Financial Review

Tuesday, April 22, 2014 – Helicopter Drops Were Successful, and Other Revisions

Helicopter Drops Were Successful, and Other Revisions
by Sinclair Noe
DOW + 65 = 16,514
SPX + 7 = 1879
NAS + 39 = 4161
10 YR YLD + .01 = 2.73%
OIL – 1.77 = 101.88
GOLD – 6.60 = 1284.70
SILV – .05 = 19.49
Sales of previously owned homes fell in March for a third consecutive month as rising prices and a lack of inventory discouraged would-be buyers. The National Association of Realtors reports closings, which usually take place a month or two after a contract is signed, fell 0.2% to a 4.59 million annual rate, the lowest level since July 2012. It was the seventh drop in the last 8 months pushing sales down 8.5% compared with the same month last year before adjusting for seasonal patterns.
The drop in demand might not lead to a flat-line in home prices. That’s because one obstacle to lower sales is the low number of homes on the market. The number of houses for sale at the end of last month rose to 1.99 million compared with 1.93 million a year earlier. At the current pace, it would take 5.2 months to sell houses compared with 5 months at the end of February.
There are some positives in the housing market: distressed sales are down; delinquencies are down; negative equity has declined; and even though inventory is up slightly, that is a positive because inventory had been too tight.
The median price of an existing home climbed 7.9% from March 2013 to $198,500. The appreciation was led by a 12.6% year-to-year advance in the West, while the Northeast posted a more moderate 3.2% increase. As prices increased, sales dropped, with the biggest 12-month drop coming in the West at 13.5%, and the smallest in the Northeast, with a 4.4% decrease.
Million-dollar home sales are on the rise, while deals for cheaper homes are dropping. In March, sales of single-family existing homes priced at $1 million and above were up 7.8% from the year-earlier period. Meanwhile, sales of homes that cost between $100,000 and $250,000 fell 9.9% over the past year. This might say something about the weak labor market and eroding income levels; it also speaks to mortgage lending practices, which remain strict for all but the jumbo market, where standards have eased; and it screams about the growing divide in America.  
Meanwhile, each month Bloomberg conducts a survey of 67 economists and one of the questions is where yields on the 10-year Treasury note are headed for the next six months; and the answers have overwhelmingly been that yields are headed higher. This month’s survey was more than overwhelming, it was unanimous; 100% say yields will be up by the end of the year. The last time the survey had that result was in May 2012, when benchmark yields were well below 2%.
Of course the Federal Reserve has said they intend to keep their target for Fed Funds rate right at zero; that has been the policy since the aftermath of the 2008 meltdown and Janet Yellen has let the markets know that there is no reason to expect a change in the policy “for a considerable time” after it ends its QE bond buying program, which means no change until around the Spring of 2015; and even then, it will be dependent on data showing the economy has improved. So, what has unanimously convinced economists that yields are going higher, faster than the Fed has plotted? What is wrong with the current, low interest rate environment?
Fed Governor Jeremy Stein delivered a speech last month arguing that the Fed should withdraw stimulus or raise interest rates, even if that means allowing a higher-than-normal unemployment rate, all to prevent the growth of a bubble in the bond market. Stein points to three things: first, the rising level of private-sector debt as a percentage of the US economy; second, narrowing spreads between risk-free Treasuries and corporate bonds; and third, the growing proportion of corporate debt going to riskier companies, or junk bonds going to companies that have a greater likelihood of defaulting on their loans.
Private sector, non-financial debt has now grown to 55% of gross domestic product. Meanwhile, low rates may have distorted the proper evaluation of risk; the spread between Baa rated corporate debt and risk-free Treasuries has dropped. Those spreads were high during the financial crisis but have since dropped down below pre-crisis levels. Total corporate bond issuance hit $1.3 trillion last year, not just recovering but surpassing pre-crisis levels and a big chunk of that issuance, $336 billion, is going to junk bonds.
The housing market has seen some recovery, depending on location, but the latest data on new and existing sales shows a market that is slowing for now. The market for debt has been expanding much faster than seems reasonable, and might indicate an area of concern for the Fed. Or maybe the Fed is realizing that their policy just hasn’t worked and they are now sitting on a huge balance sheet that can’t be artificially propped up indefinitely.
Meanwhile, the former Fed Chairman Ben Bernanke was speaking today at the Economic Club of Toronto and he said the Fed could have done a better job communicating during the financial crisis. He said the public incorrectly believed the Fed’s emergency-lending programs benefited Wall Street over Main Street. Bernanke also said, “There will be a time coming soon when inflation will improve and when central banks will move to a more normal monetary-policy road.”
Of course, that might be part of the problem; the markets always expected the Fed to have their helicopter drops directly over Wall Street and then get back to more normal monetary policy. In other words, the Fed never truly committed to all out monetary stimulus, and the result was a prolonged economic slump as the velocity of money slowed to a crawl. Bernanke would like to say everything worked out for the better, but that wasn’t really the case.
Bernanke likes to think Fed policies helped Main Street as much as Wall Street, but we all know better and now we have facts to refute Bernanke. The New York Times reports the American middle class is no longer the most affluent in the world; we have lost that distinction even as the wealthiest Americans outpace their global peers and most American families are paying a steep price for high and rising income inequality.
After-tax middle-class incomes in Canada are now higher than in the United States. The poor in much of Europe earn more than poor Americans. The data on Europe is a bit tricky as some countries such as Portugal and Greece have seen income fall sharply in recent years, while other countries, such as Sweden and the Netherlands have narrowed the gap. One large European country where income has stagnated over the past 15 years is Germany, but even poor Germans have fared better than poor Americans.
The struggles of the poor in the United States are even starker than those of the middle class. A family at the 20th percentile of the income distribution in this country makes significantly less money than a similar family in Canada, Sweden, Norway, Finland or the Netherlands. Thirty-five years ago, the reverse was true. The top 5% of American income earners still top their global counterparts, and for those well-off families, the US still represents the world’s most prosperous economy. The US still holds the title of the world’s richest large country based upon per capita gross domestic income, but those numbers are averages which don’t capture the distribution of income.
The results of the 35 year study compiled by LIS recognize 3 major factors behind the weak income performance in the US. First, educational attainment in the US has risen far more slowly than in much of the industrialized world, and especially among younger workers. Literacy, numeracy, and technology skills of younger Americans have fallen well behind counterparts in Canada, Australia, Japan, and Scandinavia, and close to those in Italy and Spain.
Another factor is the distribution of income in the US; it has been growing faster for the top earners, but shrinking for the middle class and poor. Yet the American rich pay lower taxes than the rich in many other places, and the United States does not redistribute as much income to the poor as other countries do. As a result, inequality in disposable income is sharply higher in the United States than elsewhere.
So despite Bernanke’s assertions that the Fed helicopter drops benefitted all American, we know better. And we also know that there are some policy tools that haven’t been used that could change the situation. The best place to start would seem to be the financial industry, since this is the sector that benefitted most from Fed policy and has continued to act as a drain on the productive economy.
A new IMF analysis found the value of the implicit government insurance to backstop too big to fail banks, just the idea that the government would not allow the mega-banks that have been labeled systemically important would not be allowed to fail, that subsidy is pegged at $50 billion a year in the US, and about $300 billion a year in the Eurozone.
Maybe the Fed could even act like a regulator and break up the biggest banks, cut them into small pieces; and in that way, if there was a failure, it wouldn’t represent a threat to the broader economy; as long as that threat hangs over our heads, it is hard to accept Bernanke’s assurances that Fed policy benefits all equally.

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