Friday, December 25, 2009
Happy Holidays!
In order to enjoy time with family and friends, we will take a short break from our weekly postings over the holiday season. We will resume again on January 8, 2010. Best wishes in the upcoming year!
Friday, December 18, 2009
What's Next in the Year Ahead?
First, we would like to take a moment to wish you and your family a Merry Christmas, Happy Hanukkah, and a very happy New Year! Please enjoy the time with family and friends as we begin a new decade come January 1, 2010.
In recent weeks economic data continues to show improvement for the U.S. economy. Economic data, like most things in life, are usually measured on a relative basis. The economy looks fantastic relative to where it was a year ago and today it would be difficult to find someone who would argue that point.
But the past is the past and is now forever part of history. We must focus on the future and what lies ahead. In the financial world there is always an abundance of opinions and ideas. However, the smartest minds in the investment business and economic arena are theorizing totally different outcomes in 2010 and the years ahead. Some are expecting low inflation and slow growth for a number of years, while others expect a fairly robust worldwide recovery along with higher levels of inflation. We suspect the various economic outcomes will be debated heavily in future months. So what's possible for the economy and the markets in the years ahead?
First, we have to expect that interest rates will move higher in 2010 and beyond. A number of determinants have held down interest rates over the past year - a near-zero interest rate policy by the Fed, a surplus of savings around the world, government interest rate intervention and stimulus, a banking industry reluctant to loan, low current inflation readings and future inflation expectations, and quantitative easing by the Fed to jump start growth.
However, the higher probability of a reviving world economy, the structural imbalances and worsening financial conditions of our state and local governments, the liabilities associated with an aging population and the need to finance our federal deficit will likely weigh on the bond markets and interest rates in the year ahead. While it is always easy seeing the world from a rear view mirror, the difficulty, of course, is in figuring out when the turn will come. If economic growth is robust, the turn may come sooner. If growth is not as robust as expected, interest rates could remain at lower levels.
Second, we should expect higher inflation in the future. Again, it will be difficult to predict when it will start to accelerate, but we can be fairly certain it will arrive. The Fed is determined to bring inflation back and current policies will likely bring about their desired result. With so much liquidity being pumped into the global financial system through extremely low interest rates, massive government stimulus programs, along with Federal Reserve and other world government's monetary policies, we should expect a pickup in inflation, especially if we have no clear and definitive program in place to withdraw the excess liquidity from the system.
Third, just as the 1% interest rate policy and massive liquidity injections under the Greenspan administration caused the housing bubble and relatively lack luster economic growth coming out of the last recession; we can expect the 0% interest rate policy along with an obscene amount of liquidity injections under Bernanke will have unknown implications and unintended consequences. Unfortunately, it is extremely difficult to predict what will happen and where it will manifest. The unexpected could surface in a year from now, 2 years from now, or 5 years from now, but we can be almost 100% certain something will result from current policies.
Finally, there seems to be a societal and political shift towards more populist ideals in this country. Since the crisis began, more people are questioning the structure and perceived inequalities of capitalism and are beginning to think about alternative ideas on how to structure society. Citizens are collectively moving toward the belief that they are entitled to have access to what they need in order to live a full life. Of course, in our society, human needs have always come before private profits. These include access to food, housing, education, and medical care. However, "human needs" is a very broad term and is expanding to include other wants to which citizens believe they are entitled.
While this populist shift may not have an immediate impact on capital markets, if the movement gains traction there could be an impact on economic growth and corporate profitability in the future. If the economy recovers and the unemployment rate declines significantly, we should expect the movement to lose traction. However, if the unemployment rate remains high, the populist movement could really begin to impact policy coming out of Washington.
While we can attach a higher probability of certain outcomes in the coming years based on current economic conditions and market expectations, we can't predict the timing or possibility of another crisis, which would dramatically impact the probabilities of the various outcomes discussed. The next several years could prove to be very interesting and we look forward to navigating through whatever environment unfolds.
In recent weeks economic data continues to show improvement for the U.S. economy. Economic data, like most things in life, are usually measured on a relative basis. The economy looks fantastic relative to where it was a year ago and today it would be difficult to find someone who would argue that point.
But the past is the past and is now forever part of history. We must focus on the future and what lies ahead. In the financial world there is always an abundance of opinions and ideas. However, the smartest minds in the investment business and economic arena are theorizing totally different outcomes in 2010 and the years ahead. Some are expecting low inflation and slow growth for a number of years, while others expect a fairly robust worldwide recovery along with higher levels of inflation. We suspect the various economic outcomes will be debated heavily in future months. So what's possible for the economy and the markets in the years ahead?
First, we have to expect that interest rates will move higher in 2010 and beyond. A number of determinants have held down interest rates over the past year - a near-zero interest rate policy by the Fed, a surplus of savings around the world, government interest rate intervention and stimulus, a banking industry reluctant to loan, low current inflation readings and future inflation expectations, and quantitative easing by the Fed to jump start growth.
However, the higher probability of a reviving world economy, the structural imbalances and worsening financial conditions of our state and local governments, the liabilities associated with an aging population and the need to finance our federal deficit will likely weigh on the bond markets and interest rates in the year ahead. While it is always easy seeing the world from a rear view mirror, the difficulty, of course, is in figuring out when the turn will come. If economic growth is robust, the turn may come sooner. If growth is not as robust as expected, interest rates could remain at lower levels.
Second, we should expect higher inflation in the future. Again, it will be difficult to predict when it will start to accelerate, but we can be fairly certain it will arrive. The Fed is determined to bring inflation back and current policies will likely bring about their desired result. With so much liquidity being pumped into the global financial system through extremely low interest rates, massive government stimulus programs, along with Federal Reserve and other world government's monetary policies, we should expect a pickup in inflation, especially if we have no clear and definitive program in place to withdraw the excess liquidity from the system.
Third, just as the 1% interest rate policy and massive liquidity injections under the Greenspan administration caused the housing bubble and relatively lack luster economic growth coming out of the last recession; we can expect the 0% interest rate policy along with an obscene amount of liquidity injections under Bernanke will have unknown implications and unintended consequences. Unfortunately, it is extremely difficult to predict what will happen and where it will manifest. The unexpected could surface in a year from now, 2 years from now, or 5 years from now, but we can be almost 100% certain something will result from current policies.
Finally, there seems to be a societal and political shift towards more populist ideals in this country. Since the crisis began, more people are questioning the structure and perceived inequalities of capitalism and are beginning to think about alternative ideas on how to structure society. Citizens are collectively moving toward the belief that they are entitled to have access to what they need in order to live a full life. Of course, in our society, human needs have always come before private profits. These include access to food, housing, education, and medical care. However, "human needs" is a very broad term and is expanding to include other wants to which citizens believe they are entitled.
While this populist shift may not have an immediate impact on capital markets, if the movement gains traction there could be an impact on economic growth and corporate profitability in the future. If the economy recovers and the unemployment rate declines significantly, we should expect the movement to lose traction. However, if the unemployment rate remains high, the populist movement could really begin to impact policy coming out of Washington.
While we can attach a higher probability of certain outcomes in the coming years based on current economic conditions and market expectations, we can't predict the timing or possibility of another crisis, which would dramatically impact the probabilities of the various outcomes discussed. The next several years could prove to be very interesting and we look forward to navigating through whatever environment unfolds.
Pay Mortgage or Walk Away
Debtor's Dilemma: Pay the Mortgage or Walk Away
By JAMES R. HAGERTY and NICK TIMIRAOS (WSJ)
PHOENIX -- Should I stay or should I go? That is the question more Americans are asking as the housing market continues to drag.
In good times, it would have been unthinkable to stop paying the mortgage. But for Derek Figg, a 30-year-old software engineer, it now seems like the best option.
Mr. Figg felt trapped in a home he bought two years ago in the Phoenix suburb of Tempe for $340,000. He still owes about $318,000 but figures the home's value has dropped to $230,000 or less. After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them.
Mr. Figg plans to rent an apartment nearby, saving about $700 a month.
A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a "strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.
A standard mortgage-loan document reads, "I promise to pay" the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.
George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.
Walking away isn't risk-free. A foreclosure stays on a consumer's credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.
In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.
Even so, in neighborhoods with high concentrations of foreclosures, "it's going to be really difficult to prevent a cascade effect" as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.
Derek Figg sits in his Tempe, Ariz., home on Tuesday. He stopped making mortgage payments in September. Driving this phenomenon is the rising number of households that are deeply "under water," owing much more than the current value of their homes. First American CoreLogic, a real-estate information company, estimates that 5.3 million U.S. households have mortgage balances at least 20% higher than their homes' value, and 2.2 million of those households are at least 50% under water. The problem is concentrated in Arizona, California, Florida, Michigan and Nevada.
Josh Cotner, who owns an insurance agency, says his mortgage balance is about $100,000 more than the market value of his home in Gilbert, Ariz. Mr. Cotner could rent a bigger home nearby for $600 a month, far below the $1,655 he now pays on his mortgage, home insurance and property tax. He says he recently stopped making mortgage payments because his lender wouldn't help him reduce the principal on his loan under a federal program in which he believes he is qualified to participate. Given the sometimes lengthy legal process of foreclosure, he may be able to stay in the home for at least another nine months without making any payments.
Banks warn they may get tough with strategic defaulters by pursuing legal claims on a borrower's other assets. "We will try to reduce people's payments if they have a hardship," says Thomas Kelly, a spokesman for J.P. Morgan Chase & Co. "But we have a financial responsibility to get people to pay what they owe if they can afford it."
Steven Olson, a loan officer and roof installer in Roseville, Minn., defaulted in 2007 on a plot of land in Florida he had bought as an investment. "I thought I could move on with my life," he says. But the lender, RBC Bank, a subsidiary of Royal Bank of Canada, sued him, seeking to make him pay more than $400,000 to the bank to cover its losses on the loan. Mr. Olson has hired a Florida lawyer, Roy Oppenheim, to resist the claim. An RBC spokesman declined to comment.
States where lenders generally can pursue such legal claims include Florida and Nevada but not California and Arizona, where laws generally prohibit lenders from pursuing other assets of mortgage borrowers. A new Nevada law will protect many borrowers from these judgments if they bought a home for their own use after Sept 30, 2009.
Another risk for defaulters is that banks could sell the rights to pursue claims to collection agencies or other firms, which could then dun the borrowers for up to 20 years after a foreclosure. Such threats appear to deter some borrowers. A recent study from the Federal Reserve Bank of Richmond found that under-water borrowers were 20% more likely to default in a state where mortgage lenders can't pursue claims on other assets than in those where they can.
Brent White, an associate law professor at the University of Arizona who has written about this issue, says homeowners should make the decision on whether to keep paying based on their own interests, "unclouded by unnecessary guilt or shame." He says borrowers can take a cue from lenders that "ruthlessly seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility."
But it isn't just a matter of the borrower's personal interest, says John Courson, chief executive of the Mortgage Bankers Association, a trade group. Defaults hurt neighborhoods by lowering property values, he says, adding: "What about the message they will send to their family and their kids and their friends?"
In Mesa, another suburb of Phoenix, low prices are helping to draw buyers who may walk away from other homes. Christina Delapp bought a house out of foreclosure in July for $49,000 in cash. She says she will stop paying the mortgage on another home she still owns in Tempe if she can't sell in the next few months for more than the $312,000 that she owes.
Ms. Delapp, who has been jobless for 18 months, says that the new home is part of her survival strategy. "I feel very fortunate," she says. "Regardless of what happens to my credit, we've managed to put together the best safety plan that I possibly could."
By JAMES R. HAGERTY and NICK TIMIRAOS (WSJ)
PHOENIX -- Should I stay or should I go? That is the question more Americans are asking as the housing market continues to drag.
In good times, it would have been unthinkable to stop paying the mortgage. But for Derek Figg, a 30-year-old software engineer, it now seems like the best option.
Mr. Figg felt trapped in a home he bought two years ago in the Phoenix suburb of Tempe for $340,000. He still owes about $318,000 but figures the home's value has dropped to $230,000 or less. After agonizing over the pros and cons, he decided recently to stop making loan payments, even though he can afford them.
Mr. Figg plans to rent an apartment nearby, saving about $700 a month.
A growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a "strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.
A standard mortgage-loan document reads, "I promise to pay" the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.
George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.
Walking away isn't risk-free. A foreclosure stays on a consumer's credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.
In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.
Even so, in neighborhoods with high concentrations of foreclosures, "it's going to be really difficult to prevent a cascade effect" as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.
Derek Figg sits in his Tempe, Ariz., home on Tuesday. He stopped making mortgage payments in September. Driving this phenomenon is the rising number of households that are deeply "under water," owing much more than the current value of their homes. First American CoreLogic, a real-estate information company, estimates that 5.3 million U.S. households have mortgage balances at least 20% higher than their homes' value, and 2.2 million of those households are at least 50% under water. The problem is concentrated in Arizona, California, Florida, Michigan and Nevada.
Josh Cotner, who owns an insurance agency, says his mortgage balance is about $100,000 more than the market value of his home in Gilbert, Ariz. Mr. Cotner could rent a bigger home nearby for $600 a month, far below the $1,655 he now pays on his mortgage, home insurance and property tax. He says he recently stopped making mortgage payments because his lender wouldn't help him reduce the principal on his loan under a federal program in which he believes he is qualified to participate. Given the sometimes lengthy legal process of foreclosure, he may be able to stay in the home for at least another nine months without making any payments.
Banks warn they may get tough with strategic defaulters by pursuing legal claims on a borrower's other assets. "We will try to reduce people's payments if they have a hardship," says Thomas Kelly, a spokesman for J.P. Morgan Chase & Co. "But we have a financial responsibility to get people to pay what they owe if they can afford it."
Steven Olson, a loan officer and roof installer in Roseville, Minn., defaulted in 2007 on a plot of land in Florida he had bought as an investment. "I thought I could move on with my life," he says. But the lender, RBC Bank, a subsidiary of Royal Bank of Canada, sued him, seeking to make him pay more than $400,000 to the bank to cover its losses on the loan. Mr. Olson has hired a Florida lawyer, Roy Oppenheim, to resist the claim. An RBC spokesman declined to comment.
States where lenders generally can pursue such legal claims include Florida and Nevada but not California and Arizona, where laws generally prohibit lenders from pursuing other assets of mortgage borrowers. A new Nevada law will protect many borrowers from these judgments if they bought a home for their own use after Sept 30, 2009.
Another risk for defaulters is that banks could sell the rights to pursue claims to collection agencies or other firms, which could then dun the borrowers for up to 20 years after a foreclosure. Such threats appear to deter some borrowers. A recent study from the Federal Reserve Bank of Richmond found that under-water borrowers were 20% more likely to default in a state where mortgage lenders can't pursue claims on other assets than in those where they can.
Brent White, an associate law professor at the University of Arizona who has written about this issue, says homeowners should make the decision on whether to keep paying based on their own interests, "unclouded by unnecessary guilt or shame." He says borrowers can take a cue from lenders that "ruthlessly seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility."
But it isn't just a matter of the borrower's personal interest, says John Courson, chief executive of the Mortgage Bankers Association, a trade group. Defaults hurt neighborhoods by lowering property values, he says, adding: "What about the message they will send to their family and their kids and their friends?"
In Mesa, another suburb of Phoenix, low prices are helping to draw buyers who may walk away from other homes. Christina Delapp bought a house out of foreclosure in July for $49,000 in cash. She says she will stop paying the mortgage on another home she still owns in Tempe if she can't sell in the next few months for more than the $312,000 that she owes.
Ms. Delapp, who has been jobless for 18 months, says that the new home is part of her survival strategy. "I feel very fortunate," she says. "Regardless of what happens to my credit, we've managed to put together the best safety plan that I possibly could."
Friday, December 11, 2009
Sovereign Default Risk
According to the CMA Sovereign Rate Risk Monitor, below is a list of the top ten countries with the highest default probilities on their respective debt based on current CDS (credit default swap) pricing.
Venezuela 60.71%
Ukraine 53.75%
Argentina 50.93%
Pakistan 36.21%
Dubai 31.14%
Latvia 30.38%
Iceland 25.65%
Lithuania 19.67%
California 19.16%
Romania 17.35%
Notice number 9 on the list? While there is usually always a mix of countries and republics, it was surpising to see a US state on the top ten list. It may mean something or may mean nothing, but interesting none the less.
Venezuela 60.71%
Ukraine 53.75%
Argentina 50.93%
Pakistan 36.21%
Dubai 31.14%
Latvia 30.38%
Iceland 25.65%
Lithuania 19.67%
California 19.16%
Romania 17.35%
Notice number 9 on the list? While there is usually always a mix of countries and republics, it was surpising to see a US state on the top ten list. It may mean something or may mean nothing, but interesting none the less.
Friday, December 4, 2009
Unemployment Rate Declines
Nonfarm payrolls fell by just 11,000 last month, slowing down from a downwardly revised 111,000 drop seen in October, reported the Labor Department.
It was the best showing in payrolls since December 2007, when the recession began and payrolls had risen by 120,000. Economists surveyed by Dow Jones Newswires had expected a payroll decrease of 125,000.
The unemployment rate, calculated using a survey of households as opposed to companies, edged lower to 10% in November from 10.2%. Economists had forecast the jobless rate would remain at October's level of 10.2%, the highest level since April 1983.
The payroll data reflect the first notable improvement in the jobs market since the recession began two years ago; although we still have yet to see net job growth. However, it seems as though we should see some job growth in the payroll data in the coming months.
Employment in the service sector -- the main source of U.S. jobs -- rose by 58,000 in November. But that was more than offset by manufacturing companies shedding 41,000jobs and construction companies cutting 27,000.
Health-care employment continued to rise in November, by 21,000. The industry has added 613,000 jobs since the recession began at the end of 2007.
With unemployment still at 10%, the Federal Reserve's view that interest rates must remain at a record low to bolster a soft recovery should remain unchanged. The central bank left interest rates close to zero a month ago in the face of low inflation and still-high unemployment.
It was the best showing in payrolls since December 2007, when the recession began and payrolls had risen by 120,000. Economists surveyed by Dow Jones Newswires had expected a payroll decrease of 125,000.
The unemployment rate, calculated using a survey of households as opposed to companies, edged lower to 10% in November from 10.2%. Economists had forecast the jobless rate would remain at October's level of 10.2%, the highest level since April 1983.
The payroll data reflect the first notable improvement in the jobs market since the recession began two years ago; although we still have yet to see net job growth. However, it seems as though we should see some job growth in the payroll data in the coming months.
Employment in the service sector -- the main source of U.S. jobs -- rose by 58,000 in November. But that was more than offset by manufacturing companies shedding 41,000jobs and construction companies cutting 27,000.
Health-care employment continued to rise in November, by 21,000. The industry has added 613,000 jobs since the recession began at the end of 2007.
With unemployment still at 10%, the Federal Reserve's view that interest rates must remain at a record low to bolster a soft recovery should remain unchanged. The central bank left interest rates close to zero a month ago in the face of low inflation and still-high unemployment.
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