allaboutthebenjamins

Business as Usual

2008-09-21T20:54:00.000-07:00

Being that the last few months have been financially challenging for me, I'm going to use the Federal Reserve's new relaxed lending rules to get a low-interest loan. I wasn't sure if I had acceptable collateral, but standards have gotten rather loose. Thus, I was able to come up with some collateral that passed the (new) muster:

Okay, so standards haven't declined that far. Yet. However, the Powers That Be seem to be willing to lower standards as far as is necessary to sweep the whole credit crisis under the rug--to say, in essence, we weren't really playing for keepsies, that these millions of loans were just pretend mortgages.

The part of the bailout plan that really stinks is that Joe and Jane Taxpayer are going to get snookered twice. First, we're on the hook for the umpteen billion dollars (700, and if the politicians are saying 700 it's at least 850 and quite possibly over a trillion). What we don't pay back directly in the form of higher taxes, we'll pay in the form of inflation and eroded paychecks. But it doesn't end there. Just because the banks get to settle their books with virtual Monopoly money doesn't mean the banks will in turn allow us plebs to pay our mortgages with phony paper. Certainly not! We have to have standards and integrity, after all.

So while the banks get bailed out, homeowners in over their heads get foreclosure notices, evictions, and sacked credit scores for seven years (ten if they are unfortunate enough to have to file bankruptcy, and the same politicians that want to engineer this massive bailout made that more difficult a couple years ago).

There is, however, a silver lining for homeowners...at least some homeowners.

What the bailout essentially has done is to remove moral hazard from the mortgage loan underwriting business. When a bank places "bets" on the table by loaning consumers money, historically the banks had an incentive to be cautious. While frustrating for some consumers (especially those with marginal credit), this caution helped to limit the amount of money on the "table," which in turn kept housing prices in check.

Along about the year 1999 or so, that train left the track, banks began loosening standards, and more and more money sluiced into the housing market. Prices began their epic, irruptive rise to where they were last year. Trouble is, a lot of the money placed on the table by the banks was on bad numbers: people who couldn't pay it back.

What was supposed to happen next--what was in fact beginning to happen--is that the man overseeing the table (the market) reaches over with his croupier stick and pulls all the losing chips off the table. Those players whose resources are exhausted leave the table (go bankrupt), and the rest who placed wild bets...well, they learn a serious lesson about prudence and likely don't repeat their mistakes again. Those who placed rational, responsible bets profit, and become stronger and able to place more such bets in the future. With less money on the table, housing prices fall--which is what was happening.

But many of the players have a big, beefy, Nicky Santoro-type friend named Uncle Sam, and they get him to muscle the casino manager to not collect. So the players get to keep all their chips after all, even though by all rights many should have left the table poorer or downright broke.

What do you suppose happens after that? Anyone with even an associate's degree in human nature can tell you: the players are going to just throw out even more chips than before. Why shouldn't they? When it's "heads I win, tails the house loses," why not just throw those chips out there? The element of risk has been removed, so anything goes.

We'll hear a lot of noise about how standards for lending are being tightened and we're not going back to NINJA loans and blah blah blah. But politicians and laws and regulations can't change human nature. Only that fabled School of Hard Knocks and enforcement of risk can, and school's out. So the players are going to do what they believe will lead to the most profits, and that's going to be to place as many chips out there as possible.

If this bailout is approved, and the economy in general is at least well enough to fog a mirror, look for the housing market to reflate over the next year or two, as money pours back into it. We're essentially going to at least attempt to rebuild the housing bubble. How far we get depends on how long foreigners are willing to loan Uncle Sam the money to cover everyone's bets. When that lifeline disappears, we're in a world of hurt...

Digging Holes in the Desert

2008-09-18T19:51:00.000-07:00

Those of you who have seen the movie Casino probably remember De Niro's early line about the desert being the place where Las Vegas's real problems got solved. The movie was a (mostly) true-to-life depiction of how business was done when the Mob ran the city, and problematic people were disposed of in holes out there in the vast, dark expanse of the windswept desert...never to be seen again.

I lived in Vegas for a few years, and while I never saw any mobsters, I did hear about how, with the irruptive growth in the real estate market and suburban sprawl on steroids, Vegas Valley builders would occasionally unearth some old corpse from those notorious days.

Wall Street today has some real problems, with the decimals several places to the right of the worst problems the wiseguys ever had in running Vegas, and the high rollers have decided on the same outcome: digging holes in the desert. Like the Mob buried its "liabilities" in the dead of night, so the high masters of finance usually do their dirty work on the weekend, when the markets are closed.

We've already had some small holes dug and some lesser banks dropped in. That seemed to work, so now apparently the thinking is, no matter how big the corpse, it can be disposed of in an orderly fashion, and life can go on as if nothing is amiss. Now the idea has been broached of digging the mother of all holes (maybe we'll call it "MOAH") and just dropping all these subprime mortgages into it.

The line of thinking involved in creating a "financial entity" to absorb all of this and then quietly taking that entity out into the desert some night is classic Mafia mentality. The subprime mortgages, collectively, represent a great big fat blabbermouth that just won't shut up. Here the politicians keep glad-handing us and telling us "the fundamentals are strong," while this pesky trillion-plus in bad debt that was the froth on the bubble that propped it all up screams out otherwise, that we've got a major problem, that easy money and credit bubbles are no substitute for fiscal discipline, financial responsibility, prudent regulation, and common sense. So before the ultimate "gaming control board"--the American voter--starts to hear this blabbermouth "talking" about how one hand has been washing the other lo these many years, it's best for business if the blabbermouth were "silenced" permanently, and with extreme prejudice.

So look in the next couple weeks for this "entity" to be quickly named, and all of the bad debt to be sluiced into it. Then, probably sometime after the election, when the spotlight is elsewhere, the Powers that Be are going to duct-tape the entity, stick it into the trunk of a Buick, and drive it out into the financial desert.

However, the bad debt is only a symptom, not the actual problem. The problem still exists: the financial system is badly out of balance with reality. Houses are still overpriced. Eliminating the symptoms of imbalance merely encourage more imbalance. Moreover, the ability of even the Federal Reserve to dispose of this "corpse" without serious repercussions elsewhere in the system is questionable, given we're talking over a trillion dollars here.

What's worse is that The Powers That Be appear to be still stubbornly clinging to the mentality that houses must be an investment and must always increase in value so that Joe and Jane Consumer can cash out tens of thousands in equity every few years to finance cars and boats and vacations and whatnot out of thin air and "stimulate" the economy. As long as that fantasy is held so dear, the laws of economics will continue to have to be bent to make it come true...and we will have more meltdowns, more corrections, more Fannie Maes and Freddie Macs.

Whatever Happened to Peak Oil?

2008-09-11T17:02:00.000-07:00

As oil settles at one thin dime over $100, the question inevitably arises, "what happened to the oil crisis?" Wasn't oil supposed to get more and more expensive until we all had to ride horses? Dude, where's the oil shortage?

It's a fair question.

The answer, I fear, is that peak oil and the oil shortage are still very much with us. Even at $100 a barrel, oil is still up approximately 30% from where it was last year around this time. That's still quite an increase. But why is is going down at all?

There are several answers to this. First, that's what commodities tend to do. Market forces tend to kick in and over-correct for large price movements. If the price of widgets plunges 40% one year, people tend to buy more widgets and producers cut back on production. So a year or two later, widgets are likely going to be more expensive than they were before the widget crash began.

When oil got expensive, most of the low-hanging conservation fruit got picked. People checked their tire pressure, traded in those SUVs and bought economy cars, moved closer to the office, and so on. The economy itself wilted, reducing oil demand.

Other factors intervened, too. While oil production overall has peaked, most oilfields have marginal wells that are turned off when oil prices are low, but switched on when prices rise. Oil speculators also sensed the ride was over, and sold off oil futures. Some also believe the Bush Administration pulled some strings with the Saudis to get them to squeeze out some extra production to bring oil prices down in time for the election. I'm not going to say I necessarily believe that last item, but it wouldn't surprise me; his entreaties to the Saudis last spring are on the record.

So add all that together, and oil came partway back down. However, the forces that led to the last run-up in prices are very much in place. China, India and other developing countries are continuing to demand more oil. We continue to burn several times as much oil as we discover. More and more countries are shifting from being oil exporters to oil importers; Indonesia didn't bother to renew its OPEC membership because it now uses more oil than it pumps from domestic wells.

The difference is that, the next time a supply pinch occurs, we're going to have a harder time reducing demand. We've already traded in many of the SUVs, and otherwise taken the easy steps to conservation. And at some point, I'm sure we'd like the housing correction to end and for the economy to grow again...when it does, that means more oil consumption and higher prices. Of course we don't want to have to endure a recession every time oil prices go up just to get gas down below $4 a gallon.

But in the absence of vigorous conservation elsewhere, that's exactly the scenario we're looking at. And it gets worse from there: if production continues declining, we'll reach the point where even a recession won't tamp down demand for oil enough to bring prices below nosebleed levels.

The bottom line: don't be fooled. And for goodness' sake, don't start thinking it's safe to buy SUVs again. This is a temporary lull. If you started making plans to trade in for a more fuel-efficient vehicle but are wavering because you see gas prices falling, stay the course and make the trade. A few months or a year from now, you'll be glad you did.

Everyone Needs a Rich Uncle

2008-09-08T16:49:00.000-07:00

Everyone, it seems, could use a rich uncle...like our favorite (?) uncle, Uncle Sam. Witness the federal takeover of Fannie Mae and Freddie Mac, those quasi public/private entities that underwrite much of the mortgage paper being written in America today.

First off, one has to wonder at just how two corporations, one named like a country schoolgirl and the other like a rap star, managed to get to be such bellwether names in High Finance. The answer lies in how both of these giants were implicitly, kinda-sorta backed by the government...at least until last weekend, when the "implicitly" and "kinda-sorta" were removed from the phrase "backed by the government."

Anytime a rich uncle stands behind an organization, even in the shadows backstage, the risk versus rewards assessment made by the operators of that organization get skewed. When risky decisions come up to be made, the operators can't help but think, "Well, if things go south, our rich uncle will save our hides, so why not throw the dice?" That's when speculation enters the picture...exactly the kind of speculation that took us down the primrose path to ruin in the housing market.

This mentality is what, at least in part, led up to "liar loans" and NINJAs ("No Income, No Job or Assets" loans made to anyone who could fog a mirror) that are floating belly-up across the country. When your rich uncle is standing by to absorb your losses, why not place risky bets?

And this is why the federal takeover is about the worst long-term event that could happen to the housing market. Sure, it's lowering rates, but is that what we really need? The whole problem began with a skewed risk-versus-rewards assessment on the part of these and other organizations. History has shown that, while private enterprise is often imperfect at gauging these matters, the state is far worse. Government running such a huge sector of the economy brings to mind that dreaded "s"-word: socialism.

For private enterprise, the main incentive to place responsible bets is the threat of loss--and, at the extreme, total loss (going out of business). Left to its own devices, the market usually administers discipline to those who bet irresponsibly. The "housing crash" was, in fact, just that correction in action. The banks going out of business, while painful for shareholders, was the whack with a switch on the rear end out back of the woodshed that the lenders needed.

Up until this weekend, Uncle Sam was doing the responsible thing and letting the market administer whuppings (while protecting depositors who had nothing to do with where the "chips" were placed on the table). And banks, hearing the excruciating sound of leather and wood hitting the financial flesh of their peers, were responding by tightening standards and curtailing the easy money that caused the problem in the first place.

But now, just when the punishment was beginning to modify behavior, Uncle Sam steps in to call it off. The message that is being sent--and, IMHO, it's highly detrimental to the healthy functioning of a capitalist economy--is that dysfunctional practices won't be punished if the punishment is "too painful." The problem with that is that the most painful punishments tend to result from the most dysfunctional behaviors...like basing a large part of a superpower's economy on the premise that housing values can only go up.

These are the behaviors that most urgently need to be corrected. They will be corrected...one way or another. All Uncle Sam did was postpone--and worsen--that day of reckoning.

GDP Grew Last Quarter. Does it Matter?

2008-08-28T17:32:00.000-07:00

The question of how the U.S. economy as a whole fared during the second quarter of 2008 has been answered...supposedly. GDP, which is the sum total of all goods and services produced within our borders, adjusted to avoid counting added value twice, for trade deficits, and quite possibly for the number of daily riders on "it's a small world after all," managed to grow 3.3%.

Economists were thrilled, and no doubt whoever runs the McCain campaign cracked a smile. Justifiably or not, McCain is seen by a sizable fraction of the electorate to be a successor to Bush, so whatever reflects well on Bush will give him a boost, too.

However, 3.3% really isn't that high a rate of growth, not by historical standards. It's not terrible. It puts a comfortable distance between the economy and that dreaded "R" word, at least for now. If the GDP report had been a golf stroke, the crowd would break out in polite but not particularly enthusiastic applause. At this juncture, since expectations had been a half to full percentage-point lower, 3.3% fills that proverbial square for the heirs-apparent to current politicians: the economy isn't great, but it wasn't as bad as we were all afraid it would be.

However, I see two problems with using GDP as a tool to measure the economy.

First, citing GDP growth as evidence that Things Are Getting Better carries with it an implicit but very real assumption that everybody's economy is growing 3.3%. The Powers that Be want us to believe that Richie Rich, CEO of Whatever, Inc. took home an extra 3.3%, and that his middle managers also took home 3.3% more, and that the rank and file at the factory took home 3.3% more, and the drivers of company trucks got 3.3%, and that overall everything is peachy-keen.

However, as you might imagine, that's quite an oversimplification. If we take a look at this past decade, we can see plainly that a rising tide has not, in fact, lifted all boats. So a simple increase in GDP is not a guarantee, nor even a reliable indicator of, an increase in our standard of living.

So how can we measure standard of living? The simplest method is to divide GDP by population, but this still just measures an average, saying nothing about distribution. So, several economists are trying out complete rethinks of the GDP statistic, factoring in equality of income, life expectancy, vacation time, and other variables which also impact quality of life. The theory goes that someone who makes, say, $35,000 a year but enjoys a good education and transportation system,
a low crime rate, substantial freedoms, paid vacation and a clean environment might well be happier than someone making $50,000 but with no social safety net, failing schools, no time off, a corrupt and dictatorial government, and polluted air and water. More wealth is not always better.

For some examples of alternative systems, check out
Genuine Progress Indicator
Human Development Index
Happy Planet Index
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The second problem I have with reading too much into that 3.3% growth was that the number was skewed by the tax rebate ("economic stimulus") checks being sent out. The money is borrowed money, and so the resultant increase in income is no more genuine than a guy who gets a $300 cash advance on his MasterCard claiming his income went up $300. It didn't; he just borrowed the money. So some of that 3.3%, we borrowed. How much? No one can determine with certainty, but it's safe to say some of it.

So, aside from a new generation of economic indicators, how can we know the economy is really improving? Some indicators to watch for: a reduction of inflation (inflation having a corrosive effect on the buying power of consumers) and increases in personal income and employment. These indicators, more than raw GDP, would show a nation on the mend.

Breathing a Little Sigh of Relief

2008-08-18T18:34:00.000-07:00

My apologies for the month hiatus. I was moving, and dealing with some personal crises. Fortunately, the situation seems to have stabilized. Things still aren't really where I would like them to be, but things have eased from red alert to a slightly orangish yellow.

You could say the same about the U.S. economy the past few weeks...not out of the woods, but breathing a little sigh of relief. The prime mover of the economy, oil, has eased from an economy-throttling $143 a barrel down to a merely painful $113. The spike in interest rates that was threatening to send the housing market into another death-spiral reversed a bit and then plateaued. The dollar has even regained a little ground. In short, things aren't back to what we want to call "normal," but we're no longer--for now at least--in acute crisis.

So how big a sigh of relief can we breathe? I would say, not very. Unfortunately, none of the underlying forces that made oil more expensive, the dollar lower, and interest rates higher have been dealt with. The fundamental imbalances between supply and demand of oil still exist in the long run, even if a reduction of demand in the short run has caused what I believe to be a temporary retreat in oil prices.

The problem is that we are entering an era of permanent decline for oil production. Thus, in order for price to keep declining, demand has to keep declining...as it has in the U.S. for the past several months. The only way demand can decline, other than a reduction in the population, is through conservation. (In the long run, hopefully we'll develop substitutes for oil, but for the next decade at least, we're pretty much stuck with petroleum as the prime mover for our economy.)

Energy conservation is a noble idea, and almost everybody seems to want to practice it...at least in the beginning. We've been doing a decent job of it for the past year or so, which is one of the reasons oil prices have declined. But the problem is that each subsequent reduction in energy usage gets progressively more inconvenient and difficult. Think about your own use of energy. Unless you're already an energy-conscious person, you could probably reduce your total consumption by 10% without significant changes to your lifestyle. Inflate tires properly, be careful to turn out lights, maybe bump the air-conditioner thermostat up a degree or so, avoid jackrabbit starts, and so on. That's pretty much what we did as a nation to shave oil consumption in the first half of this year.

However, energy conservation gets progressively more difficult and painful the more one is called upon to conserve. That first 10% or so of reduction was easy, but the second 10% requires more conscious effort. And the third 10% reduction...now we're talking some real lifestyle changes, like trading in the SUV for a Hyundai or even a hybrid, moving so you're fifteen minutes from work instead of an hour and a half. To sustain and further the reduction in oil usage, we're talking about changes as a society. We're talking bosses giving up control-freakery and letting office workers work from home offices a couple days a week. We're talking about car lots not seeking to be seen from space a la the Luxor in Las Vegas every night, and shutting off or dimming their lights. We're talking fewer nights out on the town, and more nights at home.

Is it possible? Yes. Is it going to be easy? No. Reducing our use of oil to the level necessary in the next decade to make oil a viable energy source is going to challenge some of our core beliefs about what the "American Way of Life" (which is actually a fairly recent cheap-oil invention) ought to be. There'll be push-back from companies and groups who stand to lose if change occurs.

But if you think that's bad, console yourself (if you want to) with the fact other societies around the world are going to be facing even more wrenching changes and hard choices: most notably China. While China is making some progress in becoming more energy-efficient, it still has a long ways to go. The Chinese practice of subsidizing fuel will also work against it, as those subsidies will grow more expensive as oil appreciates. Check out this map...the nations in yellow are going to be in for a rough ride, and those red nations that do not produce at least most of the oil they consume will have a worse time of it.

So my advice to Americans is to make the most of the economic uptick we seem to be experiencing (or will be experiencing once the fall in oil prices percolates through the economy and helps tamp down price pressures). Use this time to begin adjusting to a lower-energy future. Pay down your debts, sell that SUV in a couple months once the gullible begin to become convinced gasoline prices have returned to "normal," try to get closer to your job, and so on.

Breathe a sigh of relief, but don't be fooled. We're not out of this one yet.

Bad Credit? No Credit? All About Credit and FICO Scores

2008-07-19T05:50:00.000-07:00

Mention credit scoring or FICO to most people, and you've got a conversation topic that's about as pleasant as income tax or root canals. "That's going to go onto your credit report" evokes much the same loathing from a modern consumer as "that's going on your permanent record" got from a schoolchild a couple decades or further back.

As recently as a couple years ago, credit scoring in general, and FICO scores in particular, were almost mystical entities that were all-but-inaccessible to the average consumer. Sure, you could pony up ten to twelve bucks and get your score, but there was no guide to interpreting the furlongs-per-fortnight number you got, and only cryptic hints as to why your score was the way it was. I remember rather vividly pulling my score a few years back, and under the explanation was indecipherable gobbledygook that even a lawyer would have had difficult wading through. I finally told the lady at the bank it would be much simpler for the computer to just print the words YOU SUCK! at the top of the page--that at least would have been clear.

Google wasn't even your friend then...you could enter in a credit scoring topic and get five different answers, some contradictory, none authoritative. It was enough to make someone with bad credit put their fist through their own monitor. What made this supremely annoying was that your credit score was--and is--a major indicator of your financial life. Not knowing your credit score and trying to plan things like mortgages and car purchases is like not knowing your weight, blood pressure and cholesterol levels and trying to manage your health. A good credit score can save you enough money (through lower interest rates) over the life of a 30-year mortgage to buy a whole new house.

What a difference a few years makes. While misinformation still exists on the Internet and elsewhere, consumers now have authoritative, easy-to-understand sources of information to turn to to acquire, understand, and manage their credit scores. For starters, you can order real Fico Scores/Reports
online by clicking the link in this sentence.

Think you're already getting FICO scores? Maybe, maybe not. Unfortunately, there are many non-FICO credit scores offered by banks and other vendors that are not the same as FICO scores. These scores often deviate from FICO scores by dozens, sometimes even around a hundred points. Since mortgage lenders, car loan providers, credit card companies, and most other creditors use FICO scores, FICO scores are the scores you want to obtain. If you currently get a "credit score" for free with a checking account, credit card, or other service, chances are it's not a true FICO score and therefore is not indicative of where you actually stand with prospective lenders.

The FICO scores available via the link above come with a copy of your credit report. Moreover, the score reports also contain detailed, easy-to-understand annotation that tells you why your score is where it is, and what you can do to improve it. Gone are the Magic 8-Ball type cryptic numbers and code-words.

As part of my effort to educate consumers on how to profit from the current economy, I have put together a Web site (and I'm talking a real site, not some crappy link farm) called www.allaboutthebenjamins.org that gives detailed information on FICO scoring. The site shows you how to improve your FICO score yourself without resorting to gimmicks or costly and often ineffective credit repair services. My site helps you improve your score by enabling you to understand and correct the factors that lower it rather than applying Band-Aid "solutions" like renting other people's lines of credit.

Once you've ordered your scores and checked out my Web site, continue on to the FICO Forums, which contain the most well-informed user base on the planet concerning FICO scoring and credit issues in general. Overstating just how knowledgeable and willing to help the denizens of the FICO Forums are would be rather difficult; there are some Vulcan-class brains over there.

This is the Information Age. Be informed, and take command of your credit. We're coming up on some unprecedented opportunities to buy housing on the cheap, and you don't want to be left out.

Are Interest Rates Headed Up? Should I Care?

2008-07-12T18:27:00.000-07:00

What is interest, anyway?

I'm starting this post with a definition of interest, because many folks out there on the fruited plains don't really understand what interest is, what affects interest rates, and how interest rates affect us. To most people, "interest" has acquired a negative connotation, as it denotes the extra we pay to borrow money. Increases in interest rates tend to bring groans, and decreases, relief.

The definition of interest is simple: interest is the cost of money (specifically, using someone else's money). When you borrow money, you are "renting" the money in the same way you "rent" a DVD or car. You are using something that belongs to someone else, for a set period of time, and paying them for the privilege. The price you pay depends on market conditions (usually the costs incurred by the provider in bringing the product to market and maintaining it). In the case of renting a car, the rental company has to maintain the car, takes a hit on depreciation, and runs the risk that you'll wrap it around a telephone pole. Those costs, plus the company's profit margin, are factored into your rental rate.

The same overall set of forces drive the price of money, but there are some differences. One of the major determinants of interest rate is the level of risk involved that the borrower will default and the lender will be unable to recover its loan. This is why a consumer with a high credit score putting 10% down on a new house can secure a low interest rate: the consumer has shown him or herself to be trustworthy and reliable, and if push comes right down to shove and the borrower gets hit with a garbage truck, there's still the house itself as collateral. So the lender can get away with a small risk premium.

Another factor determining interest rates is inflation, which is something Netflix doesn't have to worry about. The value of that copy of I Am Legend that you rented on Tuesday isn't going to change significantly by the time you return it on Saturday. Not so with money, especially over time. If you're over 40 or so, you know exactly what I'm talking about. In the Seventies, you could do dinner and a movie with your sig.other on $20. Now movie tix and popcorn alone would run close to $25. So, if you loan someone $100,000 today, charge them 4%, with the loan due in 2018, you're not going to make 4%, because the value of those loaned dollars is being chipped away at every year by inflation. In fact, if inflation runs at 5%, even if the loan is repaid as agreed, you've lost money, because the dollars you were owed were depreciating more quickly than the interest you charged was adding up.

So how do lenders know what inflation will be like the next ten years? They don't. But because interest rates factor in inflation, they also factor in the big banks' guesses at to what inflation is going to be doing. Because there are billions of dollars on the line, you can bet banks have some of the best economic minds on retainer to game out where interest rates are headed, but after all is said and done, it's only an educated guess. They could come out ahead...or behind. But the moral of the story is, when long-term interest rates start going up, that's a signal that the Big Boys expect more inflation down the road. On the other hand, if long-term rates remain low, that means the banks are relatively unconcerned with inflation down the road.

There's a third factor figuring into interest rates, and that is the Federal Reserve. The role the Fed plays in the economy is too complex to go into here, but for the purposes of our discussion, think of the Fed as a reservoir of money, upstream from the rest of the economy. As a reservoir serves to moderate the flow of the river downstream, so the Fed moderates--or tries to moderate--the economy. When the economy runs too slowly (the "river" starts to dry up), the Fed opens the spillways and releases money. When the "river" runs high, and "excess" growth threatens to spur inflation, the sluice-gates are constricted, and the Fed draws more money to itself.

Operationally, what the Fed does to loosen or tighten the flow of money is to lower and raise, respectively, the interest rates it charges to the banks. The Fed also engages in what are called open-market transactions, selling U.S. Treasury bonds to suck money out of the economy when it wishes to tighten the money supply, and buying bonds to sluice money back out. These measures act, usually quickly, to affect the prime rate, which is the interest rates the banks charge their biggest, best, most reliable customers. Most other interest rates are pegged to the prime (with some level of markup), so changes in the prime rate richochet rather quickly through the economy.

However, mortgage rates are relatively insensitive to the prime rate. Why? Because mortgage rates are a 15 to 30-year "bet," the "odds" on the table today really don't matter much to mortgage lenders. (A nominal exception to this are ARMs (Adjustable-Rate Mortgages); since interest rates can be adjusted over time, the initial rate does more closely correspond with current market conditions.) The 30-year fixed mortage interest rate offers the average consumer the best look at what the experts (the ones with a lot of casino chips on the table) see as the future of the economy.

So when you see the 30-year fixed rate increase sharply, you should be seeing a red flag. Such an increase means that the Big Boys see trouble over the horizon (higher inflation, more economic uncertainty, a possible nosedive causing higher defaults that need to be factored into the risk premium, etc.).

This is why I have a widget posted in the right column of this blog, tracking interest rates over time. In fact, it shows the very phenomenon I've been alluding to. Note how the ARM rates have been fluctuating around a mean, whereas long-term rates have noticeably increased over the last six months. In fact, the 30-year fixed rate has gone from around 5.9% in March to 6.35% at the end of last week.

How worried should we be? At this point, I don't consider the increase to be overly alarming. Recall that we have been operating for several years in an environment of unusually low interest rates. Through much of the Nineties, 30-year rates fluctuated between 6.5% and 9%. So the increase to 6.35% isn't much to get worried about--for now.

However, this statistic bears watching, as further run-ups in the 15 and 30-year rates could mean that knowledgeable people in high places see trouble up ahead.

Welcome to California

2008-07-09T20:48:00.000-07:00

Please observe the no-smoking sign, as our state is already on fire. Thank you.

Just for grins and giggles, here's the page listing all of the NOAA weather warnings in effect for our great state at the moment. My patio thermometer still reads 107 after an excursion past 110 this afternoon.

Just Make a New Plan, Stan

2008-07-07T16:36:00.000-07:00

As the Fourth of July holiday recedes, and the election season shifts into high gear, The Plans are emerging from the McCain and Obama camps. Don't worry, America, the candidates tell us, we have...a Plan.

In keeping with political neutrality, I'm not going to go through the candidates' plans and pick them apart, nor say which candidate or party I recommend. That's not what this is about. My thesis is far simpler than saying McCain's plan won't work because of this, or Obama's plan will fail because of that, or liberal this or conservative that. To me, that's like arguing over the placement of deck chairs or the musical accompaniments on the Titanic. It's worse than futile, because it distracts us from the real dangers we face: time spent arguing over these trivialities is time one could be spending finding a lifeboat or at least a piece of furniture that will float.

Instead, I'll just cut right to the chase, and say that neither Obama's nor McCain's plan are going to fix what's wrong with the American economy. Why is this? "How can you so cavalierly dismiss the plans," you ask? I can and I do, because the candidates are not addressing the underlying issues afflicting the American economy. Since the Seventies, if not before, we've based our economic policy on the following set of assumptions:

1. We can consume more than we produce, and continue doing so indefinitely. This is probably the root of most of the other issues. For decades now, Americans have bought more from the world than the world buys from us. We've spent more than we've made, especially in the public sector.

2. Free trade is always beneficial, no matter how uneven the playing field. It's that last half that's the trouble. Free trade with our industrialized peers is fine. Free trade with nations that use slave labor--that's another story. Competition is good, but any competition has to have rules that apply to both sides. There's a difference between competition that's fair and which makes you work harder and improve (like when our auto industry was forced to reform by Japanese competition), and a football contest where your opponents get to wear chain mail and carry maces (like "competing" with Chinese slave labor whose products are artificially cheapened by a devalued currency). The reality is that free, fair trade is beneficial.

3. Cheap oil is a national birthright, and no matter how much we use, we'll always find more...and more...and more. This is a classic human failing, confusing abundant with unlimited. Abundant is not unlimited. We found that out the hard way with the passenger pigeon, which once existed in flocks of billions of birds, some such gatherings being hundreds of miles long. As of 1914, the passenger pigeon was extinct. How could that happen? People assumed that, because the passenger pigeon was abundant, it was unlimited, and they could hunt as many as they wanted as often as they wished. They likely thought Earth would magically produce more. It didn't.

4. The market always knows best. Don't get me wrong: I believe in free enterprise and private property as the foundation of a solid economy. The 20th century showed conclusively that private enterprise, not the State, is the most efficient engine a society can rely on to produce economic growth. But the market is a playing field, and ball games need some rules and referees. Note that I said "some." You don't see ball games with more umpires and referees on the field than players, and likewise over-regulation is a bane to economic progress. But there's no question that excessive deregulation of the financial sector aided and abetted the mortgage crisis. Loans were made that should not have been made. Low-grade shady paper was repackaged and passed off to investors as prime-grade securities. Banks were allowed to lie to shareholders by reducing payments on mortgages to try and keep borrowers from defaulting--yet could still report full payments on their books. The whistle should have been blown three or four years ago.

If you examine the candidates' plans, none of them comprehensively address these issues.

The standard lip service is paid to #1...there's not a candidate who has run for President since the Seventies who doesn't promise to balance the budget. We're now $10 trillion in the hole and counting.

#2, which has decimated our manufacturing base and contributed the most to the decline in the standard of living of American workers, is barely even mentioned.

#3 is getting some attention, but the predominant thought pattern remains that either the oil companies are bilking the public and manufacturing the shortage, or that environmentalists are the only thing standing in the way of America exploiting the big gobs of crude oil off its coasts and becoming the next Saudi Arabia. Token measures are advocated to support R&D into alternative energies.

We are in an unfolding crisis, and token measures aren't going to cut it. When World War II was raging and two hostile regimes threatened us, Roosevelt didn't say he was going to look into the idea of harnessing nuclear energy for military purposes, and bump up R&D over the next five to ten years. No, he got the best minds in the country together, gave them a budget with teeth, placed all the resources of the United States at their disposal, and told them to find the answer--and yesterday! The candidates today pledge nickels and dimes when what we need is a new Manhattan Project.

#4 is getting some attention, in that some of the worst deficiencies that permitted the mortgage crisis to unfold are finally being looked at...kind of like fixing up the barn and upgrading the quality of the hinges on the door after the horse is long gone. It's a start, but only that.

So, what can we as citizens do about all this? This blog doesn't make partisan political recommendations, but I will say that, when leaders refuse to lead, it's up to citizens to take the initiative. The change that's coming in this country is going to be bottom-up, not top-down. We can each take some steps to address those four issues on a personal, microeconomic level.

#1: Get your own finances in shape. Cut spending. Consider lifestyle changes. Let's face it: much of what we Americans spend money on are wants, not needs. While some of us are facing an inability to pay for basics (rent, food, electricity) despite good financial stewardship, many of us are in financial binds that are, at least to an extent, our own doing. We pay $25,000 for an $18,000 car when really we could have gone to a used car lot and paid $8,000 for a $7,000 car that would have done what a car is supposed to do: get us from point A to point B. We eat out and pay $20.00 for a meal we could have made at home for $8.50 (this is one of my personal weaknesses).

#2. We can't personally affect trade policy...or can we? If we buy less, then we import less. If we buy a couch for $75 at a secondhand store versus $750 at a furniture store, we save $675 and reduce our trade deficit by several hundred dollars. If we buy our children quality toys that make them think rather than showering them with cheap plastic crap, we reduce imports.

#3. We can vote with our wallets for alternative energy. We can drive less, and bike, walk, and take the bus more. Check your local utility: many allow you to specify that your energy is to come from wind, solar, and hydropower and pay only 3-5% more. And lowering consumption (see #2) reduces fossil fuel use.

#4. We don't have much power to affect this issue directly, but we can choose as individuals to lead ethical and prudent lives. We can take a look at what people propose to us and decide if it sounds too good to be true, it probably is.

The candidates don't have viable plans to fix what ails the country, so I suggest to everyone out there that you come up with your own personal and family plans to downshift and localize your lives.

Can't We Have Some GOOD News?

2008-07-06T00:15:00.000-07:00

The past several months certainly have not been for the light of heart. Between the housing crisis, the ongoing massive run-up in oil prices, and rising unemployment, economics has duly earned its moniker as "the dismal science." I haven't seen many bell-bottoms yet, and there's still nary a leisure suit to be found in public, but these days are otherwise feeling more and more like the Seventies with each passing suckflationary week.

So is there any good news to be had? The answer is, yes...though some of it you may have to make for yourself.

Good news: the commuter culture is coming to a close. Finally, the utter insanity of spending the equivalent of an entire waking day in an automobile each week going to and from work so you can (among other things) pay for the gas to make the trip is being exposed for all to see. Fathers might actually start arriving home in time to do something other than nuke a microwaveable dinner and tuck their kids in. We might actually (gasp!) get home from a day's work while there's still daylight, at least March through October or so. Families might actually start spending time together again. Family dinners, anyone?

Good news: energy conservation and alternative energy are finally being taken seriously. Even when gas was $1.78 a gallon, deep down inside we all knew it couldn't last. Someday we knew the cheap ride was coming to an end. Yet it was all too expedient for politicians to punt the ball and leave solving the problem to future generations. Now the ball has come to rest. Sure it's painful, but finally the foundation is being laid for America to have an energy source that doesn't enrich people who hate us, doesn't pollute, and that will last forever. That source is likely to be thermonuclear fusion (unless there's a real technological breakthrough and we come up with cold fusion, zero-point energy, or total mass conversion). The technical hurdles to harnessing any of these energy sources are formidable, but even a journey of a thousand miles begins with a single step. Despite the malingering of two generations of politicians, that step is now being taken.

Good news: our cities and towns are going to be reinvigorated. As life becomes more local, people will be looking more and more to the communities they live in for entertainment, recreation and economic sustenance. Look for fewer anonymous, cookie-cutter suburbs, and more vibrant city plans that mix residential and commercial development. After virtual extinction during the automobile-driven mid-to-late 20th century, the concept of civic space is experiencing a renaissance. Local forms and venues of entertainment--harvest festivals, farmer's markets, county fairs, carnivals, Christmas festivals, small dance halls, bowling alleys, movie theaters, local attractions, even libraries--the localization of our lives in the next decades will breathe new life into these venerable American traditions. One man who has minced no words about these trends is James Howard Kunstler.

Good news: our food is going to become more nutritious. Why? We'll be growing more of it ourselves and relying less on mass-produced, processed mega-foods. Prices may be zooming at the grocery store, but raising your own fruits and veggies isn't much more expensive than it was ten years ago. Even an apartment balcony can grow a surprising amount of food. Enterprising locals are making money selling tomatoes to local restaurants since salmonella fears have severed conventional supply lines for this ubiquitous food.

If you have a yard, even a small one, growing a garden opens up all kinds of possibilities for not only your own sustenance, but bartering with neighbors for their produce or even other goods and services. Now would also be a good time to plant fruit trees, especially citrus and other tropical fruits, as these take several years to become productive. Even if they have to be grown indoors in pots because you live in a cold climate, they can be nurtured with highly efficient shop lights, and moved outside when danger of frost is past.

Good news: more and more of us will be going to four-day workweeks and telecommuting. With gas costs soaring, the idea of working from home and working a four-day week is gaining increasing acceptance. While some people may chafe at more regulations, as gas goes past $5 a gallon and the need to conserve fossil fuels becomes a matter of national security, we may well see government applying pressure to business to reduce the workweek and shift workers who could work remotely back home, at least one day a week.

The math makes compelling sense: say a city has 100,000 commuters. 50,000 of these could be shifted to a four-day week. 25,000 could also telecommute one day a week. So that's 150,000 commutes a week that don't need to happen (counting to and from work). Figuring from a base of one million commutes a week, that's a 15% reduction in commuter traffic. If each commute burns a gallon of gas, that's 150,000 gallons a week, which translates into a savings of $750,000 a week, or $39 million a year those commuters could save or drop into other parts of the local economy. Those numbers were easy to blow off during prosperous times when gas was cheap, but will become increasingly difficult for policymakers to ignore as gas prices climb.

Good news: our air is going to be getting a little cleaner. As gas prices rise and people drive less and shop less, that translates into fewer car trips, shorter car trips, and fewer truck-miles. People will also have a stronger incentive to retire old, gas-guzzling, high-emission vehicles and replace them with newer, low-emission vehicles. That in turn means less air pollution.

Good news: we're going to be getting into better shape. The bicycle, often arrogantly dismissed outside of college campuses as the means of transport of paupers over the past couple decades, is coming back into style. Look for more bicycles to be made, and for cities and towns to increasingly take bicycle and pedestrian traffic into account when planning cities and making changes to existing plans. Once the public feels the numerous benefits of physical exercise, look for bicycling to nearby attractions to become an outing and leisure activity in its own right.

Good news: home improvement, home decorating and home design will be growth industries. We're going to be spending less time getting away from home, and more time enjoying our homes. Thus, home will once again be the hearth, the focus of familial activities. The drive to make the home a place to live rather than spend the year commuting away from it and the summer vacationing away from it will strengthen over the next decade. Saturday afternoon barbecues and Christmas dinners will return. Everything from exotic plants to softer furniture to PlayStation 3s will be in demand as more nights and weekends are spent "in."

Good news: normal people will be able to own homes again. After two decades of housing prices absurdly inflated by cheap commutes and easy credit, pricing is on its way back down to Earth. The housing bubble still has quite a ways--at least another year or so--to deflate, with rising gas prices, layoffs and more foreclosures on the way. Even renters will see some relief, as homeowners "on the margins" of foreclosure rent out rooms and their second homes that they can't unload at anything close to the rate they paid for them, thereby increasing the supply of rentals and decreasing the price.

Good news: political reform will come sooner rather than later. I think we'll see changes across the board, but the area I'm thinking of is how we treat the poor. America has become polarized into two camps. The first camp, often referred to as "conservatives," believes the poor are poor because they want to be, and that sharing resources is bad because that will just encourage poor people to be lazy. The fact that many of these poor are in fact working seems to matter little to people on this side of the issue. The second camp, often referred to as "liberals," believes that is we take money from somewhere, create a bureaucracy, and hand out money from on high, the poor's predicament will be resolved. The dismal record of inefficiency most social welfare programs have doesn't factor in to these folks' calculations.

The 20th century showed us neither scorning nor subsidizing the poor seemed to work too well. The coming decline will force us to look beyond these ossified notions, because there are going to be too many poor people to just ignore, and the government, already hip-deep in debt, isn't going to be in a position to offer much more aid than it already does. I don't claim to know exactly what solution will be arrived at. Given that the political Establishment seems to be without a clue as to the kind of world we're headed for, my educated guess is that this new approach will be communal, bottom-up, grass-roots driven, and do an end run around conservative and liberal politicians alike. By 2012, I predict the American two-party duopoly is going to come under unprecedented pressure to do something it's quite unaccustomed to: stop posturing and start delivering results.

Good news: we're going to be slowing down. Cheap oil and easy credit energized our lives and helped us move faster, but somehow we just never got ahead. We couldn't ever get where we were going quite fast enough. If we moved a little quicker, the clock just seemed to speed up a bit, and we ended up just as far behind. But if we have fewer places to go and less ability to get there, it stands to reason we'll be racing the clock less, and stopping to enjoy life a little more.

The unchallenged control the clock holds over us Americans is actually a fairly recent invention. For 99% of the human race's history, the time of day was "sunrise," "morning," "noon," "afternoon," and "gonna be dark soon." I'm not seeing us return to that level, but I do believe the pace of life is going to shift to a lower gear as we focus less on where we "have to" be, and more on where we are.

Good news: the concept of community is going to undergo a revival. As our lives become more local, and we focus on where we are, we're going to begin to notice (as our elders did a couple generations ago) the people we share that locality with: also known as neighbors. The block party is going to come back into vogue, as is the park where kids used to play kick-the-can, trick-or-treating on Halloween, and so forth. This represents another downshift in political culture, as the nation and state, strapped for resources, recede into the background and the community and town become more important...as they once were.

Good news: spirituality is going to experience a revival as well. It's a truism noted throughout human history: during prosperous times, people turn from the spiritual to the physical, and when times get hard, people look for spiritual answers to the questions of life. (In the interest of being nonpartisan and unbiased, I'm not going to speculate here which specific spiritual traditions and faiths will enjoy growth--at this point in time, it's too early to tell anyway.) Likely it will vary widely by location and culture, because during the era of cheap, global travel, we imported quite a few faiths and traditions, and America has developed some of its own.

All of this isn't to say that we're not going to be having some trying times ahead. We're headed for turbulence the likes of which we haven't seen since the 1930s. That old Chinese curse, "may you live in interesting times," is definitely coming to fruition. Our nation may not survive, if things go badly and (more importantly) if we react badly. We could see America splinter into regions a la Jericho, if too many people opt for a "last man standing" war over dwindling oil and resources. But it doesn't have to be that way, if we keep our wits about us and see the positive in the changes that are to come.