US to G20: Spend, Spend, Spend

This post first appeared on Minyanville.

4 months ago, as financial markets spun out of control, the world’s brightest economic minds engineered a coordinate global cut in interest rates. Their aim: Save the financial system from imminent collapse.

The move sparked a sharp 20% rally in the S&P 500. The index has since tumbled more than 30% to lows not seen since the 1990s.

If markets are jittery once again, it’s not without justification: In just under a month, global leaders will once again put their heads together, this time to hash out the best way to solve the deepening economic malaise. Hopes are high lawmakers will dream up new (and better) ways to get the world's largest economies back on track.

On April 2, in London, the US is expected to encourage its counterparts at the Group of 20 Summit to increase government-spending efforts to revitalize flagging economies. According to the Wall Street Journal, President Obama and Treasury Secretary Tim Geithner are expected to butt heads with European officials, who would prefer to shift the focus onto crafting stricter financial regulations.

The European Union, many believe, is facing an even worse economic outlook than the US. But those across the pond could need fewer new spending initiatives, since they have further-reaching social programs already in place. In addition, the European Central Bank, or ECB, is far more hawkish (read: concerned) about inflation than is our Federal Reserve.

Digging ourselves out of this mess with more borrowing could spark renewed inflation.

The ECB took longer to lower interest rates last year despite deteriorating economic conditions, citing worries about rising prices. In contrast, Fed Chairman Ben Bernanke aggressively reduced borrowing costs in the hope that companies would borrow to jumpstart new growth. Frozen credit markets didn’t cooperate, plunging the financial system into widespread disarray.

Of the countries that make up the G20, only Saudi Arabia, Spain and Australia plan to spend more propping up their economy than the US, according to data compiled by the International Monetary Fund. Of course, that doesn’t include the hundreds of billions already wasted - um, injected into the likes of Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan (JPM), Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC).

Also left out of these figures are the trillions of dollars the Fed has pumped into the financial system to keep credit flowing -- however reluctantly -- throughout the economy.

The upcoming meeting marks President Obama's first chance to woo world leaders on the global stage. And while his social programs may gain favor among certain European lawmakers, his country's role in creating this mess certainly won't.

The rest of the world increasingly feels its being forced to clean up a problem that was largely American-made.

Moody's List of Riskiest Companies Forgets to Include Moody's

This post first appeared on Minyanville.

Make-up calls belong in basketball, not finance.

In an attempt to render itself useful, Moody’s Investors Services (MCO) is issuing a list dubbed “The Bottom Rung,” cataloguing the riskiest 15% of all companies it tracks. The effort, which the company claims is an attempt to get ahead of the looming mountain of corporate defaults, has already ruffled a few feathers.

According to the Wall Street Journal, Eastman Kodak (EK), which appeared on the list, issued a harsh rebuttal last night, saying “Any speculation, however informed, suggesting that Kodak is less than financially sound is irresponsible.”

Among the list of allegedly shaky companies: Familiar names like Ford (F), General Motors (GM) and Chrysler made the cut, along with airlines AMR Corp (AMR) and US Airways (LCC). Retailers, restaurants and even a few energy firms also appeared in this corporate hall of shame, in addition to chipmaker Advanced Micro Devices (AMD) and chemical manufacturer Georgia Gulf Corp (GGC).

Moody’s, along with fellow ratings agencies Standard and Poor’s (MHP) and Fitch Ratings Services, played a major role in the recent financial market meltdown. Conflicts of interest with debt issuers, faulty models and lax internal controls all led to credit ratings that were unreliable at best, deceptive at worst.

Unfortunately for Moody’s, gone are the days when investors valued haphazard assessments of credit risk. The Bottom Rung, while generating ample work for Moody’s customer-complaints department, isn’t likely to reclaim any of the company’s lost glory.

When a firm that specializes in assessing whether borrowers will repay their debts fails to see the biggest wave of defaults in a generation, it’s safe to say that company isn’t very good at its job.

Minyanville's Jeff Macke said it best last week:

In an environment in which DC is creating and changing the laws of corporate governance on a daily basis, it’s simply lunacy to allow 3 groups complicit in the creation of the underlying problem to go on their merry ways while members of the House endlessly lambast bankers for being bankers. Take the gun away from the 5 year old; suspend the ratings authority of Moody’s, S&P and Fitch.

Consumers Still Not Consuming

This post first appeared on Minyanville.

As lawmakers busily laud their own efforts to unlock credit markets and jumpstart lending, consumers yawn. They just don’t want to spend.

And it’s not just those out of work who are paring back expenditures. According to the Wall Street Journal, even the dwindling ranks of the employed are getting thrifty. Computer users are enduring slow machines rather than buying new ones, clothes-shopping trips are being delayed, and coupon clipping is once again the vogue.

Discounters like Wal-Mart (WMT) are benefitting from bargain hunters looking to save a couple bucks, while AutoZone’s (AZO) stock sprinted to a 52-week high last week, as drivers opt to do it themselves.

Politicians, rushing to restore the “prosperity” we so recently enjoyed, are confident this is just a passing fad, and that we’ll soon return to our spend-happy ways. Indeed, the viability of President Obama’s new $3.4 trillion budget is predicated on the US economy's skipping along at a 3.4% growth rate next year - and expanding even faster in 2011.

This optimism -- idealistic at best, delusional at worst -- ignores the extent to which Americans are embracing a new, sustainable way of making ends meet: Spending less.

Meanwhile, the Federal Reserve, busy waving its magic wand over reeling credit markets, is similarly out of touch with reality.

As noted by our friends at BTIG, new federal lending initiatives aimed at funneling money to credit-starved consumers are undersubscribed. In his speech last Friday, New York Fed President Bill Dudley pointed to weak demand as evidence that financial markets were in better condition than many believed, and that investors could be willing to start taking risk again.

Not likely.

As I noted a few weeks back, consumers are roundly rejecting the idea that more debt is a good thing. Even small community banks that have money to hand out can’t find any takers. (Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) are quietly thanking their lucky stars, since they’re out of cash anyway.)

The ongoing foreclosure crisis, rising bankruptcy filings and tumbling equity values, though they do cause meaningful hardships for millions of Americans, do have a silver lining: The realization that unbridled consumerism does ultimately come at a cost. This is fostering a renewed understanding of the importance of fiscal responsibility.

Most media outlets report this in terms of increased savings, which is almost universally viewed as bad in the short run, if good long-term.

But saving now is good. Period. The notion that spending what you don’t have is somehow the patriotic thing to do is absurd. The only way out of this mess is through saving, not spending.

That is, of course, if one's time horizon extends beyond the 2, 4 or 6-year election cycle.

Foreclosure By Design

This post first appeared on Minyanville and Cirios Real Estate.

Many months ago, long before bureaucrats dreamed up their massive, ill-conceived loan-modification programs, the free market found a solution to the mortgage mess.

Specialists in handling distressed debt amassed tens of billions of dollars to buy up bad loans at steep discounts. The offending institutions who had bought the stuff in the first place would be forced to own up to their mistakes, take their lumps and move on. Meanwhile, those deft enough to clean up the problems would reap their just deserts.

Alas, it was not to be.

Sometime around the middle of 2006, some regulator woke from a decade-long slumber and decided to hazard a look at the balance sheets of America’s largest financial institutions. To his horror, just about every bank in the country would be insolvent, given the going prices for delinquent mortgage debt.

He raced off to tell his boss, who alerted his superior, and so on up the chain until then-Treasury Secretary Hank Paulson got wind of the coming tsunami of losses. Paulson barely flinched, for Wall Street’s top brass was well aware their collective predicament. After all, it was the likes of his former charge, Goldman Sachs (GS), who designed and sold the toxic assets in the first place.

The choice then was simple: Step back and let markets sort out the mess, risking the lives of storied firms like Citigroup (C), Bank of America (BAC) and JPMorgan Chase (JPM) - or latch onto the absurd notion that these institutions were “too big to fail,” and begin a process whereby the American taxpayer's hard-earned nest egg would be used to forestall the inevitable day of reckoning.

We now know how that sad story ends.

To prevent the market from clearing these assets at their true value -- sometimes just pennies on the dollar -- lawmakers, bureaucrats and big bank executives huddled together and devised ingenious schemes like the Super-SIV, HOPE NOW, Project Lifeline, TARP, and other utterly contrived “solutions” that, despite their claims to the contrary, were simply ways to extend the lives of these zombie banks.

Two pieces today, one run by Bloomberg charting the failure of myriad modification programs to address the problem of negative equity, and one in the New York Times documenting the exploits of former Countrywide executives buying distressed debt from the FDIC on the cheap, evidence the abject failure of government efforts to stem the rising tide of foreclosures.

Private investors, the ones best suited to forgiving principal or lowering interest rates to keep a family in their home, were handcuffed by political bumblings. But these programs, by preventing true price discovery in the housing market, have likely achieved their goals of their designers.

Our banking system has buckled, but not broken. The eventually recovery, however, has been pushed well down the line and the cost shoved onto future generations. Those responsible have by in large retained their posts at the institutions deemed “too big to fail,” save a couple token scapegoats tossed to the media wolves.

Meanwhile, the responsible few who did not speculate on their home, did not use credit as a vehicle for illegitimate economic growth and never thought they’d be asked to pick up the tab for those that did, have now been asked to shoulder the burden.

It should come as no surprise that housing prices keep falling -- indeed they must in order for true stabilization to occur. But the slow bleed, the persistent drag on the fundamentals of our economy, is doing more damage under the hood than our wise leaders would care to admit.

Still, they insist the more economic control centralized in Washington, the better. After all, the ones that drove us off this cliff certainly should know how to break the fall.

Keepin' It Real Estate: How to Play the Housing Rebound

This post first appeared on Minyanville and Cirios Real Estate.

There isn’t an economic forecaster or media pundit alive who isn’t angling to be the first to (correctly) call the bottom in housing. Many have tried; they all have failed.

But what happens when one’s right?

At some point in the future, broad home price indicators will cease to slide, then stabilize and even begin to move back up. When, and in what shape that trajectory will be, of course remains a mystery. As I've written in the past, the eventual recovery in housing will be a prolonged, localized event. The rising tide will not lift all boats, as the fundamentals of the old cliché “location, location, location” will be truer than ever.

And although predicting the date of this event is a fool’s errand, savvy home buyers will be ready to jump in ahead of those who remain in their shells long after the best bargains are behind them.

Here are 5 simple things you, the future home buyer can do now, without putting your nest egg at risk, to be ready for the coming opportunities in real estate:

1. Have patience.

There will be false bottoms, dead-cat bounces and treacherous pitfalls on the path to a recovery in real estate. Be patient. Don’t believe the hype - a couple months of strong sales numbers don’t foretell and imminent rebound in prices. Let the beginnings of a trend develop before you begin your home search in earnest. Future appreciation will come slowly, as tightened mortgage guidelines and fear of the collapse we’re now experiencing will not be soon forgotten.

2. Find a market, do your homework.

Had your eye on that classic Victorian around the corner from your kids’ future grade school, and hoping the elderly couple living there knock off just in time for you to swoop in at the estate sale? Expand your search.

Pick a couple of areas you could be happy in - look in multiple cities even. By focusing too narrowly on a single street, or even a single neighborhood, you could be missing out on what could be a fantastic opportunity on the other side of town. Don’t compromise, but play with your list of priorities to give yourself the most “exposure” to localized markets that may become increasingly attractive.

Tour the schools, scope the neighbors - hang around on Halloween to see who gets egged. RealtyTrac.com is a great resource for watching foreclosure activity all over the country and in your backyard. Their free site provides a great overview of cities and neighborhoods, but you have to pay for the house-by-house detail. Unfamiliar with an area? Use RealtyTrac to eyeball major neighborhood dividers (railroad tracks, highways, main roads, etc.) and examine foreclosure activity on either side.

3. Find a broker and start a housing “tracker”.

Real estate brokers can be a valuable tool in your home search - use them.

An aside: The commonly used term “realtor” denotes an association with the National Association of Realtors, or NAR, the lobbyists who have been predicting a bottom since the downturn began over 3 years ago. Tread carefully with anyone proudly bearing an NAR pin. Contrary to what many tell you, you don't need to be a realtor to have access to MLS. But I digress.

Today, with transactions down in all but the most distressed areas, any broker worth his (or her) salt should be out prospecting for future clients, not proclaiming the time to buy is now. Collect referrals, test drive a broker or 2 and find one you’re comfortable with. Your broker should not just understand the local market but be up to speed on the macro-level events affecting the real estate and mortgage markets. Ask him what a CDO (collateralized debt obligation) is - watch for a flinch. For better or for worse, understanding the state of Wall Street is as important these days as understanding the state of your street.

Ask your broker to help you develop a “housing tracker,” a simple tool that allows you to watch homes as they come on the market to see when and for how much they sell. Watching the life cycle of homes in a given market will give you a sense of how desperate sellers are, when asking prices drop and what concessions buyers are able to receive from sellers. As concessions begin to swing in favor of the sellers, the bottom may be nigh.

4. Start saving money.

If there’s one sure bet in the housing market, it’s that mortgage requirements will remain tight for the foreseeable future. Banks -- Citigroup (C), Bank of America (BAC), JP Morgan (JPM) and Wells Fargo (WFC) being the obvious examples -- are hoarding cash and reticent to lend even to the most qualified buyers. Unless a loan falls within guidelines set by Fannie Mae (FNM) and Freddie Mac (FRE), rates remain elevated and approvals elusive. This isn’t likely to change any time soon.

Save for a down payment and be able to point to liquid reserves (i.e. money in the bank) during the application process. Think about this as the lender’s cushion should you fall on hard times - and banks will need all the cushion they can get.

5. Think of your home as an investment, not just a place to raise your kids.

This may seem counter-intuitive, since speculation on housing prices played a huge role in creating the recent housing bubble. But speculating and investing are not the same thing.

A home, in addition to being a place to raise kids, is a massive financial obligation. Becoming emotionally attached to a house, rationalizing the financial realities away and hoping paychecks keep coming simply isn’t a viable home-buying strategy. As un-romantic as it may be, treat a home as you would a stock: Examine it, turn it upside down, run the numbers. Love it every day you’re there, but financial responsibility and emotional attachment don’t need to be mutually exclusive.

The time to buy may not be today -- and it may not be tomorrow -- but we’ll be closer to that day tomorrow than we are today. However, just as prices overshot to the upside, they'll likely overshoot to the downside - be ready when that day comes.

Preparation, not hoping, will be the key to taking advantage of the opportunities that will present themselves on the other side of this mess.

When Good Credit Goes Bad

This post first appeared on Minyanville.

An impeccable credit score was once a source of pride for bill-paying, fiscally responsible Americans. Now, as card issuers slash lines, up minimum payment requirements and raise interest rates seemingly at random, a stellar credit rating is rare indeed.

Besieged by mounting losses on all types of consumer debt, banks and credit-card companies are scaling back: According to Bloomberg, 45% of all US banks reduced credit card limits for new or existing customers in 2008's fourth quarter.

Issuers are attacking the problem in various ways, but the net effect is the same: Americans are using less plastic. Citibank (C) is lowering credit limits, Capital One (COF) is charging new customers higher rates, JPMorgan Chase (JPM) is upping minimum monthly payments from 2% to 5% on certain accounts, and American Express (AXP) is awarding $300 to select clients if they close their accounts entirely.

The trouble isn’t just that formerly credit-dependent consumers are having a tougher time making ends meet. FICO scores -- the most common measure of a person’s credit-worthiness -- heavily weigh total credit utilized compared to total credit available.

So as lines are cut, outstanding balances as a percentage of total credit lines rise. This in turn dings a consumer’s credit rating, making it harder to get a new card, and in some cases causing existing creditors to jack up interest rates. The vicious cycle continues, and even borrowers with heretofore unblemished credit histories are finding their FICO scores drop for the first time ever.

The solution, as evidenced by dismal earnings reports from the country’s biggest retailers, is simple: Spend less, save more.

Even as lawmakers are making herculean efforts to revitalize the economy by injecting money into the banking system and lowering taxes, reality is moving in the opposite direction.

An anti-spending, anti-consumerist mindset is taking hold across the socioeconomic spectrum. This shift cannot be stopped by flowery talk from Washington - or by vilifying Wall Street in Congress. Spending, the hobby of choice for nearly 3 decades, is becoming the thing not to do. Saving, which had begun to seem positively un-American, is once again in vogue.

This isn't some transitory fad we'll soon forget when the good times roll once again. The current crisis will be felt in the American psyche for decades to come.

Who knows - for our generation, cutting up credit cards may be our answer to the burning of bras.

Desperately Seeking Dollars: Greenback Catches a Bid

This post first appeared on Minyanville.

The phenomenon has many market observers scratching their heads: The US dollar is marching steadily upwards, despite the fact that the American banking system is on the ropes, the Federal Reserve is printing money at a record pace, and Washington wants to increase our already multi-trillion dollar deficit.

And while the answer to this conundrum is indeed complicated, its roots lie in how economic participants react to economic crisis and, ultimately, to deflation.

According to Bloomberg, in banking panics past, lenders tended to focus on doing business at home, rather than abroad. This makes logical sense: Bankers want to begin by helping those in their own backyards. The ongoing spat between Western and Eastern Europe, with the latter begging the former for help, is evidence that saving one’s own skin tends to take precedent when times get tough.

As a result, countries heavily reliant on foreign lending tend to fare poorly when such currency “protectionism” takes hold. Despite profound troubles at Citigroup (C), AIG (AIG) and Bank of America (BAC) -- to name but a few US financial institutions swimming in shark-infested waters -- many believe our banks, and indeed our economy, will fare better than those around the world.

Furthermore, as an economy spins out of control, politicians respond by firing up nationalistic rhetoric, urging a country’s citizens to band together. The widely-discussed “Buy American” provision in President Obama’s economic stimulus plan is but one example of lawmakers asking the electorate to “turn inward” in the face of danger.

Returning to the dollar, in addition to investors betting on the American economy to outperform its international counterparties, ongoing deleveraging favors the American currency. Dollar-denominated debt must be repaid with dollars, and as debtors scrounge up greenbacks to pay back their creditors, dollars become more scarce, driving their value upwards.

Deflation, which goes hand-in-hand with deleveraging, encourages consumers to hold on to cash, since as prices fall their dollars stretch further tomorrow, than they did today. Housing is a perfect example -- why buy a home today that will be worth less tomorrow?

The dollar is now approaching a near-term high not seen since the last time equity markets plunged to new lows (last November). This echoes Toddo's persistent theme of "asset class inflation vs. dollar devaluation." It's no doubt policymakers and the Plunge Protection Team are acutely aware of this relationship -- it's now a question of when, and how, they'll act.

Stay tuned, as Mr. Practical is apt to say: Risk is high.