U.S. Budget Deficit Indicates Recession

The Age reports:

The United States federal budget deficit soared in July, pushed higher by stimulus payments and outlays to protect depositors at failed banks. The Treasury Department reported that the deficit for July totaled $US102.8 billion, nearly triple the $US36.4 billion deficit recorded in July 2007.

Lets take a deeper look...

The first chart below shows historical receipts, outlays and the deficit over twelve month rolling periods, while the second shows the year over year change in receipts and outlays over these periods, along with the difference between the two YoY changes.

Interestingly, this difference has turned negative in all of the four recessions (yes I'm calling this a recession!) since this data has been released...

UK CPI... Look Familar?

While the Bank of England hasn't been nearly as aggressive as the Fed in cutting rates, inflation has crept up to similar levels due to similar culprits; energy (i.e. transportation) and food.


Where's decoupling when you need it?

Credit Writedowns: $500B and Counting

Source: Bloomberg via Naked Capitalism

Agency MBS: Cheap or "Mispriced" Options?

Fannie MBS (as defined by 30 Year current coupon TBA), is historically cheap on an option adjusted spread "OAS" to Fannie's Agency Debt (as defined by its 5 year CDS spread) basis, widening even further since last month when I asked "Are Fannie Mortgages Cheap or is its Debt Expensive?"

In researching the topic I came across an interesting post over at Accrued Interest challenging this relative cheapness:

But times are anything but typical. Various conditions are coming together which will keep homeowners in their current residence far longer than historic norms. There is a large number of homeowners currently underwater on their mortgage, and an even larger number with less than 20% equity. Given that getting a mortgage with less than 20% down payment is difficult and very expensive right now, homeowners who currently have less than 20% equity would have to come up with a lot of cash in order to move to another home.

So the housing turnover element of mortgage principal payments is set to plummet. In addition, the same factors will prevent many refinancings. A borrower underwater on his current mortgage will not be able to refinance his loan just because rates fall 50bps.

This means that the average life of a mortgage is longer than is currently being assumed.

For example, a Fannie Mae 30-year 6% mortgage security currently has a nominal yield of 6.19% and an average life of 5 years. The average life is the median of a Bloomberg survey on prepayment estimates. That calculates to a nominal yield spread of 271bps.

Note that a 6% mortgage security is typically made up of borrowers with a 6.5% mortgage. Currently mortgage borrowing rates are 6.26%, according to Freddie Mac. Under normal conditions, one would assume that a 6.5% borrower is relatively close to a refinancing opportunity. Hence Wall Street prepayment models are assuming that this mortgage will pay principal slightly faster than this time last year.

More likely is that mortgages will prepay at historically slow rates. Cutting Wall Street's estimated prepayments in half, the mortgage's average life goes from 5 years to 9 years. Because the yield curve is so steep, that results in the yield spread falling to 219bps. If you cut Wall Street's estimate by a third, the spread falls to 202bps.

As investors come to terms with the extending average lives, prices are likely to fall rather than yield spreads contract. Holding the 271bps yield spread constant but extending the average life to 9 years causes the price to drop by over 3%.

Why didn't I think of that?

Source: Accrued Interest

Net Exports (excluding Goods)

Anatomy of a Bubble?

According to AAA, the price of gas has now dropped 25 straight days. Is this the beginning of a large reversal?


Source: S&P, EIA

Hardest Drinking U.S. Cities... and Housing?

Interesting chart you say, but how can we use this for a true economic purpose...

How about we compare the percent of those in cities that occasionally drink 5+ beverages in a sitting (not that there's anything wrong with that) to the year over year drop in home values? We have the following eight cities as data points (both heavy drinking cities and data from Case-Shiller):

• Boston
• Chicago
• Cincinnati
• Cleveland
• Detroit
• Portland
• San Francisco
• Seattle

What does our completely unreliable, lack of enough data points, should probably ignore scientific experiment show us?

There is a negative correlation (cities with more 'frequent "heavy" drinkers' have experienced greater declines in their home values, all else equal).

So the lesson learned? Well, besides an investor base that may or may not have made their decision to buy under the influence or a group that is possibly drinking just to get over the sorrow of an investment gone bad, it means absolutely nothing. Please do with this info what you should do with the advice from a person who just went out and had 5+ drinks... ignore it.

Source: Forbes

The Housing Disconnect

Source: Zillow.com survey via Credit Writedowns

The Fed's (Lack of) Impact on Rates

Source: Jim Bianco of Bianco Research via Naked Capitalism.

$330,000 per Capita National Debt

Bill Walker points us to a speech made by President and Chief Executive Officer of the Federal Reserve Bank of Dallas, Richard W. Fisher. According to Mr. Fisher:

Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent.

On a per capita basis (that is for each U.S. citizen) the amount is a staggering $330,000 each, about 10 times higher than government released numbers.

There's Gold in Them Hills

Gold miners ruled when gold ran from $250 to $350 / oz from mid-1998 to mid-2003. Since that time it's been a much better investment to just buy and hold the metal, then try to dig out more.

Productivity and Costs - Q2

Per the BLS: The seasonally adjusted annual rates of productivity change in the second quarter were:

*2.3 percent in the business sector and
*2.2 percent in the nonfarm business sector

Productivity gains in both sectors reflected output increases and small declines in hours worked.

Below is a chart breaking the numbers down further in YoY terms...

Bill Miller vs. S&P 500

Per the WSJ:

Massachusetts' pension fund has dismissed five managers that handled its $1.8 billion U.S. equity portfolio, including Legg Mason Capital Management, a Legg Mason Inc. unit.

The decision is another blow to Bill Miller, manager of the Legg Mason Value Trust, which has lagged the Standard & Poor's 500-stock index during the past three years since its 15-year streak of outperformance ended.

It's been a harsh reversal of fortune for Mr. Miller who outperformed the S&P 500 fifteen straight years from 1991-2005. With that kind of run, performance must still be strong historically relative to the S&P 500... think again.


Source: Yahoo Finance

Per Capita Income by County

The top and bottom 10 per capita personal incomes by U.S. county (out of 3111). Who said New Jersey only had Bon Jovi and the Boss going for it?

Source: BEA

Putting the BS Back in MBS

Below is an EconomPic'd version of a great table posted at Calculated Risk which summarizes the percentage of loans with high loan to value "LTV" and/or low FICO (credit) scores made over the last five years. Specifically shown are fixed 30 year loans and fixed interest only "I/O" 10/20 loans (the interest-only portion runs for 10 years and then fully amortizes over the remaining 20- year term).


So what does it show? It shows that recent loans have gotten a whole lot riskier for taxpayers Fannie and Freddie, especially if prices continue to slide.

Hedge Fund Returns by Strategy (July)

Monday we took a look at how individual manager's have performed YTD 2008, now lets take a look at performance by strategy.


Source: Barclays Hedge

The U.S. Peso

I can't tell if I like the chart or not as it's possibly too tacky (the pic is from a recent protest in D.C.), but can anything really be too tacky?


Mexico City, (Reuters)

The peso last Friday broke past 10 pesos per dollar for the first time since late 2002 on expectations that Mexico's central bank will further tighten borrowing costs to battle a spike in inflation.

That would further widen the spread between benchmark U.S. and Mexican interest rates and make peso-denominated assets more attractive to investors.

Ener-GM Bail... I Mean Energy Bill

According to Bloomberg and following an $8.7B loss at Ford and a $15.5B loss at GM, Representative John Dingell (from Michigan) proposes $25B in government loans to:

Convert General Motors Corp., Ford Motor Co. and Chrysler LLC factories to build alternative-fuel vehicles.

Why? Will it help transition the U.S. into a new era of renewable energy sources. Nope, per Mr. Dingell...

"The sudden rise in gas prices, the subprime mortgage induced credit market tightening, across the board commodity price pressures, and regulatory demand for more fuel efficient vehicles have led to a sudden economic disruption of unprecedented proportion for the domestic auto industry."

So, Mr. John Dingell wants to funnel $25B of taxpayer money earmarked for energy investments from the Energy Independence and Security Act into three auto companies that are bleeding cash and located in his voting district (Michigan) because they failed to create a product as good as their competition and are struggling in a slowing economy? Back to Mr. Dingell....

``It is essential for the department to undertake this effort with urgency,'' wrote Dingell, a Democrat and chairman of the House Energy and Commerce Committee. ``Providing the domestic automobile industry with targeted and timely assistance will help stimulate the entire economy."

So now that it's clear WHY he is proposing a "bail out" (hint... NOT the energy bill), lets take a look below at what $25B is relatively speaking. Well, it's roughly the size of:

• Ford and GM's COMBINED SECOND QUARTER LOSSES
• The Market Cap of ALL THREE COMPANIES the bill is trying to "bail out"

But, what's the rush?

The loans were authorized in last year's energy bill, and the guidelines were supposed to be written within a year of its December passage, Representative John Dingell said yesterday in a letter to U.S. Department of Energy Secretary Samuel Bodman.

With the last second nature of this request and its clear conflicting purpose, the loan must be cheap for taxpayers.... right?

The rules call for loans for as long as 25 years with an interest rate set at the cost of funds to the Department of Treasury for obligations of comparable maturity, according to the text of the legislation. The loans can cover as much as 30 percent of the cost for assembly plants, component production and some engineering.

GM unsecured debt due in 25 years yields 12.94 percentage points over comparable government debt. That's $129.4 million annually over the cost of government debt in additional interest for each $1 billion.

25 * 129.4M = $3.23B / year if the loans are paid back in full

Source: Bloomberg

A Ways to Go? Case-Shiller vs. CME Futures

Mish shows an interesting chart showing the current peak to trough for ten cities, along with data available from the CME Futures market showing where we MAY be headed...

BEA's GDP Deflator... cut the BLS!

Yesterday we detailed that Q2 Real GDP appeared to be artificially high due to a GDP Deflator which implied an understated 1.1% annualized inflation rate (Real GDP = Nominal GDP / GDP Deflator). Below is a chart that shows where all of that inflation is hiding.

For the quarter, the Bureau of Labor Statistics "BLS" reported nondurable goods inflation a full 3% higher than the Bureau of Economic Analysis "BEA". With this lower inflation rate, the BEA reported a 4% annualized real growth rate for nondurable goods in the second quarter, which contributed an outsized 1.84% of the 1.9% Real GDP for the quarter.

Swapping the BLS nondurable goods inflation rate in for the BEA GDP Deflator, we knock off a full 1.2% from that 1.84%, bringing GDP in the second quarter to 0.60% all else equal.

Update:
Teresa directs us to an interesting post by James Hamilton arguing that the GDP Deflator may in fact be accurate.

I think James' example is simple and his logic is easy to understand, but it isn't necessarily applicable to the real world (or specifically to the U.S.). James' story involves an Island which grows one good (a coconut, which it doesn't "produce") and imports oil.

The U.S. does not have many "natural goods" like coconuts. Thus, we use that super-expensive imported oil as an input for our final goods. Thus, inflation has crept up as this expensive source of energy has flowed through the supply chain (YoY: energy up 70%+, PPI up 10%, CPI up 5%, Core CPI up 2.5-3%).

A better example would have been coconuts and a fertilizer that is essential to grow coconuts. In this case had fertilizer doubled in price, I have feeling that $515.10 worth of coconuts would not have gotten you the 510 initially assumed by the Island's BEA in the first round of its Real GDP calculation, but rather only 470 as the higher price of fertilizer increased the price of the final good, hurting demand. Thus, rather than an increase in GDP from 500 to 510 coconuts, there was a recession to 470 (same nominal GDP in both cases).

At the end of the day, we need to look at the numbers and ask ourselves if they make sense and 1.1% does not. Should the GDP Deflator be as high as that implied by the CPI? Probably not, but somewhere in between would cause another revision to GDP, which was my point all along...

Nation of Debt

Government
Below's chart shows social benefit payments made by the government against the amount of personal taxes collected. As can be seen, individuals have been receiving significantly more in the form of benefits than they have paid for since 2000.


In real terms (further below), we can see that the nation has never received more benefits, YET real taxes collected by individuals are lower than when they peaked in 2000. In fact, we have never experienced a longer period of time (at least as far back as 1948) when more has been spent on social benefits than collected by personal taxes.


Individuals
As a nation, we have never saved so little (and for such a long period of time). The chart below shows the aggregate dollar amount saved by individuals since 1948 in nominal terms.

Since U.S. savings peaked in the early 1990's at ~$350B per quarter (in nominal aggregate, not real per capita terms), savings has collapsed to negative territory for the first time since the great depression.

Conclusion
You learn in Economics 101 that Automatic Stabilizers should be in place to raise tax revenue during the good times to pay for government benefits during the bad. With all the tax cuts we've experienced and a continued increase in benefits paid during the past 8 years, we are now moving into unprecedented times.

In fact, we've never spent this much on benefits relative to personal taxes at the beginning stages of a recession. The government is bloated and loaded with debt, while individuals are in a similar situation. Much of the "wealth" accumulated by individuals in place of savings is under pressure by a declining equity market, high inflation, and a deflating asset bubble.

With financing becoming more expensive and harder to come by for the government and individuals alike, tax revenues under pressure, and an economy which needs a debt laden and broke consumer to spend in order to grow, we're in rough shape.

Update
Below is the nominal chart shown on a logarithmic scale as requested. Compounding is an amazing thing and it shows how what may appear to be a small difference can create such significant issues over time.

Not Too Fun(d), but Not Too Shabby

From the NY Post via Big Picture:

New York's Top 100 Hedge Funds are getting flattened in the credit crunch.

At first glance it appears that statement is pretty accurate. I will agree these fund managers have a lot of work to do in order to get their funds back to black before bonus time. However, with the S&P 500 down 12.65% YTD through July and the average Hedge Fund listed by the NY Post down -2.78%, I'd say they "haven't done horribly".

Looking at cumulative returns since the beginning of 2007, the "haven't done horribly" becomes "have done quite well". The problem is many of these funds sold their returns as absolute return alpha strategies and as many are figuring out, it was likely beta the whole time.

Additional Employment Analysis - July

If at First You Don't Succeed... Stimulus Package Edition

Since the rebate checks were sent out:

• Personal Savings is up
• Real Personal Consumption is Flat

Should we admit failure? No... lets try another!

Negative 4.5% GDP?!?!?!

Real GDP was a respectible 1.9% due to a GDP Deflator which implied a measly 1.1% inflation rate. Lets take a closer look at what GDP would have been using a few alternative measures.

Core and Non-Core CPI
As can be seen below, the resulting "Real GDP" looks dramatically different substituting either measure of CPI for the GDP Deflator. Using Core CPI (as measured by the quarter over quarter change in the seasonally adjusted core index), Real GDP for the quarter shrinks 1.4% to 0.5% annualized. Non-core CPI (same methodology) shows Real GDP contracting by -4.5% annualized as CPI jumped a shocking 7.9% Q1 to Q2 (217.403 / 213.301)^4-1!




Which do I believe is an accurate measure?
Looking below, one can see the strong historical relationship between CPI and the GDP Deflator. This relationship breaks down in Q4 2007 and continues to move wider into the second quarter.

The recent inflation uptick we've experienced should be better accounted for. I expect the final GDP figure for Q2 to fall somewhere between the two alternative measures (along with another revision to Q4 and Q1) in the coming months.

Sources: BEA, BLS

Update: much of the inflation is being hidden in nondurables

The Tale of Two Cities: Home Prices

Felix over at Portfolio.com has an interesting post looking at how the best and worst performing zip codes in various cities have fared over the past year.



So what to make of this. Lets go to Felix:

One big thing to learn from all this is that it's silly trying to hedge downside in the value of your home by using the CME's housing futures. It's entirely possible that you could short your city's house prices only to see your city's housing prices go up and the value of your own home go down -- thereby losing on both legs of the trade.

And the other thing to learn is that there are still entire zip codes, like Preston Hollow in Dallas, which have massively bucked the national trend and have seen house prices rise by a third over the course of the past year. Yes, we're in a nationwide housing recession, but not all houses in the nation are falling in value. Exactly where you are within a metropolitan area can mean the difference between soaring values and slumping ones.

Source: Portfolio.com

UPDATE: Please note that this chart reflects the year over year change in ASKING prices, thus the numbers may be slightly skewed. Another reminder that it is more important to look at the pattern that the data presents rather than the exact figures.

Is Iraq the Key to Oil?

Source: EIA

Total Borrowings of Depository Institutions

The Update:

• Extension of the Primary Dealer Credit Facility (PDCF) and the Term Securities Lending Facility (TSLF) through January 30, 2009.

• The introduction of auctions of options on $50 billion of draws on the TSLF.

• The introduction of 84-day Term Auction Facility (TAF) loans as a complement to 28-day TAF loans.

• An increase in the Federal Reserve's swap line with the European Central Bank to $55 billion from $50 billion.

The Good:

Michael Feroli, U.S. economist with JPMorgan in New York added: “more and more banks are trying to take advantage of the pure economic advantage of borrowing at a cheap rate and you are seeing a gradual fading away of the stigma of using the discount window.”

The Bad:

U.S. banks' direct primary credit borrowing from the Federal Reserve rose to a record high in the latest week. Banks primary credit borrowings averaged $17.45 billion per day in the latest week, up from the previous record set last week of $16.38 billion, the Fed said on Thursday.

On the day of July 30, banks' primary credit borrowings inched lower to $17.38 billion, down from $17.68 billion on July 23. Banks' overall discount window borrowings averaged $17.64 billion per day in the week ended July 23, up from an average of $16.51 billion per day the week before. Dealers borrowed $3 billion average per day from the Primary Dealer Credit Facility in the latest week after not borrowing at all the week before.

New York City: Dunkin Town

As a New Yorker, this definitely surprised me...




Source: Metro

Auto Sales - July

GM: A Picture is Worth a Thousand Words...

Source: Infectious Greed

Global Stock Market Performance (7/31/08)

1 Month, 3 Month, and YTD Equity Performance in Local Currency.

Source: Investment Postcards

Refill Please?

Added this late yesterday to an earlier post and quite frankly, too good not to repost.

Employment Breakdown (July)