Monthly Archives: October 2008

The folks over at RGE Monitor (Nouriel Roubini’s Blog) have compiled a list of those calling for a second fiscal stimulus plan.  For purposes of discussion here at Raw Finance, and in honor of the season, we will refer to the proposed new package as “Bride of Stimulus.”

If we take away nothing else from the discussion of another stimulus package, we should at least be alert to the fact that the numerous, alarming calls for such government intervention on top of everything else that has been done thus far means that the economy is much worse off than any of us have seen yet – 400-point gain on the Dow today and Warren Buffett’s urging everyone to buy notwithstanding.  However, before we get too euphoric and jump back in the markets with a big splash, consider the comments below with particular attention as to why another stimulus is necessary.

The pertinent part of the post at RGE Monitor is reprinted here for your convenience:

Bernanke: Economic weakness in next few quarters and risk of a protracted recession call for a well-timed, well-targeted, cost-effective fiscal stimulus w/o raising the structural fiscal deficit; given tight credit conditions the stimulus must improve credit access to consumers, home buyers, firms

Congress considering a ‘large’ (at least $150bn) fiscal stimulus after Nov 4 elections via extension of unemployment benefits beyond 39 weeks, food stamps and tax cuts for low-income groups, federal aid to state and local govts incl. medicaid funding to prevent spending/job cuts in public services or tax hike as economic downturn will worsen in Q408/Q109 led by contraction in consumer spending, rising state deficits and unemployment rate, weakening capex and exports and housing sector still far from recovery

Roubini: need traditional Keynesian spending of $300 bn to boost pvt consumption so that an unavoidable 2-yr recession doesn’t become a decade long stagnation by hitting Main Street given pvt sector is not spending and first stimulus was ineffective

Eichengreen: $700bn or 5% of GDP stimulus (income tax cuts and investment tax credits) given declining domestic demand, exports and interest rate approaching liquidity trap

Krugman: Govt spending will boost the economy overtime since the current downturn will last long and further rate cuts will be ineffective

Baker, Weisbrot, Appelbaum: Concerns over deficits during Great Depression prevented govt from boosting the economy; $300-400 bn (2-2.7% of GDP or amount of spending wiped out by decline in home prices) stimulus will avert deep downturn amid scarce capital, home wealth decline w/o raising interest rates or crowing out investment

Berry: inflation adjustment to Social Security, Obama’s middle-class tax cut, grants to states will be more effective than capital gains tax cuts, tax credit for hiring firms, infrastructure spending, capital gains tax cuts, McCain’s mortgage refinancing proposal

Merrill Lynch (not online): Stimulus will alleviate impact of unemployment on consumer spending, mortgage and other loan defaults; Goldman Sachs (not online): Stimulus won’t significantly impact growth outlook esp. in near-term if it is small in size

Stimulus with largest bang for buck: Food stamps, unemployment insurance, infrastructure spending, aid to states, payroll tax holiday, tax rebate

But transfers between govts involve delays, may be spent with a lag and mostly on less job creating services, used to pay down debt; also only up to 25% of infrastructure stimulus is usually spent in the 1st year, thereby limiting short-term impact; However, sustaining ongoing construction activity, repair and maintenance may keep jobs that would otherwise be lost during downturn

$168 billion stimulus passed in Feb-08 temporarily boosted consumer spending and retail sales in Q2 (mostly May) but were a small share of GDP  to stimulate the economy; less than 50% of rebates spent as consumers under financial pressure saved/paid off debt/spent on imports; Congress extended unemployment benefits in July by 13-26 weeks

Thoma: Govt spending better stimulus to economy in short-term than tax cuts; Infrastructure spending will create jobs when the economy is in recession and also in recovery (unlike temporary impact of tax rebates); Aid to states will contain housing downturn

Zezza et al: $450-600 bn stimulus over 3-4 quarters will temporarily boost the economy without creating inflationary pressure; FT: Need a time-efficient stimulus like tax rebates than infrastructure spending but might be constrained by fiscal deficit, public debt; pose risk of higher taxes, interest rates in future

Knzn: Fiscal stimulus can prevent interest rate from falling too low and consequent asset boom, capital outflows, dollar weakness, import inflation; Blinder: Time lag, institutional factors make fiscal policy less superior than monetary policy but is more effective if nominal rates are too low or if large boost to demand is required

Some of the comments above refer, directly and indirectly, to inflation and deflation.  In an upcoming post, I will discuss the nature and impact of both of these dangerous phenomena.

Finding a bottom in housing prices is crucial to an economic recovery, but there are still no signs that the decline in home prices has reached an end.

New home construction hit a record low in September, falling 6.3 percent to 817,000, which represented more than a 31 percent decline from one year earlier.  Applications for housing permits also declined 8 percent, forecasting weakness in home construction for the fourth quarter.  Barclays Capital economist Michelle Meyer predicted that housing starts will decline another 5 to 10 percent through the beginning of 2009, according to Marketwatch.  “This will bring the level of housing starts to a new post-war low,” said Meyer.

The difficult housing market and credit crisis have dragged home builders’ confidence to a new low.  The index of builder sentiment prepared jointly by the National Association of Home Builders (NAHB) and Wells Fargo & Co. dropped to 14 in October, down from 17 in September, and significantly lower than its high of 72 in June 2005.  NAHB chief economist David Seiders noted that the index “reflects builder assessments of the recent events on Wall Street, the rapid deterioration in job markets and the corresponding weakness in consumer confidence,” according to HousingWire.com.  “The impacts of the record-breaking housing contraction have spilled over to other key sectors of the economy and weighed heavily on financial markets, and stabilizing housing is now the best chance we have to limit the severity of recession,” said Seiders.

Rising mortgage rates only add to the poor environment for housing, making mortgages, for those can obtain them, more expensive.   The average rate for a 30-year fixed rate mortgage rose to 6.46% this week, the highest in eight weeks, from 5.94% last week, according to Freddie Mac (FRE). The higher rates reflect a rise in Treasury bond yields, which has occurred as bond traders expect the government will be forced to borrow more heavily.  In other words, the government will need to sell more bonds driving the prices of those bonds lower and forcing yields higher.  Bond prices and yields move in opposite directions.  Residential mortgage rates are generally  tied to Treasury yields.

The dramatic drop in housing prices has not let up.  According to the S&P/Case-Shiller Home Price Indicies reported for July 2008, the 10-City Composite saw a record annual decline of 17.5 percent, and the 20-City Composite a record decline of 16.3 percent.  From their peak readings in June/July 2006, the two Composites are down 21.1 percent and 19.5 percent, respectively.  Las Vegas (-29.9 percent), Phoenix (-29.3 percent) and Miami (-28.2 percent) continue to be among the hardest hit areas in terms of annual home price declines.  For more detail, please click on this link to review an article at Marketwatch.com.

Although there have been and will continue to be many prognosticators arguing that the economy is about to recover because energy and commodities prices have dropped, the stock market is oversold, the frozen credit markets are thawing, there is a presidential election coming, the media has overstated the problems, etc…, those of us who rely on data to tell the story will be watching the housing market.  There can be no economic recovery until the housing market stabilizes, and that means prices stop falling (they don’t necessarily have to return to prior highs), housing construction and starts stem their declines, and home builder confidence begins rising.