Billy Bernanke

Saint Bill of the grotto of the greenback has been beatified last week. That he performed the canonization on his own in Jackson Hole, Wyoming surrounded by some of the greatest scenery ever created gave it a certain holy gravitas. Herewith, the words of the rites.

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”

Ben Bernanke, Federal Reserve Chairman

The market cheered, the holders of short positions cringed, and the sun shone a little brighter. Wait, there must be a mistake. The keeper of the trillions said those words in 2007. Hmmm.....could it be he is plagiarizing himself. Considering those 2007 sentiments have to be among the least prescient ever uttered by a Fed Chairman maybe we should defer our accolades just a little longer.

I hope like everyone that he is right this time. But maybe first a prayer to Saint Anthony of Padua, the patron saint of lost items, soon to be declared patron saint of 401k's.

The consensus of economists now expect no recession next year. Unfortunately, the consensus has never accurately predicted a recession. So much for that comfort.

Given all the euphoria of last week, I have a feeling the animal spirits are nearing a neutering. It is always dangerous to reach a conclusion in the waning days of summer when junior traders practice and seasoned investors are on Martha's Vineyard or in the Hamptons, but things feel "toppy" and fundamentals no longer support broad valuations as they did in March.

John Barnyak

Watch This!

Any testosterone enhanced male knows that, "watch this!" are often the last words spoken before a trip to the emergency room. Last week central bankers across the globe were declaring the recession in retreat with the chest thumping certainty reminiscent of the last time I ever stood on a diving board. (yes it ended badly).

Level of consumer spending that gave us giddy investment returns is not likely to return anytime soon, if in our lifetimes. So we should expect sub par growth as personal balance sheets are repaired over the coming years.

The talking head debate now is about the shape of the recovery. "W"? "V"? or my favorite recent description "square root symbol", which is a quick rebound and then a long period of flat activity. One could argue that we are already in the long flat period as the market has gone nowhere (if a rollercoaster can be said to go nowhere) for ten years. Throwing up your hands and squealing with delight and just plain throwing up notwithstanding.

Historically, secular markets, those acting on major underlying economics last a generation. I would argue we are about half way through the current secular bear market and another decade of stumbling is very likely. Japan's Nikkei average last saw its historical high in 1990 at which point wild exuberance and real estate speculation brought market fun to an end. At the time Japan's broad market average was nearing 40,000. Today it is flirting with 10,000 after twenty years. Closer to home, from 1964 to 1981, the Dow Industrials rose an eye popping one point. Seventeen years with no return, excluding dividend yield.

Relative valuations matter. Alternative returns in other assets matter. We live in a different world of volatility encouraged by crazed derivative activity but the long term reality is the same. We remain in a time when giving up opportunity will have less negative impact than giving up capital.

This is an extraordinarily warped market as government intervention plays the tune. The fundamentals come out of Washington now, and as Keynes once said, "the market can remain irrational, longer than I can remain solvent."

John Barnyak

Eeek! Economics!

The biggest impediment to being right for an economist is the lack of fixation on time. Gary Shilling, Noriel Roubini and Nasem Taleb are all prescient economists who predicted the current deflation.....for years. In other words they were wrong until they were right. That is one of the advantages of being an academic. One can work in relative obscurity apart from occasional snickers during presentations of papers for years until reality turns to agree. Then you are a rock star....until you're not.

My economic based view has been tested the past several months. While being quite confident that March represented a buying opportunity, I have been much less assured since mid year while the market keeps moving higher. While the massive asset price lifting power of billions of public dollars has been demonstrated clearly the hangover that policy will produce has been largely ignored.

What has not changed is the massively important credit and debt aspects of the global economy and the U.S. economy specifically. The US debt to GDP ratio continues to rise with the public debt portion taking over an additional and substantial portion of total debt. Until debt declines we
are simply adding gasoline to the fire and eventually we will burn.

Those who see green shoots assume a typical "V" shaped recovery from a production/consumption recession. This is a credit and debt induced collapse and adding additional debt will not solve the problem. The public injection of capital allowing the banking system to continue to not recognize its insolvency and allow a market clearing event to take place rests on a misguided combination of fear and hope.

Schumpeter's creative destruction has been thwarted allowing zombie institutions to ultimately keep private investment to in check while ironically encouraging, once again, riskier speculation with the knowledge that public money would be made available to bail out failure.

If there is any rationale to the current public policy it is to buy time, keep the population placated and HOPE that a demographic tailwind rights the boat.

The US economy has been +70% driven by consumer spending and negative savings rates over the past 20 years. The is reasonable behaviour that will rekindle that irrationality in the near future.

The baby boom generation has seen its retirement savings decimated. Credit is no longer easily available. Unemployment appears to be structurally elevated for the foreseeable future.

Let's look at the green shoots. Housing. The good news is that there is some activity in housing. The vast majority of that activity is in foreclosure sales. That is in and of itself positive. It clears inventory, and inventory remains very high. Like the Cash for Clunkers program the government tax credit program may pull demand forward into 2009 from 2010.
This is another example of a buying time policy. Which in a normal recession would work well as spending returned. The housing stats reported last week are strong only if listening to spinmeisters. A suspicious increase in Northeast Condo sales was the only data that turned the numbers positive. Single family homes were still weaker.

The growth this past quarter seem largely limited to inventory rebuilding and cost cutting. Again, both positives for economic recovery, but with unemployment high and credit limited is it sustainable? Retail analysts continue to see very low store traffic and increasing pressure on rents by storeowners to landlords. Conversely real estate owners, i.e. landlords are facing severe financing problems of their own. Commercial real estate loans are the 1000 pound gorilla unless we begin to see a re-emergent consumer.

Think of a number and double it

The below paper written on the mortgage, housing and credit crisis gives one continuing pause. It is why it is very difficult to accept time horizons longer than our experience and why we are emotionally disposed to see recovery around each corner.


T2 July 3

Green Shoot Fatigue

It's tough fighting against the tide. For several months the popular (i.e. loudest) media spoke of the signs of the rebound. Truthfully, having a more defensive portfolio position started to look a little spooky. The chief strategist for Schwab called being out of the market now, "a career killer." Yeah, I grimaced as she seemed to be looking directly at me.

Anyone who says they know exactly what happens next is either lying or too old to be considered anything but suffering dementia. We have not seen this set of circumstances in our lifetime. It is not a recession in the usual sense of the word. Since World War II, the time period for most historical comparison there has never been a credit based recession. They have been manufacturing recessions for which inventory adjustment and interest rate policy would soon put the ship of state back on course.

This is driven by a lack of available credit. As I see some perfectly reasonably qualified individuals be rejected time and time again for credit one has to consider looking more deeply at the reasons. Based on the anecdotal information it would seem less a question of risk analysis by the banks an inability to lend within the regulatory capital requirements of the lenders.

Anticipation of commercial loan impairment is the fly in the ointment. The $3.5 trillion commercial real estate market could dwarf the residential real estate problems of the recent past. In the next year, about $700 billion will need to be refinanced or significant bankruptcies of shopping centers, hotels and other real estate holdings loom with the subsequent losses and effect on banks.

The argument for end of the recession in a traditional inventory readjustment shows signs of approaching---if only that were the problem. In a cyclical economic environment, we are near a bottom. Currently North American automobile sales are running at a rate of 7.0 million units per year. Production is at a 3.9 million units per year pace. Obviously production of automobiles will have to increase simply to slow the destocking process. The knock on effect to the manufacturing economy should bring some benefit.

The sea anchor to this positive cyclical process is credit system impairment. As long as severe credit headwinds exist, the traditional recession ebb and flow will not play out as we are used to. Despite the popular refusal to say it, we are in an economic depression not a mere recession. It is not the severity that defines this, it is the process of deflationary pressure unseen since the 1930's.

John Barnyak







Our view of CRE exposure has not changed at all, namely that the loss rates in that asset class will be multiples of the record loss rates on residential or RES exposures. Why on earth is the Obama Administration still listening to Tim Geithner and Ben Bernanke on the latest PPIP proposal to buy CMBS at current prices when the cash flows are falling every month? If you look at the yields on bank CRE and then extrapolate to the securitization market where much of the CRE exposure resides, there is no way that the pricing assumptions in the PPIP make sense. Guess we have to wait for T-Day for Obama & Co to wake up and smell the bird burning.

One of the questions I ask my clients is this: How do you think prices for exisiting homes and commercial both will react when the RES and CRE properties now in foreclosure work their way through the courts and come popping out onto the secondary market around Thanksgiving? My firm entered a JV with a very experienced asset management and disposal group earlier this year. The view from the disposal channel is ugly.

Excerpt of article below:

Commercial Real Estate Is a ‘Time Bomb,’ Maloney Says (Update2)

(Adds comments on rebound in third, fifth paragraphs.)

By Dawn Kopecki

July 9 (Bloomberg) — The $3.5 trillion commercial real estate market is a ticking ”time bomb” that may lead to a second wave of losses at large U.S. banks, congressional Joint Economic Committee Chairwoman Carolyn Maloney said.

About $700 billion in commercial mortgages will need to be refinanced before the end of 2010 and ”doing nothing is not an option,” Maloney, a New York Democrat, said at a committee hearing today. This ”looming crisis” may lead to significant losses for banks, force shopping center and hotel owners into bankruptcy, and impede economic recovery, she said.

The response by banks to this ”growing threat has been slow and inadequate,” said James Helsel, a partner at RSR Realtors in Harrisburg, Pennsylvania, and treasurer for the National Association of Realtors. ”The lack of liquidity and banks’ reluctance to extend lending are also becoming apparent in the increasing level of delinquent properties.”

Click the Boob Tube

I've long ago dismissed the financial talking heads of CNBC and other quasi financial programs as tripe. Now Barry Ritholz one of my favorite analysts has put together a list of shortcomings which all could take to heart.

I personally think it's way to late to fix it and the damage is done. By the time anything serious would be done, technology will probably sending financial news direct to our cerebral cortex.

Barry's List


1. Stop Yelling. Stop interrupting. Stop Talking Over Each Other: This is not Jerry Springer, its serious business. People’s retirement and investments are at stake. Please treat it that way.

2. Bring us People We Don’t Have Access to. What various FinTV channels do really well is when they bring us long, thoughtful interviews with the likes of Warren Buffett, William Ackman, David Einhorn, and others. People we wouldn’t ordinarily have access to. Example: This morning, CNBC had on James Rickard. More of this please.

3. S - L - O - W D - O - W - N

4. Risk: All traders must appreciate the potential downside of trades. So too, must FinTV. Explain stop losses. Understand Risk/Reward. Recognize there are periods when Buy & Hold is a jumbo loser.

5. Lose the Octobox. Fire whoever came up with the Decabox. ‘Nuff said.

6. Separate the Signal from the Noise. Understand that most of the day-to-day action is simply noise. Look at a long term chart, you can barely see 1987 or 9/11. If those major events get lost in the long term trend, what does the intraday jags, kinks and reversals mean? Very little. Recognize that not every data release, slice of news, or rumor is at all significant. Stop treating them as if they were.

7. Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

8. Accountability is important: I am astounded at some of the money losing hacks that are various shows again and again. These are the “articulate incompetents” to use Bennett Goodspeed’s phrase. Why not keep track of the records of guests — and let the viewers know how their past few calls have been. Are they Perma-bulls or bears? Are their stock picks awful? Are they reliable money makers? If not, let us know. (Of course, the better question is, if not, why even have them on?)

9. Bring Back Louis Rukeyser: Not the man, but rather, his style. Wall $treet Week — Rukeyser hosted it from 1970 to 2005 — was plain-spoken, thoughtful and accessible. Quiet, contemplative, discussions, with intelligent market participants, revealing helpful information. The investing public would appreciate something of that sort — again.

10. Sound FX: What is with all the bizarre sound effects every time a screen changes? Its financial news, not a video game. Kill ‘em.

11. Embed your video (on your own website or YouTube) instead of using WMP. At long last, thank you.

12. Investigative Pieces: David Faber seems to have a monopoly on deep, long thoughtful analyses. Be they on Wal-Mart, the credit crisis, whatever, his long format work is a highlight of CNBC. More of these, please.

13. Most stock picks are losers. That’s normal, but the audience does not realize this. A big part of the challenge is informing the viewer that finding the biog winners is a low probability, high outcome event. As in a baseball, a 350 hitter is a star. Explain this to your audience.

14. Stop the Bull/Bear Debate: This is a vast over-simplification of the market, and often does not serve the audience well. There are nuances and variables that get lost when you reduce everything to black and white.

15. Partisanship: Leave your personal politics at home. Viewers don’t care what most of you think.

16. Respect the Audience: We are adults. Treat us that way.

Mortgage Chaos

The government is buying Fannie Mae and Freddie Mac debt to force down yields and stabilize home prices. Could it reach still lower? 3.50%? Perhaps. But if it does it will likely be of extremely short duration as suddenly every mortgage in America will benefit from refinancing. If you haven't done your homework you will likely miss it. So do your homework, be prudent and conservative. If you plan in remaining in your home for more than a few years, this could be a windfall moment when you look back.

That was my view on April 10th and I am sticking with it. Particularly since it turned out to be right. Less than 1/10% from the bottom, I think we won't be seeing those rates again in our lifetimes. C'est la vie.

Unless the fed begins to increase purchase of mortgage backed securities massively that ship has sailed. Mortgage originators have frozen all new applications until they work through the backlog of committed but not closed loans on their books. Below is a letter being sent out by one mortgage originator.




John Barnyak
President
www.stonehouseasset.com