Nouriel Roubini's Global EconoMonitor

Archive for June, 2007

  • The Economist Post-Mortem on the Asian Crisis


    The Economist magazine presents this week a long and thoughtful post-mortem of the 1997-98 Asian Crisis. In this discussion the Economist also widely cites and assesses the view that I presented in my recent paper “Asia is Learning the Wrong Lessons from Its 1997-98 Financial Crisis: The Rising Risks of a New and Different Type of Financial Crisis in Asia” that the current exchange rate policies of China and other members of the Bretton Woods 2 regime (i.e. countries that are still effectively pegging to the US dollar) are leading to significant domestic imbalances (rise in either goods inflation and/or asset bubbles) that are dangerous and risk to eventually lead to other financial pressures.

    The Economist agrees with my analyss for the case of China but not for other Asian economies. In The Economist‘s view:

    On the external side, however, the optimists are right to say that Asia is stronger and more resilient. The region is far less vulnerable to a balance-of-payments crisis than it was ten years ago, when all the crisis-hit countries had large current-account deficits. Now they all have current-account surpluses and much less foreign debt. They also have vast foreign reserves to protect them against any future speculative attack. As a rule of thumb, a country should have enough reserves to cover its short-term foreign debt. On the eve of the crisis in June 1997 South Korea’s reserves were only one-third as big as its short-term debt; today they are twice the size. In most of the other countries, reserves are also two to three times bigger.

    That was then

    These large war chests mean that a repeat of 1997 is unlikely. However, some economists, such as Nouriel Roubini, of Roubini Global Economics, argue that the build-up of reserves is itself creating new hazards. East Asian policymakers, says Mr Roubini, failed to learn the most important lesson of the crisis. Exchange rates are once more, in effect, tied to the dollar. This, he argues, risks creating a new, but different financial crisis—not a balance-of-payments shock like last time, but booms and busts in asset markets.

    As governments try to keep their currencies cheap, developing Asia’s total reserves have jumped from $250 billion in 1997 to $2.5 trillion this year. The desire to build up reserves is understandable, but they are now excessive. Asian economies’ policy of tracking the dollar and the consequent rapid increase in reserves, argues Mr Roubini, is leading to excessive growth in money and credit, inflationary pressures and asset bubbles in shares and housing. This, he concludes, will eventually lead to vulnerabilities similar to the massive capital inflows, credit boom, overheating and bubbles that preceded the 1997 crisis.

    His grim prediction is based on the “impossible trinity”: an economy cannot control domestic liquidity and manage its exchange rate if its capital account is open. If it holds down its currency, foreign-exchange inflows will boost money growth. The central bank can try to “sterilise” the impact of bigger reserves by selling securities to mop up the excess liquidity. The snag is that bond sales will tend to push up interest rates and so attract yet more capital inflows. Mr Roubini believes that the room for sterilisation by Asian central banks is severely limited and so rising reserves mean even greater excess liquidity.

    The big difference

    However, these economies may be able to sustain today’s policies for longer than Mr Roubini expects. This is because many of the economic characteristics he describes—such as fixed exchange rates, massive current-account surpluses and asset-price bubbles—certainly apply to China, but not to most of the smaller East Asian economies. To begin with, the chief victims of the crisis have let their currencies appreciate against the dollar by much more than China has. Only Hong Kong still pegs to the dollar. The South Korean won has risen by 42% since 2002 and the Thai baht by 28%. China accounts for most of the increase in Asian reserves. Since December 2004 the combined reserves of Indonesia, Malaysia, the Philippines, South Korea and Thailand have risen by only one-third; China’s have doubled.

    Second, the common claim that these economies have big current-account surpluses, which proves their currencies are undervalued, is much exaggerated. China has a big surplus, but of the former “crisis countries” only Malaysia has a large surplus (11% of GDP). South Korea, Thailand and Indonesia have an average surplus of less than 1% of GDP (see chart 2). Indeed, Morgan Stanley reckons these currencies are now overvalued against the dollar.

    Third, in most countries the build-up of foreign-exchange reserves has not hugely pushed up the growth of money and inflation. The broad-money supply in the crisis economies is up by just over 10% on average over the past year, much less than China’s 17% and well below their money growth of more than 20% in the mid-1990s. Inflation also remains tame. In its Asia and Pacific Regional Economic Outlook, the IMF concludes most emerging Asian economies are not on the verge of overheating. It sees little evidence of housing bubbles in most countries: average house prices have not risen by much more than incomes in recent years. Share prices have soared, but those gains follow sharp declines. With the notable exception of China, price-earnings ratios in East Asia remain below those in developed markets.

    Foreign-exchange inflows are not causing money and credit to explode partly because central banks’ sterilisation has been relatively successful in mopping up liquidity. One important difference between now and the years leading up to the crisis is that the upward pressure on currencies and the increase in foreign reserves almost entirely reflects current-account surpluses and inwards foreign direct investment, not net inflows of hot money. According to David Carbon at DBS, a Singapore bank, net capital inflows into the crisis economies have averaged only 0.5% of GDP since 2004, compared with 6.5% during 1991-96.

    Only Thailand has seen large net capital inflows and last year it ran into trouble. Inflation started to rise, leading the central bank to lift interest rates. This pulled in yet more capital and pushed up the exchange rate. In December, to stem the rise of the baht and regain control of liquidity, the government made a bungled attempt to slap a tax on inward portfolio investment. The stockmarket plunged. In most of the other small Asian economies, however, central banks have not been deluged by net inflows of short-term capital. This may be why countries have been able to sterilise large amounts of foreign reserves without attracting yet more capital.

    Thus neither of the two commonly held views about the victims of the Asian financial crisis ring true. The economies hit hardest by the crisis have not fully recovered: their growth remains much slower than before 1997. But nor are they awash with excess liquidity and heading for another financial meltdown.

    One big change over the past decade is the emergence of China as an economic power. Other Asian economies have lost some exports to China, but it imports large amounts of capital equipment and components from within the region. China’s demand for raw materials has also pushed up commodity prices, benefiting some South-East Asian producers. China now takes 22% of the exports of the rest of emerging Asia, up from 13% in the late 1990s. Smaller East Asian countries have seen a slight decline in their share of global trade as China’s has risen, but their exports have continued to grow rapidly. In the late 1990s, for
    eign direct investment in South-East Asia fell, stoking fears that China was stealing investment. However, over the past few years it has rebounded strongly. Overall, China has almost certainly been a net boost for the rest of Asia.

    Nevertheless, the fear of losing competitiveness relative to China has played a big role in these countries’ reluctance to allow their exchange rates to appreciate any more rapidly. If China allowed its currency, the yuan, to rise, they would have less need to intervene.

    Wrong lessons

    Could China be the source of the next crisis? China was less affected in 1997-98, thanks to strict capital controls. Indeed, by not devaluing its currency it helped to prevent a worsening of the financial contagion. But China, more than its neighbours, may have drawn the wrong lesson—namely the need to keep its exchange-rate stable and to build up massive reserves. China’s monetary policy has been overly lax and low interest rates on bank deposits have encouraged a huge shift of money into its stockmarket. Thus Mr Roubini’s diagnosis of Asia does apply to China.

    If China’s share-price bubble burst, the economic consequences in China—and among its neighbours—would probably be mild, since Chinese share-ownership is relatively low. Nervous investors might pull money out of other Asian stockmarkets, but large foreign reserves should prevent serious capital flight.

    Rather than shielding themselves with big reserves, East Asia’s governments should make their economies more pliable and their banks more resilient, and thus better able to cope with future volatility. They need more flexible exchange rates, which would not only prevent a further excessive build-up in reserves, but also help to shift growth towards domestic demand and away from exports. Governments must also restore business confidence and create a healthier investment environment. Asia has performed better than most people expected ten years ago. But it could have done better still.

    So, the Economist and I do agree that the exchange rate and reserve policies of China are leading to financial imbalances and bubbles that are becoming dangerous and unsustainable.

    The main issue is whether other parts of East Asia and other members of BW2 outside East Asia should worry or not about such real and financial imbalances deriving from effective dollar pegs and excessive forex reserve acccumulation. It is clear that not all of East Asian economies are currently members of BW2: as I show in a new paper (The Instability of Bretton Woods 2) – to be presented next week in Singapore – a number of economies in East Asia have now exited BW2 given the real and financial costs (rising inflation, risk of asset bubbles) of membership in this club; thus, they have allowed much greater exchange rate flexibility since 2005. These are Korea, Thailand, Indonesia, Philippines, Singapore, India. Still, many other economies remain members of the BW2 club in Asia: Hong Kong, Taiwan, Malaysia, Vietnam. However, the risks of financial imbalances are meaningful in a number of countries: inflation was rising in some and this is why they abandoned BW2 while significant financial imbalances remain.

    Let me now elaborate on these imbalances…

    More ›

  • When mainstream analysts compare CDOs to “subslime”, “toxic waste” and “six-inch hooker heels”…

    You know you have a serious problem with subprime-related CDOs and the housing and mortgage markets when mainstream analysts compare CDOs and mortgage backed securities to “subslime”, “toxic waste” and “six-inch hooker heels”…   The conservative Kudlow had a heading in his show last nite that referred to CDOs and to the Bear Stearns CDO […]

    More ›

  • EMU: Divergence or Convergence?

    Has the process of monetary unification in Europe led to economic convergence or economic divergence in the Eurozone since 1999? This is a key issue that was discussed at a conference on EMU Divergences in Berlin last week that was co-organized by RGE.

    Indeed, the long-run performance and success of the EMU depends on whether economic convergence or divergence is occurring. The ideas and debates at the conference are nicely summarized by Sebastian Dullien and Daniela Schwarzer (who co-organized the conference) in a blog at Eurozone Watch

    Before the formation of EMU there were long debates on whether or not the Eurozone was an optimal currency area. The economic criteria for a successful monetary union were widely debated in principle. Now several years after the formation of the monetary union (formally started in 2002 but already effectively in place since 1999) there is enough economic data to make a preliminary assessment of the success of the monetary union.  It is useful to go back to some of the conceptual criteria for a successful monetary union and then test whether the economic performance of EMU has been consistent with such criteria.  Here is a concise overview of the economic criteria that make a currency or monetary union desirable:  

    a)      There are little asymmetries in shocks and in macroeconomic transmission so that business cycles (per capita output levels and growth rates) are not widely and persistently divergent across countries;

    b)      Consumption risk is sufficiently diversified across borders. In other terms, international financial markets work efficiently, so that agents can easily smooth consumption via risk sharing and international borrowing and lending across time.

    c)      Fiscal policy – at the national and union level – can help stabilize national economies given asymmetric shocks;

    d)      Prices and wages are sufficiently flexible so that relative prices (including real exchange rates) can adjust sufficiently even in the absence of a domestic currency;

    e)      Factors are sufficiently mobile across regions of the union also in the short run, at low private and social costs.  

    In the RGE paper Economic Divergences in EMU? Facts and Implications  (co-authored by Christian Menegatti, Elisa Parisi-Capone and myself) that we presented at the EMU conference we conducted a systematic overview of the evidence on economic convergence or divergence within the EMU.  In summary we found that:

    –         There is only little evidence of per capita GDP convergence (in PPP terms), with Ireland being the only true example of standard of living catching up. Portugal, Greece and Spain do not show evidence of per capita income catching up.  Italy shows a decline in the standard of living.

    –         Based on some measures there has been some decrease in growth dispersion within the EMU countries. Whether the recent pick up in growth in the Eurozone will continue this trend is a still an open issue. 

    –         Financial channels (credit and capital markets) provide only very modest degrees of smoothing of national shocks in the EMU, especially compared to their role within the United States. Only 7% of shocks were absorbed during the full sample. However, this risk-sharing channel via the financial channels and the fiscal channel has significantly improved over time in the Eurozone and during the EMU period. 36% of the idiosyncratic shocks are now smoothed via these channels across the Eurozone. This is consistent with the evidence that the degree of financial integration has increased over time in the Eurozone.

    –         The role of the financial channel is larger than the one of the fiscal channel; even in the most recent EMU period only 9% of asymmetric shocks are absorbed by the fiscal channel (as opposed to 1% for the full sample period). In the most recent EMU period the financial and credit channel smooth 27% of shocks.

    –        The real exchange channel provides a mixed picture: there is some evidence of mean reversion, especially in Germany; but there is also evidence of persistent loss of competitiveness in countries such as Italy, Spain and Portugal. 

    –         Finally, real interest rates have moved in way that has been partly destabilizing: based on trends in housing markets and other variables differences in real interest rates may have exacerbated financial and asset price bubbles in some economies with the risk of a boom-bust cycle. This is what happened to Portugal and to the Netherlands and what could happen to Spain.  

     Based on these results what can we say about the success or limitations of EMU? I would summarize the evidence from our paper and from the discussions at the conference as follows: 

    More ›

  • Housing “Blood Bath”, ABX Free Fall, CDO Market Shock and Worries About “Systemic Risk”

    The links between the seriously worsening housing recession and the financial assets backing the increasingly risky mortgages has now come to an ugly crossroad: there are now concerns about the systemic risk fallout from the collapse of two Bear Stearns hedge funds with large exposure to mortgage backed securities and CDOs.


    First, this week’s news on the housing market confirmed that the housing recession is getting much worse: Home builders (NAHB) confidence down to its lowest level since 1991, housing starts falling again, mortgage rates rising further, mortgage applications falling again. These bad news were on top of the previous week’s new of a sharp rise in foreclosures and of falling home prices. So, as even Bernanke has now admitted, the housing recession has not bottomed out and the wealth effects of falling home prices may be more severe than previously expected. Things are getting so bad that Bloomberg used the term “Blood Bath” to describe the housing market in a recent article headline: “Rising Rate Pushes Housing, the Economy to a Blood Bath”:


    Second, the worsening of the housing market is reflected by the free fall in the ABX index. The prices for the BBB- tranches of this index are back below the lows that this market experienced in February when the subprime carnage blew up in public. So investors are pricing again the highest probability of sharp upcoming defaults on subprime mortgages.


    Third, the recent near default of two Bear Stearns hedge funds with heavy exposure to mortgage backed securities has revealed the dirty secret of the mortgage related CDOs market: these instruments have not – until now – been marked to market. But the upcoming auction of about $800 million of these CDO claims of the Bear Stearns fund seized by Merrill Lynch is now going to reveal the true market price and value of these risky securities.


    Fourth, these highly illiquid securities have been priced so far based on unrealistic and distorted credit ratings as the rating industry has been complicit with the mispricing and misrating of these securities: most of these securities have not been re-rated in a way consistent with the rising default rates on subprime mortgages.  That is why Wall Street is now in a panic about getting true market values – through an auction  – of such securities. Losses for CDOs investors will be massive once these assets are correctly priced to market rather than kept on books based on valuation that do not make any sense as they were based on distorted and obsolete ratings.


    Finally, and more seriously, the SEC is now worrying about the “systemic risk” deriving from this Bear Stearns hedge fund collapse and comparisons are being made to the LTCM near collapse in 1998 with worries that the problems of the Bear Stearns hedge fund will lead to contagion to other hedge funds and to their prime brokers. As Bloomberg put it today:


    U.S. Securities and Exchange Commission Chairman Christopher Cox said yesterday that the agency’s division of market regulation is tracking the turmoil at the Bear Stearns fund. “Our concerns are with any potential systemic fallout,” Cox said in an interview. …

    The reaction to the Bear Stearns situation is reminiscent of Long-Term Capital Management LP, which lost $4.6 billion in 1998. Lenders including Merrill and Bear Stearns met and agreed to take a stake in the Greenwich, Connecticut-based fund and slowly sold the assets to limit the impact of its collapse. “We’re not surprised to find the principal circle of players is pretty interconnected,” said Roy Smith, professor of finance at New York University Stern School of Business and former head of Goldman’s London office. “What we’re looking for is whether the interconnection creates a negative domino effect: Whether Hedge Fund A creates a problem for other hedge funds, which in turn creates a problem for the prime brokers that are lending to them.”

    Also, some of the most sophisticated researchers of the mortgage market – the analysts at Bank of America – are now suggesting that this is just “the tip of the iceberg”:


    Losses in the U.S. mortgage market may be the “tip of the iceberg,” Bank of America Corp. analysts said today in a note for clients.

    Higher interest rates have yet to filter through to many home owners who took out adjustable-rate mortgages, the Charlotte, North Carolina-based bank said.

    Home owners owing about $515 billion in adjustable-rate home loans will face higher interest payments this year and about $680 billion-worth of mortgages are due to reset next year, according to Bank of America estimates. More than 70 percent of that debt is in so-called subprime mortgages, loans made to the riskiest borrowers, the bank said.

    Bear Stearns Cos. plans to take on $3.2 billion of loans to stop creditors from taking over assets of one of its hedge funds, people with knowledge of the proposal said. The fund rescue attempt is the biggest since 1998.

    “The demise of two Bear Stearns managed leveraged mortgage funds could be the tipping point of a broader fallout from subprime mortgage credit deterioration,” Bank of America analysts, led by Robert Lacoursiere in New York, wrote.

    Worries about contagion, concerns about systemic risk, comparisons to the 1998 LTCM near collapse, now widening corporate risk spreads. The picture is pretty ugly. 


    But let us now consider this housing and financial mess in much more detail… 

    More ›

  • Conference on EMU Divergences co-organized by RGE Monitor

    Today a conference took place in Berlin, Germany on “EMU under Stretch? Analysing Regional Divergences in EMU: Facts, Dangers and Cures”  that was co-organized by RGE Monitor together with two German think tanks. The papers presented at this conference – including one by RGE authors – are available on the conference website. The performance of EMU since its inception […]

    More ›

  • Bernanke: Wealth effect of housing on consumption higher than previously estimated

    As reported by the FT new research by the Fed has led Bernanke to suggest that the wealth effect of housing on consumption may be higher than previously estimated and higher when home prices – like in recent times – are falling: Changes in house prices could have a bigger effect on consumption than the […]

    More ›

  • Wesbury vs. Roubini on the Housing Recession on a CNBC Video

    This blogger debated Brian Wesbury on the housing recesssion on CNBC yesterday. Here is link to a video of this debate courtesy of Bubble News. See also a summary of this debate on this CNBC news report.  

    More ›

  • WSJ: Greenspan Added to Subprime Woes by Blocking Crackdown on Predatory Lending and Preventing Further Supervision of Lenders

    Under the headline “Did Greenspan Add to Subprime Woes? Gramlich Says Ex-Colleague Blocked Crackdown on Predatory Lenders Despite Growing Concerns” the Wall Street Journal reports the views of former Fed Governor Gramlich – to be presented in a forthcoming book – that Greenspan “blocked a proposal to increase scrutiny of subprime lenders under the Fed’s broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers.”

    The fact that the unregulated subprime boom occurred while federal and state regulators were effectively “asleep at the wheel” is widely known by now. But now the role that the Fed and Greenspan played in allowing this reckless subprime bubble to grow with no control with becoming clearer.

    As reported by Greg Ip in the Wall Street Journal:

    Alan Greenspan was arguably the country’s most powerful financial cop in his 18 years as chairman of the Federal Reserve. But Mr. Greenspan’s regulatory record has received far less scrutiny than his management of the economy.

    That may be changing. A former colleague says Mr. Greenspan blocked a proposal to increase scrutiny of subprime lenders under the Fed’s broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers. Democrats in Congress are now turning up the heat on regulators, especially the Fed, for failing to do more to stamp out those practices, and the Fed appears increasingly likely to overhaul its approach.

    Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

    “I would have liked the Fed to be a leader” in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

    “He was opposed to it, so I didn’t really pursue it,” says Mr. Gramlich, a Democrat who was one of seven Fed governors.

    Greenspan’s Response

    Mr. Greenspan, in an interview, says he doesn’t recall a specific discussion of the idea but confirmed his opposition to it.

    There is “a very large number of small institutions, some on the margin of scrupulousness and very hard to detect when they are doing something wrong,” says Mr. Greenspan, who retired in February last year. “For us to go in and audit how they act on their mortgage applications would have been a huge effort, and it’s not clear to me we would have found anything that would have been worthwhile without undermining the desired availability of subprime credits.”

    Mr. Greenspan adds that borrowers might get a false sense of security from a lender that advertised itself as Fed-inspected.

    Ben Bernanke, Mr. Greenspan’s successor, told Congress in March that he has asked his staff for “a complete review of our powers and practices” in examining holding-company units. A Fed spokesman this past week said “that review is under way.” The Fed Thursday will conduct a public meeting on steps it could take to strengthen laws governing subprime lending.

    On June 29, the Urban Institute will release a book by Mr. Gramlich, “Subprime Mortgages: America’s Latest Boom and Bust.” It argues, among other points, that all lenders affiliated with banks and thrifts could “be brought under the same supervisory conventions as their parents seemingly without major culture shock.” It wouldn’t be a huge undertaking by policy makers, and it would lead to more uniform, stringent practices.

    Mr. Gramlich, who is being treated for cancer, says, “There are certain things that unsupervised lenders do that a Fed supervisor would not let you get away with,” such as not escrowing taxes and insurance, not verifying an applicant’s stated income, or assessing the borrower’s ability to repay based on an introductory “teaser” rate. But he said the proposal’s reach would have been limited by the fact that many lenders would still have no federal supervision.

    At the time President Clinton appointed Mr. Gramlich to the Federal Reserve Board, he was a University of Michigan academic who had served on commissions studying Major League Baseball and Social Security. Mr. Greenspan put him in charge of the board’s community and consumer affairs committee.

    Mr. Gramlich often pushed the Fed to expand fair-lending and consumer-protection rules, winning the admiration of consumer groups that often accuse the Fed of being too supportive of the financial industry. Despite their differing philosophies, Mr. Gramlich says he got along well with Mr. Greenspan, who supported him on most initiatives, especially those involving increased disclosure.

    Nonetheless, his remarks represent a rare insider’s criticism of Mr. Greenspan’s regulatory record. Mr. Greenspan says he didn’t get heavily involved in regulatory matters in part because his laissez-faire philosophy was often at odds with the goals of the laws Congress had tasked the Fed with enforcing.

    “I basically listened to the staff and tried as best I could to support the staff’s recommendation,” he says. He notes that with one exception, on a highly technical issue, he always voted with the board majority.

    Still, Mr. Greenspan’s views did color the regulatory environment, facilitating growing concentration in banking and a hands-off approach to derivatives and hedge funds. That approach, broadly shared by both the Clinton and Bush administrations, is coming under increased scrutiny.

    Heat on the Fed

    The Fed has taken heat recently for not more vigorously using its power to write consumer-protection rules for the entire industry, not just the lenders it oversees directly. Before it proposed new standards last month, the Fed hadn’t conducted a broad review of its credit-card disclosure requirements since 1981 — six years before Greenspan took office.

    In 2005, 52% of subprime mortgages were originated by companies with no federal supervision, primarily mortgage brokers and stand-alone finance companies; 23% by banks and thrifts; and 25% by finance companies affiliated with banks and thrifts, including units of bank holding companies.

    According to Inside Mortgage Finance, an industry publication, in 2006 three of the eight largest subprime mortgage lenders were units of bank holding companies. The Fed is one of four federal regulators that supervises deposit-taking banks and thrifts. It also has oversight over bank holding companies, with the discretion to delegate authority over their operating units to other agencies.

    Thus the Fed generally leaves regulation of nationally chartered banks to the Office of the Comptroller of the Currency; of securities-dealer units to the Securities and Exchange Commission; and of consumer-finance companies to the states.

    However, state regulation is generally considered inconsistent and usually less rigorous than federal oversight. Moreover, 18 states offer some form of exemption from state regulation to bank holding company units, according to the Conference of State Banking Supervisors.

    The Fed periodically exami
    nes the finance-company units to ensure that they pose no threat to the “safety and soundness” of their deposit-taking affiliates and to assess their controls for things like money laundering. In special situations, it does scrutinize their practices for compliance with consumer-protection laws. In 2004, it fined Citigroup $70 million for alleged abuses by its CitiFinancial unit.

    But Mr. Gramlich fretted that extending those standards to holding-company units would create an unlevel playing field unless stand-alone lenders were subjected to the same thing.

    Jim Strother, general counsel for Wells Fargo & Co., said oversight of bank holding company units isn’t “where the need is,” noting the Fed does examine Wells Fargo Financial, a major subprime mortgage lender. “The gap is for companies that aren’t in the banking system at all.”

    In summary, a lasseiz-faire regulatory policy allowed the subprime bubble to grow with almost no constraint until it burst in the current subprime meltdown. But – as the WSJ showed – now the worst problem is that the regulatory gaps and holes in the US system remain as deep as before.

    How did this systematic failure of supervision and regulation occur? Let us elaborate on this issue…

    More ›

  • WSJ Lead Story: “Economists See Housing Slump Enduring Longer”

    This weekend the lead front page story on the Wall Street Journal is “Ripple Effect: Economists See Housing Slump Enduring Longer. Downturn is expected to keep growth tepid; retailers feel the pinch“. The points made in this most excellent and interesting article are not new to those who have followed closely the housing recession and […]

    More ›

  • US Consumer Under Stress: May Sales Weak after a Mediocre April

    Bloomberg is reporting today – under the headline “U.S. Retailers’ Sales Declined in May; Macy’s, J.C. Penney Trail Estimates”:

    Sales at Macy’s Inc., J.C. Penney Co. and other U.S. retailers fell in May as shoppers curbed purchases due to higher gasoline prices and a sluggish housing market.

    Wal-Mart Stores Inc., the world’s largest retailer, said U.S. sales at stores open at least a year gained 1.1 percent, on the low end of its forecast for a 1 percent to 2 percent advance.

    U.S. retail sales from February through May rose at half the pace from a year earlier as consumers reined in purchases of non-essential items such as clothing and home furnishings..

    “The American consumer is not aggressively shopping right now as they are shut in with further worries,” said Eric Beder, an analyst at Brean Murray Carret & Co. in New York.

    U.S. sales last month came in at the “high end” of the International Council of Shopping Centers’ forecast for an increase of 2 percent to 2.5 percent, it said June 5. Same-store sales are an industry benchmark because they exclude results from new or closed stores.

    Shares of Macy’s fell 33 cents to $39.17 as of 9:59 a.m. in New York Stock Exchange composite trading, J.C. Penney lost $3.06, or 3.8 percent, to $78.13 for the biggest drop since July 2006. Wal-Mart slipped 42 cents to $50.33. The Standard & Poor’s 500 Retailing Index lost 0.3 percent.

    Limited Brands Inc. and Kohl’s Corp. were among retailers’ whose gains beat analysts’ estimates as the warmest May in six years spurred sales of shorts, bathing suits and other lightweight clothing.

    Gas Prices, Housing

    The national average pump price for regular gasoline reached a high of $3.227 a gallon on May 23. Gasoline has climbed about 11 percent since last year.

    U.S. sales of previously owned homes dropped in April to the lowest level in almost four years, the National Association of Realtors said May 25. The median price of an existing home fell 0.8 percent last month from a year earlier to $220,900.

    With lower home prices and higher interest rates, people are finding it harder to extract equity from their homes. That may contribute to a slowdown in consumer spending, which accounts for more than two-thirds of the U.S. economy, economists have said.

    The drop of 3.3 percent in same-store sales at Macy’s, the second-largest U.S. department-store chain, trailed analysts’ estimates for a decline of 1.4 percent, according to data from Retail Metrics LLC. Macy’s was formerly called Federated Department Stores Inc.

    J.C. Penney

    J.C. Penney, the third-largest department-store chain, reported a sales drop of 2 percent. Analysts projected a gain of 0.1 percent, while the company forecast unchanged sales. Home goods, fine jewelry and women’s accessories hurt results, J.C. Penney said.

    Dillard’s Inc., a department-store chain that operates mostly in southern U.S. states, reported a same-store sales decline of 2 percent, trailing the estimate for a drop of 1.6 percent. AnnTaylor Stores Corp., a clothes retailer geared at women ages 25 to 55, said sales last month fell 4.6 percent, worse than the estimate for a 2.9 percent drop.

    Wal-Mart said demand for holiday barbecue and lawn-and- garden goods lifted purchases.

    Consumers’ “worries about gas prices have increased from January through April,” the Bentonville, Arkansas-based company said today in a statement. Wal-Mart predicted June same-store sales will be unchanged or gain as much as 2 percent.


    The US consumer is clearly under stress and these early May retail sales figures confirm the weak consumption trends already evident in April:

    – April retail sales fell in nominal and real terms

    – Nominal and real disposable incomes fell in April

    – Real consumption spending in April was weak at +0.2%

    – Real spending on goods in April fell with spending on services being the only component of spending growing in real term

    – Oil and gasoline prices are rising further denting the real incomes of households.

    – Some high frequency measures of  consumer confidence are weakening. Specifically, confidence of U.S. consumers reached a new 2007 low due to rising gasoline prices, a weekly survey showed on Tuesday. The ABC News/Washington Post Consumer Comfort Index fell to -15 in the latest week from -13 in the previous period. The measure ranges from -100 to +100; its 2007 average is -5 and its average since 1985 is -9.

    – The worsening housing recession and a serious mortgage credit crunch are further hurting the US consumer. These weakening housing/mortgage indicators include: a further sharp fall in pending home sales, very weak housing demand, falling mortgage applications, a mortgage credit crunch getting worse, home prices falling, home equity withdrawal sharply shrinking, and a trillion dollars of ARMs being reset this year. Then, in spite of the recovering supply side factors (a rising ISM in manufacturing, some modest increase in capex spending by the corporate sector), the outlook for the US economy remains relatively weak.

    What does all this imply for US economic growth? There are good reasons to argue that the recent optimism about a growth recovery – after the near stall of growth in Q1 – is not granted by the data on housing and consumption. Let me explain further why…

    More ›