Archive for the Economics Category

Housing Again (October 8, 2007)

Posted in Economics, Housing on October 8, 2007 by e-commentary.org

A house is a bundle of 1) sticks, 2) dirt, and 3) money/interest obligation.  The Truth In Lending Act requires the lender to provide basic information about the terms of a loan.  A $100,000 house subject to a 30 year mortgage at 10 percent requires the borrower to pay a total of over $316,000 during the life of the loan.  Thus, more than 2/3rds of the money ($216,000) pays for the money; less than 1/3rd ($100,000) pays for the sticks and the dirt.

When interest rate drops to 5 percent, the borrower pays a total of over $192,000 during the life of the 30 year loan.  Thus, less than 1/2 of the money ($92,000) pays for the money; more than 1/2 ($100,000) pays for the sticks and the dirt.

Reducing the interest rate reduces the total purchase price of the sticks, dirt and money/interest obligation needed to acquire the house.  When Greenspan reduced the Federal Funds Rates in 2001 and mortgage interest rates dropped, the price of the money/interest obligation dropped correspondingly.  Those who had the sticks and the dirt at the time were in the money.  Others were able to acquire a house (sticks, dirt, and money/interest obligation), for at least a few years.  Those who obtained a house in the early days of the run-up with a fixed rate mortgage of 5 to 6 percent have a “bird’s nest on the ground” if they keep a cool head.

The interest rate in a typical adjustable rate mortgage (ARM) adjusts upward in the next months and years even if other interest rates do not rise.  When the interest rate rises to 15 percent, the borrower pays a total of over $455,198 during the life of the 30 year loan.  Thus, almost 4/5ths of the money ($355,198) pays for the money; little more than 1/5th ($100,000) pays for the sticks and the dirt.

Many of the ARMs are more difficult to refinance because they include “pre-payment penalties” if the notes are paid early.  A borrower could pay off all but the last month’s obligation and then pay off the last month according to the terms of the note.  Some judges might allow it; some would not.  The pre-payment penalty provisions should be stricken because they are 1) against public policy, 2) unconscionable, 3) fraudulently obtained, 4) buried in adhesion contracts, and/or 5) _________.  There will still be an economic impact because so many investors were fooled and/or fooled themselves into believing that they would receive the substantial returns from the ARMs and other bogus instruments.

The “wealth effect” now has been supplanted by the “poverty effect.”  The “multiplier effect” is being supplanted by the “divider effect.”  And there is not a whole lot that the Fed can do to improve our lot.

However, Al Greenspan recently announced unambiguously that the credit crunch is behind us.  In the near future, no one will even remember this latest pronouncement and hold him to it.

Bumper sticker of the week:

“Time is money, money is time, that is all ye know on earth, and all ye need to know.”    John Maynard Keats

The Fed: Doin’ What It Can? (September 24, 2007)

Posted in Economics, Federal Reserve, Housing on September 24, 2007 by e-commentary.org

Reducing the FFR by .50 and the discount rate by .50 may work.  May not.  The Fed is mainlining more junk to the junkies who marketed and continue to market junk.  “Easy” credit in recent years produced “hard” credit this year.  Providing more “easy” credit may soften the current credit crisis for a few weeks or even months.  The availability of ARMs (adjustable rate mortgages) in recent years and other dubious instruments allowed individuals to acquire and occupy a house and use it as an ATM (automatic teller machine).  With a short term decline in interest rates, a few ARMs may not reset upwards as quickly.  The fix is only effective in the short term.  The underlying problems are unchanged.

In a rising real estate market, prices often accelerate quickly because buyers try to outbid each other.  In a declining market, prices do not fall quite as quickly because many sellers refuse to outbid each.  Some homeoccupiers will not lower a sales price lower than 1) the price they paid for the structure, and/or 2) the amount due on the loan.  Some borrowers fear paying all of the deficiency that would become due immediately if they sold for less than the remaining obligation, so they hold on for a few more months.  This “stubborn irrationality” offends economists, but they live with it.  This propensity to repudiate the market in the short term is ineffective in the intermediate run, although it slows what otherwise could be a spiraling decline in prices.

The financial markets, however, could enter a declining spiral with little notice.  The financial markets are benefiting from the recent flood of money.  However, even those who want to appear to believe in the Economy so that others stay in the game and hold up the market will get spooked.  Those who invest other people’s money (OPM) are not particularly concerned because they benefit as prices gyrate; those who are investing their own money do not want to be the last one to sell and end up the last chump standing.  The Economy is best served by a soft decline rather than one that accelerates downward uncontrollably.  In light of the fundamentals (realistic profit predictions; realistic price/earnings ratios for the respective industries), a Dow (Murdoch ?) of 12,000 is more realistic.  However, the “exuberant irrationality” that underpins the financial markets could drive the Dow (Murdoch ?) down even lower in a panic.

Bumper sticker of the week:

Do Anything.  Something.

More Exuberant Irrationality (August 20, 2007)

Posted in Economics, Federal Reserve on August 20, 2007 by e-commentary.org

Last Friday, the Federal Reserve lowered the “Discount Rate” it charges commercial banks for the money it loans directly to them by a substantial half a percentage point.  The Fed also suggested that it might take more action to cushion the economy from tightening credit.  The “Discount Rate” is not the same as the Federal Funds Rate (FFR) which is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.  The Discount Rate is the rate charged by the Fed to a bank; the FFR is the rate charged by one bank to another.  Banks typically do not borrow from the Fed, so the Discount Rate does not usually impact the economy as substantially as the FFR.

As a professor, the Chairman of the Fed, Ben Bernanke, studied the impact of illiquidity on the Great Depression.  He also has stated that the Fed should be concerned primarily about “price stability” or in popular parlance should set rates to avoid inflation.

Junkies crave junk.  The purveyors of junk bonds/stocks (collateralized mortgage loan obligations and the like) are seeking a bail out from the Fed.  Bernanke’s concern should be the impact on the economy not on those who were and are part of the problem.  The concern should be with Main Street not Wall Street.

The meeting of the Federal Reserve Open Market Committee (FOMC) on September 18 may be the most important gathering since Bernanke began his term.  The underlying economy is unsound.  [See the e-ssay dated January 30, 2006 entitled “Greenspan’s Legacy – Apres moi, Le Meltdown”].  The dilemma is that there is both stagnation [see the e-ssay dated August 7, 2006 entitled “The Fed: Deal With ‘Stag’; Deal with ‘flation’?”] and inflation [see the e-ssay dated July 16 entitled “Back Door Inflation”].  Reducing interest rates will encourage inflation and promote more debt.  Raising interest rates will both contain inflation and attract private funds.  Tough call.

Bumper sticker of the week:

I want to be irrationally exuberant again

The Dow Jones (the Murdoch ?) Hits 14 K In A Hollow Economy (July 23, 2007)

Posted in Debt/Deficits, Economics, Housing on July 23, 2007 by e-commentary.org

The Dow Jones Industrial Average (the Murdoch Average?) exceeded 14,000 last week.  At some time it will retreat because it has to retreat.  Why is it so high?  First, there are a small number of individuals who have too much money and few productive outlets.  That money has no ready home now that the last domestic American industry–the real estate industrial complex–has run its course.  However, no one, Republican or Democrat, will get elected by arguing that too much money is in private hands and not enough in government hands to pay for the common weal and reduce purposefully the nearly 9 Trillion dollar  Debt.  Government borrowing is “crowding out” funds for private sector projects.

In addition, the rampant easy credit has fueled a hollow and unsustainable expansion.  The economy since 2002 was driven and is being driven by spending that mortgages the future of the country and its citizens.  Too many Americans view their residence as an asset.  A residence may be an asset if there is some equity, yet it is not a productive asset.  Too many Americans view their residence as an ATM (automatic teller machine).  The “wealth effect” experienced by homeowners who see their home prices rise is giving way to a more realistic “poverty effect.”  The purchasers with “sub-prime loans” drove up the price of all homes and made everyone feel wealthy and thus more inclined to spend.  When some of these purchasers are unable to pay and foreclosures result, the price of all homes will decline.  Even homeowners without dubious mortgages are negatively impacted if they have used their homes as an ATM to purchase other consumer goods.  When the value of a home declines below the remaining arrears on a mortgage, some homeowners may question how long they are willing to sustain the hemorrhaging.  [See the e-ssay dated February 7, 2005 entitled “The Microeconomics of Suburban Subsistence”].

The myopic emphasis in business on the next quarter is not surprising.  Bonuses are paid for results in the short term not for long run performance.  Although some businesses are reporting profits, the consumer spending that is driving the economy cannot continue.  Many companies are selling to foreign consumers with more disposable income which admittedly diversifies the sources of revenue and offsets the decline in spending in America.  Americans are in debt their tonsils.  They do not save.  Soon there will be few funds available to borrow and few Americans willing and able to loan them.

Bumper sticker of the week:

It is only a matter of time

Back Door Inflation (July 16, 2007)

Posted in Economics, Inflation on July 16, 2007 by e-commentary.org

A half gallon of ice cream is now 1.75 quarts (or 7/16ths of a gallon).  A six pack of avocados is now “Contents: 5.”  However, the prices have not gone down correspondingly.  The “2 by 4” piece of dimensional lumber has not sported 2 inch by 4 inch dimensions for decades, but they are not called 1.5s by 3.5s.  The venerable 12 ounce beer is now 11 or 10.5 ounces (or some fraction of a liter) in some countries.  Imagine the reaction when Joseph Six Pack enters a store and discovers that a six-pack of beer contains only five 11 ounce beers.  There likely will continue to be six or four containers of some size because of design considerations.  The ad types will give it some manly spin.  However, the Interstate Commerce Clause or some penumbral provision in the United States Constitution may prohibit the sale of anything less than a 12 ounce beer in anything smaller than a pack of six.  Perhaps Bobby Bork will bring the law suit.

The government’s figures on inflation do not reflect things on the ground.  Or at the gas pump.  Or in the supermarket.  The government’s “core inflation” figure does not include energy or food prices.  The “core inflation” figure is only insightful if the populace does not drive or eat.  The public policy encouraging ethanol production, which requires large quantities of corn to produce, favors energy over food.  Food prices rise even more.  The trade-off may be desirable, yet it still comes at a cost.  At core, prices are rising higher and faster than the government statistics reflect.

The price of a “Support The Troops” decal is also going up.  The decals may get smaller.

Bumper sticker of the week:

Whip Inflation How?

When the Bubbles Burst (December 4, 2006)

Posted in Economics, Housing, Taxation on December 4, 2006 by e-commentary.org

When the technology bubble burst in March, 2000:

     1.     Individual investors who had invested post-tax or pre-tax (SEP; IRA; 401(k), etc.) funds often were left with marginal or worthless investments;
     2.     The invested funds were transferred to those individuals, usually Americans, who were clever or tenacious enough to sponsor an ipo (“initial public offering” of stock) and offer their “blue sky” ideas to the public;
     3.     They spent some of the money on yachts, polo saddles and large vacation homes and likely on other productive investments that spurred economic growth;
     4.     A few of the ideas endured, gained traction and contribute to growth and productivity today;
     5.     The taxes on the economic expansion resulted in more bountiful federal and state treasuries for a time;
     6.     The investors who lost money soldiered on and consciously or unknowingly delayed some purchases and/or other investments and deferred their retirements by a few years; and 
     7.     Life went on.

Direct tax impact:  The federal and state governments taxed the earnings each year and added substantially to their coffers.  The decline after March, 2000 negatively impacted federal and state revenue.  The local governments typically do not tax earnings; a few may have benefited from revenue sharing provided by the state.  Some taxpayers are able to take capital losses of up to $3000 a year on their federal returns which impacts somewhat on federal tax revenue.

As the real estate bubble deflates and bursts today:

     1.     The last domestic American industry (the real estate industrial complex) which was jump-started by the Fed (Federal Reserve) in 2001 ran its course by 2006 [See the e-ssay dated April 25, 2005];
     2.     Many houseoccupiers are saddled with investments they are not be able to afford particularly those who purchased at the peak with interest-only or adjustable rate mortgages (ARMs) and those who used the houses as an ATM (automatic teller machine) to finance other purchases [See the e-ssay dated February 7, 2005];
     3.     The size of the average house may be too large for the typical family, unless the house is occupied by two or three generations of a family [See the e-ssay dated April 24, 2006];
     4.     The house likely is not as energy-efficient as economically possible and desirable which is impacting and will impact the economy/environment for decades [See the e-ssays dated May 8 and June 19, 2006];
     5.     The structures are in the nature of durable consumer goods not productive investments that provide jobs and growth; 
     6.     The financiers, both domestic and foreign, likely will confront many foreclosures and suffer substantial uninsured losses;
     7.     The resulting dislocations and forced moves will weaken families and undermine community ties and involvement (PTAs, Little Leagues, etc.);
     8.     The Bankruptcy Code is now a more expensive and inaccessible safety valve [See the e-ssays dated March 21, 2005 and October 16, 2006];
     9.     Consumer spending remains the double-edged sword because it drives current economic growth but also increases personal debt owed to foreign nations [See the e-ssay dated January 17, 2005];   
     10.     The taxes on the appreciation in the value of real property filled local and some state treasuries while negatively impacting federal tax revenue slightly; 
     11.     The federal deficit and debt are growing exponentially while the unfavorable trade deficit continues to expand;
     12.     There is no other major domestic industry to stimulate; and 
     13.     Life will go on, because it goes on; however, it will go on very differently.

Direct tax impact:  The federal government does not tax real property, but it does allow homeowners to write-off local and state property taxes which may cost the federal government as much as 20 billion dollars a year.  State governments typically do not tax real property.  Local governments typically tax real property and received a tremendous influx of funds from the inventory of more expensive real property within their jurisdictions.  However, as the value of the houses declines, the local tax revenue will decline.  

The “Marketplace” radio program produced by American Public Media and available on National Public Radio presented a program “Local budgets rise and fall with housing” on November 29.  The program notes that the public desires roads without pot holes and safe streets without additional tax increases.  “This dilemma is motivating some like [Scott] Peterson [with the National Association of State Budget Officers] to look at how governments are funded: cities and counties mostly count on property taxes.  States, on the other hand, tend to rely on sales and income taxes.  And it was just a couple years ago that states battled horrible budget crises as those revenues plummeted after 9/11.  Peterson believes it shouldn’t be boom for one and bust for another.  So he’s taking a tax proposal to Indiana’s state legislature that would allow local governments to also charge sales or income taxes if they cut back on property taxes.  The state, in turn, would get a share of cities’ property taxes.  These are big new ideas.” 

Bumper stickers of the week:
 
If it can’t go on forever, it won’t.

If it sounds too good to be true, it is.

The Fed: Deal with “Stag”; Deal with “Flation”? (August 7, 2006)

Posted in Economics, Federal Reserve on August 7, 2006 by e-commentary.org

The economy has been heading toward stagflation for over a year.  The trade deficit reflects the fact that America does not make anything other than houses that are consumed domestically.  Inflation is taking off with a vengeance.  Calculating the core price index without accounting for food and energy prices assumes that citizens do not eat or travel or heat and air condition their homes and businesses.  The rising cost of energy will act synergistically to drive up the cost of food.

The Fed meets tomorrow.  The Fed must not raise the Federal Funds Rate (FFR) because it would exacerbate the stagnation.  However, the Fed must raise the FFR to dampen the current and impending inflation.  In his academic writings, the Fed Chairman Ben Bernanke refers often to “price stability” as the primary goal of the Fed.  Raise the rate .25 percent?  Or defer to those on Wall Street who are more concerned about the slowing economy and leave the rate unchanged?  Inflation is the graver threat.  Raising the rate .25 percent is painful but necessary.

Minimum Wage and Maximum Earners (July 31, 2006)

Posted in Economics, Estate Tax, Politics on July 31, 2006 by e-commentary.org

Raising the minimum wage to provide a livable wage is virtuous.  However, the economic evidence is almost irrefutable that a rise in the minimum wage leads to a reduction in employment.  The head says no.  The heart says yes.  Support the higher wage.

The Democrats are critical of the effort to raise the amount exempt from the estate tax.  However, raising the exemption to 10 million per couple would protect the assets of many hard-working members of the Greatest Generation.  [See the April 18, 2005 e-ssay entitled “Death and Taxes: $10 M and 33 1/3 %.”]  The more substantial figures suggested in the pending legislation are excessive.  Some who seek to eliminate the estate tax altogether may view this change as a start.  However, if reasonable legislation is adopted, the momentum to eliminate the estate tax altogether may dissipate.

Congress Is Out Of Control (June 26, 2006)

Posted in Congress, Economics on June 26, 2006 by e-commentary.org

Congress refuses to address the most pressing problems today–a bloated and growing federal budget and the Iraqi Quagmire–and instead is trying to find more ways for the government to interfere in our lives.  Social Security, Medicare and Medicaid exceed 40 percent of federal spending and will increase with each birthday of the Baby Boomers.  Another looming problem–unfunded or inadequately funded pensions–will require increased funding of the Pension Benefit Guaranty Corporation or another government agency with a similar mission in the near future.  The Iraqi Quagmire has now slogged on longer that America’s involvement in World War II.  Continued involvement does nothing to protect American interests.  The National Guards of the states need to be redeployed to their home bases to assist in protecting citizens from the ravages of hurricanes, tornados, wild fires, earthquakes and rain damage.  These issues do not trouble Congress.  Rather, Congress wants to define marriage, yet marriage must be defined by consenting adults.  Congress wants to ban flag burning, yet free speech is an individual right.  The Fall elections offer a chance to adjust priorities. 

McMansions and the (Extended) Family of Tomorrow (April 24, 2006)

Posted in Economics, Housing, Society on April 24, 2006 by e-commentary.org

McMansions are littering the landscape.  Monoliths that consume space and resources.  Some McStructures are not even finished on the inside because the goal is to loom large when viewed from the outside.  “Potemkin Estates.”  The larger structures demand increasingly expensive hvac systems (heating ventilation and air conditioning systems).      

Kids are returning home, with and without jobs, and flopping in their former bedroom or on the couch in the basement.  They are “failing to launch.”  The kids can’t afford a home even if they can find a job.  Some parents charge rent or require contributions for food and utilities.  This relationship may develop into a permanent and positive lifestyle.  Extended families may pool their talents and grow old together in one mega-structure.  One sibling may be a single parent; the others can help raise the kids/grandkids.  One sibling may go and come at unusual times to juggle two part-time jobs in the craven new economy.  There will be no retirement, no social security, and no long-term health care, so the kids will be expected to take care of their parents in this assisted-living situation.  The home theater room will be remodeled into another bedroom.  Situation comedies (tragedies?) on the tv relocated to its traditional home in the den will chronicle the exploits of the new mega-nuclear family.  The McMansion could bring families together in unexpected ways.