Boom2Bust.com

Weekend Edition: June 30-July 1, 2007

This afternoon, the United Kingdom raised its terrorism threat level to critical, the highest level possible, after a vehicle plowed into the Glasgow International Airport terminal building and burst into flames. According to CNN, authorities are assuming the incident is directly linked to the discovery of 2 explosives-laden cars in London on Friday. In the United States, security is being boosted at airports across the country as I write this post.

The other day, I talked about the threat posed by natural disasters, specifically hurricanes, to the U.S. economy. Today I’d like to focus on man-made disasters, particularly the threat of nuclear terrorism. Warnings of a nuclear attack on American soil have originated from the government, the military, and academia, as well as the private sector. In the 2004 American presidential election, both President Bush and his opponent John Kerry agreed on only one fundamental point. In the first televised debate the two were asked, what is “the single most serious threat to the national security to the United States?” President Bush, who answered second, said, “I agree with my opponent that the biggest threat facing this country is weapons of mass destruction in the hands of a terrorist network.” According to journalist, author, and former FBI consultant Paul L. Williams in his book The Al Qaeda Connection, Vice President Dick Cheney, while on the campaign trail, warned that a nuclear attack by al-Qaeda appears imminent. Upon leaving office, Attorney General John Ashcroft and Homeland Security Director Tom Ridge both indicated that plans for a nuclear attack on the U.S. might be carried out. General Eugene Habiger, the former executive chief of U.S. Strategic Weapons at the Pentagon, claims that an act of nuclear terrorism is “not a matter of if, but when.” Graham T. Allison, Director of the Belfer Center for Science and International Affairs at Harvard University’s JFK School of Government, concludes that the chances of a nuclear terrorist attack in the next decade are greater than 50%. He was quoted in WorldNetDaily on April 20 to say, “From the technical side, Richard Garwin, a designer of the hydrogen bomb who Enrico Fermi once called, ‘the only true genius I had ever met,’ told Congress in March he estimated a ‘20 percent per year probability with American cities and European cities included’ of ‘a nuclear explosion — not just a contamination, dirty bomb — a nuclear explosion.’” Finally, legendary investor Warren Buffett, who establishes odds against cataclysmic events for major insurance companies, predicts that a nuclear attack within the United States is “virtually a certainty.”

Dr. Allison, a well-know nuclear terrorism expert, explained at a Council of Foreign Relations forum in April why the stakes are so high for terrorists to conduct a nuclear attack. He said, “[T]he effect of a nuclear terrorist attack would reverberate beyond U.S. shores. After a nuclear detonation, the immediate reaction would be to block all entry points to prevent another bomb from reaching its target. Vital markets for international products would disappear, and closely linked financial markets would crash. Researchers at RAND, a U.S. government-funded think tank, estimated that a nuclear explosion at the Port of Los Angeles would cause immediate costs worldwide of more than $1 trillion and that shutting down U.S. ports would cut world trade by 7.5 percent.” Dr. Williams paints a grim picture of what would happen if a 10-kiloton nuclear device is detonated in New York City. In his book he says, “The financial and cultural center of America would cease to exist. The GNP would drop more than 3 percent in a matter of seconds. One of America’s ports would be closed indefinitely. Millions of Americans would lose their jobs… Within hours of the blast, the US economy would fall into a deep depression from which it might never recover.”

The detonation of a nuclear device in an American metropolitan area is a chilling thought. Such an event could in and of itself trigger a financial crash in the United States. In an upcoming post, we’ll look at a purported al-Qaeda plan to detonate nuclear devices in several U.S. cities simultaneously.

Have a SAFE weekend!

Christopher E. Hill
Editor
editor@boom2bust.com

Subprime Lenders Still Pushing Dangerous Loans

According to the consumer advocate group Center for Responsible Lending (CRL), abuses by subprime mortgage lenders persist, even with the recent meltdown. The Center presented its findings on subprime loans included in 10 recent packages of mortgage-backed securities to a Senate subcommittee hearing on mortgage abuse earlier this week. Keith Armstrong, CRL’s senior policy counsel said in CNN Money on June 27 that, “A lot of the terms that make these loans so dangerous are still being used. We had been told that these things are going away.” The CRL found that more than 75% of the subprime loans turned out to be adjustable-rate mortgages (ARMs), with 90% of those hybrid ARMs. Hybrid ARMs have 2 to 3 years of cheaper, low-interest, fixed-rate payments, commonly known as “teaser rates.” However, these loans reset at higher rates later on, leading to significantly-increased payments for the homeowner. In addition, more than two-thirds of the subprime loans it looked at contained pre-payment penalties, which make it very expensive to re-finance out of them and into a lower-rate fixed mortgage. Finally, the Center uncovered many loans which don’t require proof of earnings, assets, or both- commonly referred to as “liar loans.” Americans will lose up to $164 billion in home-based wealth due to foreclosures in the subprime mortgage market, according to the CRL. Due in part to adjustable-rate mortgages, 1 out of 5 subprime loans issued during 2005 and 2006 will fail, they predict.

CNN Money asked Doug Duncan, chief economist for the Mortgage Bankers Association, as to why lenders are continuing to offer subprime loans when they’ve proven so dangerous? Duncan said that troubled lenders are aggressively making new loans for an infusion of cash. “They’re gambling,” said CRL’s Armstrong, “doubling down and that’s a recipe for disaster.” On June 29, MarketWatch reported that federal regulators issued new rules, effective immediately, for adjustable-rate mortgage products that can cause payment shock. The new regulations call for banks to improve disclosures, limit prepayment penalties, limit the use of “stated income” loans, and include a fully-indexed, fully-amortized qualification for borrowers. The problem is that while banks are held accountable to these new rules, mortgage brokers are not. As John Taylor, president and chief executive of the National Community Reinvestment Coalition told MarketWatch, “This guidance is simply not enforceable against the majority of people who do these kinds of activities.”

A Different Kind Of Storm, Part 2

Yesterday I talked about how the 2007 hurricane season forecast is for above-average activity, with the U.S. Gulf region once again a target. However, my greatest concern is the possibility of a major hurricane shooting up the Eastern Seaboard and making landfall in the New York City area. How likely is this scenario? A 1990 study by the U.S. Army Corps of Engineers said the 3 U.S. cities most vulnerable to hurricanes are New Orleans, Miami, and New York. The Associated Press on May 31 pinpointed 5 of the most vulnerable U.S. coastal spots, with New York City one of them. Joe Bastardi, the chief hurricane forecaster for AccuWeather.com, said that in past years with the same climatological patterns, “Some of those years also saw a storm break out of the pack and head up the East Coast, and we would not be surprised to see this scenario play out this year as well. Any storm that strikes north of Hatteras has increased potential to be a major one,” he said. Last year, Bastardi correctly forecast that the Gulf Coast would get “minimal” attention by that season’s hurricanes. According to ScienceDaily.com yesterday, University of Rhode Island Professor Isaac Ginis, who helped develop an ocean-based hurricane forecast model that has been the most accurate prediction tool at the National Hurricane Center, believes that the Eastern Seaboard may be at greater risk for a hurricane this year. Professor Ginis said, “We just finished an El Nino period, which results in fewer storms, but now we’re transitioning to La Nina, which favors storm development… We’re overdue here in New England for a big storm. Category 3 storms strike our region about every 60 years, and the last one was Carol in 1954.”

A major hurricane making landfall at or near New York City will result in extensive flooding and heavy storm surges. Even a minor hurricane has the potential to submerge Lower Manhattan and the runways at JFK Airport. A direct hit on New York’s Long Island by a Category 3 or higher hurricane could cost $100 billion (as compared to Katrina’s $81 billion), according to a CBS News report last July 30. The same size storm hitting south of the City in central New Jersey would be catastrophic, with $200 billion in damages and lost business. “And much of that disruption will not be covered by insurance,” according to catastrophe risk analyst Karen Clark. “It will be the largest financial disaster that this country has ever seen,” she added. Scott Mandia, a professor of physical sciences at Suffolk County Community College in Selden, New York, predicted in National Geographic News on May 19, 2006, that “There will be an economic shutdown for a few weeks, if not a month.” Nicholas Coch, a professor of environmental sciences at Queens College in New York City, added, “Should a hurricane close the port of New York and the New York Stock Exchange for a week or more, the damage to the nation’s economy would be more severe than that caused by Katrina.”

The socioeconomic impact of hurricanes in the United States is much more significant today than in years past because Americans have a love affair with coastal living. The U.S. Census Bureau estimates that 35 million people, or 12% of the population, live in coastal areas most threatened by Atlantic hurricanes. The number has more than tripled since 1950, and the Census doesn’t even count Northern coastal states, according to an Associated Press article on May 31. Margaret Davidson, director of the National Oceanic and Atmospheric Administration’s Coastal Services Center, told the Associated Press that, “When I was growing up on the Redneck Riviera, most of the stuff we built was built out of plywood, and you built it with your cousins on a weekend. And if it blew away, you got yourselves a keg of beer and you got your relatives together and you went out and built it again. And what we now have strewn across the coast is a bunch of McMansions.”

Contrary to what some economists would have you believe, natural disasters, such as hurricanes, do not benefit the U.S. economy. The dollars spent on reconstruction must come from somewhere- it doesn’t just materialize out of thin air. Money spent on reconstruction is money not spent on other projects, or on reducing government debt, or on tax cuts, etcetera. In the case of Hurricane Katrina, faced with the difficult choice of either reducing spending in other areas or borrowing money to pay for the recovery effort, the United States chose to borrow funds overseas, according to Peter Schiff in his book Crash Proof. Schiff said, “As a result, our external debt grew by that much more, exacerbating our current account deficit and representing a drain on our future consumption for generations to come. However, once foreigners no longer make their savings available to Americans, the real burden of natural disasters will be more apparent.” While hurricanes, like other natural disasters, may not in themselves cause a financial crash, they have the ability to hasten and magnify the pain of our “financial reckoning day.”

A Different Kind Of Storm, Part 1

In Boom2Bust.com, we’ve examined different threats to the U.S. economy. However, we must not forget natural and man-made dangers as well. One threat that I am deeply concerned about is that of hurricanes. The major forecasting centers are calling for above-average storm activity this year. However, complacency is evident in a recent survey by TripAdvisor.com, the “world’s largest travel community.” In a PR Newsire release on June 12, TripAdvisor reported that 92% of the travelers polled have not been influenced by predictions for an active 2007 hurricane season, compared to 89% in 2006. Granted, to date this year’s hurricane activity has been uneventful.

Yet, the National Oceanic and Atmospheric Administration places the odds for better-than-normal hurricane activity at 75%. NOAA is predicting 13 to 17 named storms. 7 to 10 of these storms will become hurricanes, and 3 to 5 will become major hurricanes. Colorado State University predicts that 17 storms will form, producing 9 hurricanes, 5 of which will be major events. The CSU team thinks one of those major hurricanes will probably make landfall somewhere on the Gulf of Mexico or Atlantic coasts. Another forecast team at North Carolina State University predicts 12 to 14 storms, 8 to 9 hurricanes, and 4 to 5 major hurricanes. The NCSU team foresees 1 to 2 hurricanes making landfall. Finally, AccuWeather.com expects 13 to 14 named storms, with 6 or 7 of these striking the U.S. coast. Joe Bastardi, the chief hurricane forecaster, says the Texas Gulf coast is twice as likely to be hit as in an average year and Florida appears four times as likely. Bastardi fears climatic conditions could lead to storms that intensify relatively late in their life when they are closer to landfall.

We all witnessed the devastation to the Gulf Coast region from hurricanes in 2005. Hurricane Katrina alone caused $81 billion in damage. New Orleans and other affected communities are slowly rebuilding. The U.S. Army Corps of Engineers just released a report which showed that large areas of New Orleans are still likely to be flooded in a major storm, according to the Kansas City Star on June 20. The petroleum industry has spent nearly 2 years trying to repair the damage from Hurricanes Katrina and Rita, rebuilding platforms, pipelines, and refineries in a region that produces roughly 25% of the nation’s oil and 15% percent of its natural gas. Those storms destroyed 113 of the Gulf’s 4,000 oil and gas platforms and damaged 52 others. According to the Atlanta Journal-Constitution on May 29, the Minerals Management Service, a division of the U.S. Interior Department that manages offshore leases, says the “vast majority” of production from 2 years ago has resumed, but it didn’t have precise figures. Analysts say gas prices are certain to shoot higher ($4 a gallon, perhaps) if and when the season’s first storm enters the Gulf of Mexico.

And what is the likelihood of hurricanes targeting this region in 2007? According to the Colorado State forecast team, there is a 74% chance at least one major hurricane would hit the U.S. coastline in 2007, with a 50% chance that it would happen on the U.S. Atlantic Coast and a 49% chance on the Gulf of Mexico Coast. Joe Bastardi in the Hurricane Season Forecast 2007 on AccuWeather.com predicts, “The highest area of risk has swung southwest from the Atlantic to Florida and the eastern and central Gulf Coast regions. In past years that exhibited the same climatological patterns we expect this season, these areas were the main target of Atlantic hurricanes and tropical storms.” Not what anyone wants to hear.

Believe it or not, it could be worse. Tomorrow’s post will focus on an area along the eastern seaboard that could result in the evacuation of 3 million people (more than six times the population of pre-Katrina New Orleans) and over $100 billion in economic losses from a Category 3+ hurricane.

Real Estate, Real Denial

A recent survey by the Boston Consulting Group reveals that 55% of Americans believe they can sell their house for more now than a year ago, which is down slightly from the 59% who felt that way in summer 2006. 49% percent of those polled in the Northeast think their home is worth more now than a year ago, compared with 51% in the Midwest, 56% in the South, and 64% in the West. Nearly three-quarters believe they can sell their homes within the next 6 months at a price they set, and 63% feel that real estate is a good or excellent investment. The survey was conducted by phone from May 31 to June 3, with 1,007 responses.

In a June 22 Associated Press article, Michael J. Silverstein, a senior partner at the Boston Consulting Group, said, “Americans believe their homes are still their best investment. They’re positive about their homes’ value and believe in a bounce-back in residential real estate, overall.” In a June 25 CNNMoney.com article, Silverstein added that he believes the strong faith in home values shown in the latest survey is due to homeowners’ long-term view of their real estate investment. He pointed to another survey question that found 85% believe their house will be worth more in 5 years than it is today. According to Silverstein, “American consumers think long-term and they have a five-to-seven year time frame about the value of their home… I think what people want for their home is more than [what] they paid for it. They are looking at the glass and saying it’s half-full and I’m going to make some money if I sold it today. Do they know what their house was worth precisely a year ago, and what it’s worth today? The answer to that is no.”

BCG’s Silverstein may be correct in stating that the survey results are so upbeat because American consumers think long-term (5 to 7 year timeframe) about the value of their homes. After all, as Americans we have been told all along that housing values never go down. However, consider the following points made by the Wall Street Journal on March 12:

If you bought a house in Los Angeles in 1990, just as the real-estate market turned downward, you would have had to wait a decade for your home’s value to return to what you paid.

If you bought in Rochester, New York, in 1980, you would have seen only a mediocre 4% annual growth for the next 25 years.

If you bought in Dallas in 1986, as the oil boom went bust, your home wouldn’t have appreciated at all before 1998.

The reality is, real estate values can and do go down, significantly and for an extended period of time.

Home prices in 10 major U.S. cities dropped at the fastest pace in 16 years during the 12 months ending in April, according to Standard & Poor’s Case-Shiller home price index that was released earlier today. Home prices in the 10 cities fell 2.7% on a year-over-year basis, the largest decline since September 1991. Prices in the 20-city composite dropped a record 2.1% year over year. According to Robert Shiller, chief economist for MacroMarkets LLC and the co-creator of the index, “No region is immune to weakening price returns.”

Prestigious Bank Warns Of Depression-Style Downturn

Years of lax monetary policy has created a dangerous credit bubble, leaving the global economy vulnerable to another Depression-style downturn, according to the Bank for International Settlements, the world’s foremost financial body. In their 77th Annual Report, the BIS, an international organization of central banks, pointed to a number of worrying signs, including “mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system,” according to the Telegraph (UK). The Bank noted that, “Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived.”

Criticizing the policies of the Federal Reserve Bank, the BIS said the Fed’s foreign counterparts were beginning to question the wisdom of letting asset “bubbles” grow on the assumption that they can be prevented from “popping,” which the Telegraph says was more or less the strategy favored by former Fed chief Alan Greenspan. The Bank noted this approach failed in the United States in 1930 and in Japan in 1991 because excess debt and investment built up in the preceding years had negative effects. While lowering interest rates in such a situation may be an option, it only succeeds in transferring wealth from creditors to debtors and “sowing the seeds for more serious problems further ahead.” The world’s oldest international banking organization said it was far from clear whether the United States would be successful in avoiding the consequences of its imbalances, citing a current account deficit of 6.5% of GDP, the growth of external liabilities by over $4 trillion from 2001 to 2005, and a significant drop in the savings rate.

“The dollar clearly remains vulnerable to a sudden loss of private sector confidence,” according to the Bank.

Weekend Edition: June 23-24, 2007

Reverse indicators. Do you use them? I use the term to describe someone or something that is more often wrong than right. My favorite example of a reverse indicator, and its use, is found in George Muzea’s The Vital Few Vs. The Trivial Many. In one section of this fantastic book, Muzea talked about his experience as a stockbroker with E.F. Hutton in New York, where he had a client that was “always wrong at decision time.” He recalled, “I used to call him and tell him about a stock I liked. If he liked the idea, I never offered it to my clients, including him. If he did not like the idea, I aggressively marketed the stock. Even the other brokers would ask me to call my reverse indicator to see if he liked their ideas.” Eventually, the client lost his job and had to close his account. The E.F. Hutton brokers threw a party in his honor, and as Muzea remembers, “We were depressed for him and us.”

When trying to figure out where the U.S. economy is headed, I look to the American consumer as one of my favorite reverse indicators. Specifically, I examine what Americans are spending their “hard-earned” dollars on. I’m being sarcastic here, because Americans no longer depend on savings to make a purchase. Instead, items are bought on credit. And who can blame them? The Federal Reserve was more than accommodating in helping U.S. consumers achieve instant gratification by lowering the Federal Funds Target Rate (short-term rate objective of the Fed) all the way down to 1% back in 2003. With interest rates so low, consumers financed purchases, especially when it came to big-ticket items.

So why do I examine what Americans are buying? Because of the correlation between frivolous spending and the top of an economic cycle. And what are some of the more notable non-essential purchases being made by consumers? Glad you asked. My favorites include:

Bottled Water- Americans drank 26 gallons of bottled water per person last year, or $11 billion worth. As the Sierra Club website notes, “It’s an amazing new fad, one of the most successful advertising hypes in recent history. Advertising for bottled water suggests that drinking water in plastic can make you thin, sexy, healthy, affluent, and environmentally responsible. Water bottles have become a fashion accessory.” However, studies don’t agree that it is any safer than tap water. Yet, in the U.S. a sip of bottled water costs on average 1,000 times a sip of water from the tap.

Outdoor Rooms- According to the Wall Street Journal back on June 8, “Outdoor rooms, one of the decade’s most visible symbols of excess, have been a bonanza for manufacturers of everything from $3,700 waterproof pool tables to $130 patio umbrellas that emit a cooling mist. About one million households have outdoor kitchens, with such features as built-in grills and cooktops, outdoor stereos and TVs, refrigerators— even dishwashers.” Surprisingly, homeowners are finding out about the long hours of upkeep and costly repair involved with these expensive backyards. As a result, some are abandoning the “rooms” altogether.

Retirement Homes For Young Adults- Real estate agents and financial planners around the country are increasingly assisting younger buyers with their purchase of retirement homes for themselves in the years ahead, according to a Wall Street Journal article of May 29. These buyers (30-40 somethings) believe that retirement property is a better investment than other traditional assets classes. One buyer, who was 32 when he bought a place for retirement with his spouse, explained, “The house is an asset, so it’s not like we’re throwing away part of our retirement savings.” A young couple from New Jersey said, “We wanted to get in while it was affordable.”

The last time I saw this kind of spending going on was in the late 1990s. I told anyone willing to listen that we were at the top of an economic cycle and headed downhill. Unfortunately, I think we’re at that point again in the U.S. economy, with an even worse ending in store. So, if there’s anyone you know who’s a “reverse indicator,” ask them where they think the U.S. economy is heading. Better yet, you may want to look at what they’re buying these days.

Enjoy the weekend!

Christopher E. Hill
Editor
editor@boom2bust.com

Consumers Cut Back On Casual Dining

These days, restaurant owners are wondering where some of their customers have gone. In an ominous sign that U.S. consumers are starting to curtail spending, same-restaurant sales, or sales at restaurants open at least 16 months, were down 1.5% at casual-dining restaurants from January to April compared to the same period in 2006, according to restaurant industry consultant Malcolm Knapp in the June 20 issue of the Orlando Sentinel. High gas prices and a bad housing market are seen as the main culprits. In May, a National Retail Federation survey showed gas prices were taking a toll on consumers. According to the Consumer Intentions and Actions survey, 31.1% of adults said they have cut back on dining out due to the cost of gas. Bank of America restaurant analyst Andrew Barish told investors last month that with the summer driving season, high gas prices might make an even bigger impact as consumers are already struggling with a weak housing market. In an Associated Press article from May 30, Barish said, “For the past year, high fuel costs and slumping housing prices have contributed to weak overall restaurant sales trends (particularly casual dining)… Value offerings will be essential over the next few months as the middle-income consumer faces the potential for continued difficult macro-economic trends.” Cowen & Co. analyst Paul Westra told AP that the consumer environment and the price pressures on consumers may even continue to be a “net drag” on discretionary spending through 2007. Westra said, “As such, we believe that casual dining traffic will stay negative for the remainder of 2007.”

In addition to gas and housing, the rising cost of dining out is keeping patrons away from their local eateries. Today’s Wall Street Journal noted that, “Casual-dining restaurants are getting hit by rising inflation. Corn prices have surged due to demand for corn-based ethanol. Because corn is a big feedstock, it’s trickling into the cost of everything from chicken to cheese. Wholesale butter, cream and milk prices have jumped about 20% in the past three months, according to Raymond James.” As you can guess, menu prices are going up, and diners are staying away.

Anyone know if the 2 Whoppers for 3 bucks deal is still going on?

Housing Slump Ends In 2 Months

In an interview with Bloomberg on Tuesday, Bank of America’s Chief Executive Officer Kenneth Lewis said the U.S. economy will pick up speed due to a recovery in the housing sector. Lewis predicted, “You’ll see the economy begin to pick up in the third and fourth quarters,” and the slowdown in home sales is “just about to be over.” He went on to say that the housing market will begin to improve in the next month or two, forestalling a recession, according to Bloomberg. Lewis believes that job growth will lift home prices and reinvigorate construction by early 2008.

However, as Bloomberg pointed out, Mr. Lewis’ views contradict those of other market watchers, including money manager Paul McCulley of Pimco. At a Bloomberg News panel discussion on Tuesday, McCulley insisted that, “The housing-market recession ain’t over… It’s going to be a long, protracted recession.” Some are willing to go farther than that. Mark Kiesel, executive vice president of California-based Pacific Investment Management, said in Bloomberg yesterday, “It’s a blood bath…We’re talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.” Nouriel Roubini, a former Treasury Department director under the Clinton administration and head of Roubini Global Economics in New York, added, “It’s not just a housing recession anymore, it looks more and more like an economic recession.” Roubini believes the chance of a recession in 2007 is at “50-50,” greater than the 33% chance former Federal Reserve Chairman Alan Greenspan was calling for back in March.

It will be interesting to see just how Mr. Lewis’ housing prediction pans out 2 months from now. I’m circling August 19 on my calendar…

Crash Prophets, Part 3

In the previous “Crash Prophets” posts, we examined the U.S. economic outlook of key market watchers and investment legends. Today, the focus is on U.S. government and Federal Reserve officials, both past and present. Specifically, I am talking about former Treasury Secretary Robert Rubin, U.S. Comptroller General and Head of the U.S. General Accountability Office David Walker, and former Federal Reserve Chairman Paul Volcker.

Robert Rubin served as Treasury Secretary under President Bill Clinton. On January 22, Rubin appeared on the Charlie Rose television show and talked about the U.S. economy becoming increasingly unsound, and the need for “excruciating decisions” to be made. He explained, “I think we face [huge] challenges. I think we can do very well in what is really a transformed global economic environment with the rise of China and India. But… I think we’re on the wrong track on almost every front right now, regardless of how you allocate the political responsibility, and what I’d like to see the new Congress do- and I think they’ve gotten off to a very good start in this respect- is to address those challenges.” Rubin added, “I think we’ve got to re-establish sound fiscal conditions… so we have an environment conducive to growth, and also to avoid the dangers that, as [Federal Reserve Chairman] Ben Bernanke said very recently in his congressional testimony, [underlie] unsound fiscal conditions. I think that’s a tremendous threat to the global economy.” Regarding the deficit and its threat to the dollar, the former Treasury Secretary predicted, “If the current account deficit doesn’t change, then at some point something is going to have to give. It seems to me that it’s very likely there’s going to have to be an adjustment of the dollar. The way to minimize the adjustment that you need is to have sound policy.” In a videotaped message for a dinner hosted by the Concord Coalition in New York last November, Mr. Rubin emphasized that the U.S. budget situation needed to be addressed now because the government was just 5 years away from “rapid acceleration” in spending related to Social Security and Medicare.

The tremendous financial burden brought on by entitlements also frightens David Walker, who is basically the nation’s accountant-in-chief. Walker is touring the United States through the 2008 elections, and according to Bloomberg, is “talking to anybody who will listen about the fiscal black hole Washington has dug itself, the ‘demographic tsunami’ that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government.” His speaking tour includes economists and budget analysts from across the political spectrum. The message they are conveying is that if the U.S government continues to conduct business as usual in the coming years, the national debt ($8.8 trillion as of today) could reach $46 trillion or more, adjusted for inflation. Every year of inaction adds $2 trillion to $3 trillion, according to Walker. With the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses for these two programs are about to increase significantly. In addition, the U.S. government has spent the last few years racking up debt and borrowing money from foreign lenders. If overseas investors lose their enthusiasm for purchasing U.S. debt, the result will be higher interest rates in the United States. A large jump in interest rates would be a disaster, in which case some economists predict the federal government would print money to pay off its debt, leading to runaway inflation.

Known for his stance against inflation, Paul Volcker was Federal Reserve Chairman from 1979 to 1987 and the predecessor of Alan Greenspan. At a dinner hosted by the Concord Coalition in New York last November, Volcker predicted that the United States’ dependence on foreign money raises the risk of a crisis in the dollar as soon as the next two and a half years. He said, “It’s incredible people have gone on so long holding dollars… At some point, you will get a situation where people have had enough.” Foreign investors now own about half of the $4.4 trillion of Treasuries outstanding. On April 10, 2005, Volcker talked about the U.S. economy in the Washington Post, and said, “Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks— call them what you will… What really concerns me is that there seems to be so little willingness or capacity to do much about it.” He added, “As a nation we are consuming and investing about 6 percent more than we are producing. The difficulty is that this seemingly comfortable pattern can’t go on indefinitely… I don’t know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.” Finally, Volcker speculated, “I don’t know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”

Robert Rubin, David Walker, and Paul Volcker insist that the U.S. government must act now to prevent a U.S. financial disaster. As the former Federal Reserve Chairman recalled, “A wise observer of the economic scene once commented that ‘what can be left to later, usually is— and then, alas, it’s too late.’ I don’t want to let that stand as the epitaph of what has been an unparalleled period of success for the American economy and of enormous potential for the world at large.”

70% Of Americans Say Economy Getting Worse

The Gallup News Service reported today that the perception that the U.S. economy is getting worse is now at a level not seen since 2001. In a Gallup Poll from June 11-14, 2007, 70% of Americans said that U.S. economic conditions are getting worse. The last time Gallup witnessed such negativity was in early September 2001, just before the 9/11 terrorist attacks. Since Gallup has been asking this question, the “getting worse” percentage has been at 70% only 4 times: twice in 1992, the September 2001 poll, and the current poll.

According to the Gallup Poll, 34% of Americans say national economic conditions are “excellent” or “good,” while 43% say “only fair” and 23% say “poor.” In 2007, perceptions of the economy were at their highest in January, when 52% of Americans said economic conditions were excellent or good. Since then, positive views have deteriorated. Poll results show that the greatest concerns for the public are oil prices, the overall state of the economy, and jobs. For the first time in 2007, a majority of Americans are negative about the job market, saying it’s a bad time to find a quality job.

Rich Homeowners Bullish On Housing

According to a new survey released today, more than half of affluent homeowners expect their property value to appreciate at least somewhat during the next year, with one-tenth of respondents expecting significant gains. The Coldwell Banker Previews International Luxury Survey polled 301 homeowners with million-dollar homes (or $2 million in California) plus more than $1 million in investable assets. The study revealed 56% of the participants expect at least some gain in their property values during the next year, with 10% expecting significant gains. Further down the road, 58% expect some gain over the next 5 years, while 36% expect significant gains over the same period.

I don’t know about you, but I have a serious problem with this survey. Look closely at the number of homeowners surveyed- 301. Now, note that there are 1 million plus homes in the U.S. valued at over $1 million. Also, 4 million plus Americans have more than $1 million in investable assets. See the problem? Surely, such a small survey pool cannot accurately represent what is undoubtedly a significantly-larger demographic. Yet, we must remember that the survey was sponsored by Coldwell Banker, who understandably must pull out all stops to get Americans to start buying real estate again.

Maybe the survey respondents should take a closer look at what is actually going on in the housing sector. On March 29, 2007, Reuters released a piece entitled, “Mortgage crisis hits million-dollar homes.” The article noted that from January-March 2007, the percentage of foreclosures for U.S. homes valued at more than $750,000 climbed to 2.5%, the highest since early 2005 (when RealtyTrac began keeping data). At the time the article came out, California led the nation with 3,384 foreclosures of higher-scale homes since December, followed by Florida and New York.

Weekend Edition: June 16-17, 2007

With the creation of Boom2Bust.com, I find myself explaining the purpose and rationale behind the blog more frequently to family and friends. I’m in a tough spot. For example, I believe that the U.S. housing market is in serious trouble, and as such, I rent an apartment. However, my father is a retired realtor and owned rental properties for a good deal of his life. Since leaving my parents’ roof, he has insisted that I buy my own place because “to rent is to throw away money” and “real estate always goes up.” Not to be outdone, my sister has poked fun at me for being a renter and once referred to my Chicago apartment building as “the ghetto.” Then there are friends who bought homes during the housing bubble. I have to be honest- I find it difficult telling all these people that I firmly believe a fast-approaching financial storm is coming, with housing as a possible catalyst and casualty.

The responses I get when talking about the blog are predictable- blank stares or a change of subject. However, I’ll stick to my guns. My outlook on the U.S. economy is based on the findings of my ongoing objective research. Unlike the demented perma-bears, I do not look forward to an economic crisis. I’m in the same camp as Warren Buffett, who after placing his infamous bet against the U.S. dollar, explained in Fortune, “Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar.”

Finally, someone once told me that my views are “un-American.” The way I see it, the conditions for a financial crash were created by misguided U.S. monetary policies. I’m just fortunate that I’m able to recognize the present (and future) situation. In reality, what’s “un-American” is policymaking that is destined to rob American citizens of their hard-earned wealth.

With Boom2Bust.com, I’ll continue to warn and educate those willing to listen about the coming financial storm in the United States. It’s my duty as a “good” American…

Enjoy the weekend!

Christopher E. Hill
Editor
editor@boom2bust.com

China Sells U.S. Treasuries

Earlier today Bloomberg reported that in April, Chinese investors sold the most U.S. Treasuries in at least seven years. China sold a net $5.8 billion of Treasury securities, which is the first drop in holdings since October 2005. They held $414 billion of the $4.4 trillion in marketable Treasuries in April, making it the largest owner of U.S. debt. However, China’s actions to diversify its $1.2 trillion foreign exchange reserves, most of it in dollar-backed assets, may cause Treasury yields to rise and the U.S. dollar to fall. In March, China announced it was creating an agency to actively manage its reserves. “The old saying was ‘China would buy Treasuries come hell or high water’… The move to more active reserve management is going to spell trouble for Treasuries,” said Michael Gregory, a senior economist for BMO Nesbitt Burns in Toronto. Samarjit Shankar, global strategy director for the foreign exchange group at Mellon Financial Corp., told Bloomberg, “It’s part of the ongoing, gradual, long-term diversification story… It may not necessarily impact the daily market, but this does raise the concern about the dollar.” Bloomberg was the only major financial news outlet that picked up on this story. It will be interesting to see if China’s actions are the beginning of a trend to dump Treasuries.