number is about as exciting as kissing your sister. (Well, maybe except for Angelina Jolie's brother--those lips are huge!) Initial claims numbers bobbing around in this range tell us what we already know. The economy is in the hardly growing but not shrinking range it has been in for some time. It will take a jolt to move it out of the range--one way or the other.

The Department of Labor announced in their Unemployment Insurance Weekly Claims Report that in the week ending March 15, the advance figure for seasonally adjusted initial claims was 378,000, an increase of 22,000 from the previous week's revised figure of 356,000. The 4-week moving average was 365,250, an increase of 6,000 from the previous week's revised average of 359,250.

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March 18, 2008

February PPI +0.3%, 6.4% over last year

(March 18, 2008) - This morning the Bureau of Labor Statistics released Producer Price Indexes – February 2008 report. The February number was better than last month, but the 12 month number is still huge.

The Producer Price Index for Finished Goods rose 0.3% in February, seasonally adjusted, following a 1.0% advance in January and a 0.3% decline in December. At the earlier stages of processing, prices received by manufacturers of intermediate goods moved up 0.8% in February subsequent to a 1.4% advance in January, and the crude goods index rose 3.7% after climbing 2.5% in the prior month.

Within finished goods, energy goods increased 0.8% in February compared with a 1.5% gain in the previous month. Prices for consumer foods declined 0.5% following a 1.7% rise in January. The index for finished goods other than foods and energy moved up 0.5% in February after increasing 0.4% a month earlier.

The index for finished energy goods increased 0.8% in February after rising 1.5% in January. Unleaded gasoline prices increased 2.8% in February after 4.3% last month. Diesel fuel, liquefied petroleum gas and home heating oil fell in February. By contrast, residential natural gas prices rose 5.7% following a 0.7% gain in January.

The index for intermediate energy goods increased 1.1% in February after rising 2.8% in January. Diesel fuel prices advanced 0.9% in February following a 5.9% jump in the prior month. Prices for jet fuel, liquefied petroleum gas, home heating oil, and residual fuel turned down in February. Conversely, the utility natural gas index climbed 6.8% after inching up 0.1% in January.

The crude energy materials index increased 5.6% in February after rising 1.8% in the prior month. Natural gas prices jumped 11.5% compared with a 0.7% gain a month earlier. Crude petroleum prices moved up 0.6% after increasing 2.7% in the preceding month, and coal prices rose 1.0 percent following a 3.9% advance in January.

Bottom line--it's all oil. And the Fed does not print oil.

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Fed's FOMC Press Release

(March 18, 2008) - The Federal Open Market Committee released the FOMC Press Release today, cutting the Fed funds and discount rates by 0.75%, a little less than the full point many expected in the wake of last weekend's Hail Mary events.

As I have written recently, I believe the Fed's recent moves are inadequate to restore order to the financial markets. They are trying to be clever by targeting (micromanaging?) exactly who has access to the available stock of reserves, rather than increasing the amount generally available.

This problem is not going to be solved by squeezing on a balloon.

The reason the Fed went for 0.75%, rather than a full point, is that 2 of the FOMC members are worried about inflation--something like Joan of Arc refusing the offer of a bucket of water to put out the bonfire because it might get her hair wet.

Worries about inflation today are misplaced confusion about the Fed's role. The Fed does not print oil. Their job is not to attempt to control relative prices. Their job is to prevent the creation of a nonproductive asset class--the existing stock of tangible assets--that has long-term returns superior to long-term cash flow streams. That means not increasing the monetary base--and therefore, ultimately, tangible asset prices--in a long-term, systematic way that erodes the value of future dollars. Long-term bond yields today below 4% show they are not doing that. Monetary inflation--the job of the Fed--and growth-induced commodity price increases are entirely different animals.

The following is the text of the FOMC press release.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.
Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, and San Francisco.

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March 17, 2008

The Fed Giveth, and The Fed Taketh Away

(March 17, 2008) - The Fed almost got it right.

I have been whining for some time about the need to use asset market policies, rather than giving people checks so they can buy another iPod, to fix the current blackout in the credit markets. Friday's run on the bank at Bear Stearns has apparently gotten somebody's attention.

The Fed cannot ease the credit crisis until they increase the Monetary Base and grow bank reserves. It's as simple as that. They must stop giving with one hand and taking away with the other. Until they do, we are doomed to more crises and more alphabet soup rescue measures.

The Fed has been nibbling at the problem for some time. On January 22, they lowered their fed funds target by 0.75%, the biggest one-time drop in 2 decades. Then, on March 7, the Fed acknowledged that the Fed funds market was not performing its function by increasing the size of the temporary Term Auction Facility (TAF) they use to mainline reserves directly to banks with liquidity issues to a whopping $100 billion, doubled the length of the loans to 28 days and announced that banks would be able to use mortgage-backed and asset-backed securities as collateral to secure the transactions.

On March 11, the Fed announced a $200 billion Term Securities Lending Facility that would allow financial institutions, including the big investment banks, to borrow cash or Treasury securities using mortgage-backed securities as collateral. But last Friday, things hit the fan at Bear Stearns and the Fed stepped in to provide a non-recourse 4 week loan to Bear Stearns, through JPMorgan Chase (JPM).

Finally, on Sunday, the Fed agreed to fund $30 billion of Bear Stearns' less liquid assets, on a non-recourse basis, to facilitate the JPM purchase of Bear Stearns. At the same time, the Fed announced a 0.25% cut in the discount rate and created yet another alphabet program--this time the Prime Dealer Credit Facility (PDCF) that will provide overnight funding to primary dealers in exchange for a wide range of collateral including "investment-grade corporate, securities, municipal securities, mortgage-backed securities and asset-backed securities for which a price is available." The one day loans can be rolled over each day. The interest rate is the discount rate, currently 0.25% above the Fed funds rate. The Fed has full recourse to the borrowers capital.

Tomorrow, when the Open Market Committee meets, everyone expects them to reduce the Fed funds by another full point, with a corresponding further cut in the discount rate.

So why isn't it working? The answer is in the fine print. When the Fed announced the new PFCF (you have to use acronyms in this business) they also issued a press release, a Terms and Conditions statement and a statement on Frequently Asked Questions (although they had never done this before so I am a little skeptical about how many times it had come up in conversation).

Near the end there are 2 questions we should pay attention to.:

Will the PDCF operations have a reserve impact?
Yes, the credit advanced to the primary dealers under the PDCF will increase the amount of bank reserves.

How will we offset the reserve impact of PDCF loans?

PDCF loans made to primary dealers increase the total supply of reserves in the banking system, in much the same way that Discount Window loans do. To offset this increase, the Federal Reserve Open Market Trading Desk (the “Desk”) will utilize a number of tools, including, but not necessarily limited to, outright sales of Treasury securities, reverse repurchase agreements, redemptions of Treasury securities, and changes in the sizes of conventional RP transactions.

In other words, in conjunction with their Fed funds targeting operation, the Fed will siphon off every dollar of reserves created by the new facility--thereby, negating all of the stimulative impact of the policy! Or, another way of saying the same thing, the Fed will reduce reserves at healthy banks--thereby worsening their liquidity--dollar for dollar with the loans they are making to the investment banks.

As an example, on Monday, March 7, the same day they unveiled the $100 billion facility, the Fed announced they would sell $10 billion of Treasury bills from its portfolio on Monday, March 10 (thereby reducing reserves by the same amount), the first outright sale of securities since 1991.

This is a problem on many levels. Leave aside the obvious moral hazard problem of taking money away from careful people to give it to people who are not so careful. It also reduces the amount of bank reserves in commercial banks--as opposed to investment banks who do not hold deposits. This will further contract lending and worsen the credit crunch.

The chart above, showing bank reserves, is the picture worth 1000 words. In spite of all the Fed's huffing and puffing, the total stock of bank reserves today stands at $94.7 billion, lower than it was ($97.1 billion) on January 16 before they started inventing the alphabet facilities, roughly 0.7% lower than it was on May 23, before wither the leveraged loan crisis or the mortgage crisis reared their ugly heads.

If you prefer to think in terms of the Monetary Base, the aggregate that the Fed actually controls made up of bank reserves plus outstanding currency, you reach the same conclusion. The Monetary Base on March 12 (the most recent figure) stood at $857.6 billion. That's less than it was at the end of January ($860.7 billion), and almost exactly equal to its level on August 15, 2007 when the mortgage crisis first hit the headlines. In other words, all the Fed's stimulus since then amounts to a 0% growth in the Monetary Base.

What's at stake? So far, we have been extraordinarily lucky. Because the crisis first showed up in large leveraged loans last June, then in mortgages, it was not closely tied to commercial credit risk. As a result, banks continued to make working capital loans available for their business customers. Bank commercial and industrial loans--generally working capital loans to companies too small to raise capital on the public markets--the same ones that provide 100% of all new jobs for the economy. Bank C&I loans have grown from $1200 billion in January, 2007 to $1456 billion on February 27, the most recent figure available. C&I Loans are up $150 billion since last August, when we first heard about the mortgage crisis. C&I loans are the reason the GDP has continued to grow and jobs have continued to increase.

We should not take this for granted. Last time we got into a banking mess, in the fall of 2000, unwise actions by the Treasury Department shut down business lending and drove the economy into a recession. Loans fell from $1100 billion in November, 2000 to $870 billion in early 2004 causing tremendous loss of jobs. If the Fed does not stop siphoning off the reserves they are creating it can happen again.

Posted by John Rutledge at 7:03 PM | Comments (1) | TrackBack

Q4 Current-Account Deficit Down to $172.9 billion

(March 17, 2008) - This morning, the BEA released U.S. International Transactions: Fourth Quarter and Year 2007 Current Account , reporting that the U.S. current-account deficit decreased to $172.9 billion in Q4/07 from $177.4 billion in Q3/07. The decrease was more than accounted for by increases in the surpluses on income and on services.

2008-03-17%20-%20Current-Account%20Transactions.jpg

The deficit on goods and services increased to $177.9 billion in the fourth quarter from $172.6 billion in the third. The surplus on income increased to $33.0 billion in the fourth quarter from $21.3 billion in the third, while net unilateral current transfers to foreigners were $28.1 billion in the fourth quarter, up from $26.2 billion in the third.

The deficit on goods decreased to $815.4 billion in 2007 from $838.3 billion in 2006. Goods exports increased to $1,149.2 billion from $1,023.1 billion. The largest increases were in nonagricultural industrial supplies and materials and in capital goods. Goods imports increased to $1,964.6 billion from $1,861.4 billion. The increase was largely accounted for by increases in consumer goods, petroleum and products, and capital goods.

Income receipts on U.S.-owned assets abroad increased to $779.3 billion from $647.6 billion. Income payments on foreign-owned assets in the United States increased to $698.2 billion from $604.4 billion.

Net financial inflows--net acquisitions by foreign residents of assets in the United States less net acquisitions by U.S. residents of assets abroad--were $657.4 billion in 2007, down from $833.2 billion in 2006.

2008-03-17%20-%20Current-Account%20Components.jpg

For the full year 2007, the U.S. current-account deficit decreased to $738.6 billion from $811.5 billion in 2006. The $72.9 billion decrease was more than accounted for by increases in the surpluses on income and on services and a decrease in the deficit on goods.

The deficit on goods decreased to $815.4 billion in 2007 from $838.3 billion in 2006. Goods exports increased to $1,149.2 billion from $1,023.1 billion. Goods imports increased to $1,964.6 billion from $1,861.4 billion.

U.S.-owned assets abroad increased $1,206.3 billion in 2007, following an increase of $1,055.2 billion in 2006. Foreign-owned assets in the United States increased $1,863.7 billion in 2007, following an increase of $1,859.6 billion in 2006. Of particular interest are growing long-term direct investments in both directions. U.S. direct investment abroad increased $335.4 billion in 2007, following an increase of $235.4 billion in 2006. Foreign direct investment in the United States increased $204.4 billion in 2007, following an increase of $180.6 billion in 2006.

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February Industrial Production Down 0.5%; Capacity Utilization Decreases to 80.9%

(March 17, 2008) - The Federal Reserve Board released the Industrial Production and Capacity Utilization report for February this morning. Industrial production fell 0.5% in February after having increased 0.1% in January. Although almost 3/4 of the of the February decrease resulted from a weather-related 3.7% drop in output of utilities, the report was not good news.

Today's crisis is not a GDP event, i.e., not the result of a slowdown of spending, building inventories, and production cutbacks and layoffs like the textbooks say. This time it is almost entirely a balance sheet, or capital market event.

Some people, who only see my TV spots, have the wrong impression of my current view of the economy. The spots are usually set up so some person says there is a terrible recession, then I say no there's not a recession--end of spot. What I really want to say is that this is something different, and far more serious, than a recession. It is the total collapse of the information networks we call the capital markets.

The reason that's so important is because different tools are required to fix a GDP problem than those to address an asset market collapse. Anti-recession policies, like the ones now being implemented by policy makers ($600 checks, etc.) will do no good at all. We need balance sheet fixes for today's problem.

Balance sheet sheet fixes must be designed to repair the balance sheet problem--the inability of investors to understand, project, and trust the future cash flow streams embodied in securities. I will write more later about just what that means.

Output decreased 0.2% in manufacturing, .6% in final goods, and 1.1% in durable goods, 1.3% in automotive in appliances, furniture and carpeting. The only real bright spot were home electronics (+1.2%) and information processing (+1.4%). Total industrial production was 1.0% above its year-earlier level and 113.7% of its 2002 average. (click table below to enlarge in a separate pop-up window)

The capacity utilization rate for total industry in February fell 0.6 percentage point, to 80.9%, about equal to its 1972-2007 average rate of 81.0% but down from 82.0 in Q3/2007 before the mortgage crisis hit the headlines. Capacity increased 0.2% in February, roughly a 2.4% annual rate, slightly higher than the 1.8% recorded in 2007.

I have also included the historical charts for both Industrial Production (above) and Capacity Utilization (below) so you can compare what is happening now to previous difficult periods. The bars indicate periods of official recession, which more or less translates into declining GDP. As you can see, each time there is a recession there is a corresponding collapse of industrial production and capacity utilization. Last time it was the dotcom bust, before that the savings and loan collapse and Resolution Trust Corporation, before that the draconian disinflation of the early 1980's, and before that the oil embargo in the 1970s.

I put the charts up so you could see that this one is different. Today's crisis is not a GDP event, i.e., not the result of a slowdown of spending, building inventories, and production cutbacks and layoffs like the textbooks say. This time it is almost entirely a balance sheet, or capital market event.

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