Boom2Bust.com

Sunday Edition: September 30, 2007

Baby Bond Boondoggle
On Friday, U.S. Senator and 2008 presidential candidate Hillary Clinton floated the idea of providing every child born in the United States a $5,000 “baby bond” from the government to help pay for the future costs of college or buying a home. Senator Clinton said, “I like the idea of giving every baby born in America a $5,000 account that will grow over time, so when that young person turns 18 if they have finished high school they will be able to access it to go to college or maybe they will be able to put that down payment on their first home, or go into business.” According to ABC News Friday, with around 4 million babies born in the U.S. each year, the program would cost more than $20 billion annually, not counting administrative costs. Clinton and her aides provided no details on how the baby bond program would be paid for, what it would cost, or how it would be applied or enforced. Republican presidential candidate Rudy Giuliani said on the Sean Hannity radio show that the Clinton campaign is “based on pandering to the point where I think they think the American people are stupid.”

Senator Clinton is studying up on her history. This sounds an awful lot like the 1928 presidential campaign, where a circular published by the Republican Party claimed that if Herbert Hoover won there would be “a chicken in every pot and a car in every garage.” Our predecessors bought into it, however, and elected Hoover the 31st President of the United States.

Ironically, several months after Hoover took office, Americans witnessed the 1929 stock market crash and the Great Depression. Will history repeat itself?

The Fiscal Wake-Up Tour
Tonight I learned about “The Fiscal Wake-Up Tour” that is being sponsored by the Concord Coalition. From their website, The Fiscal Wake-Up Tour is a joint public engagement initiative by The Concord Coalition, the Budgeting for National Priorities Project at the Brookings Institution, and the Heritage Foundation. U. S. Comptroller General David Walker, who I’ve talked about before in Boom2Bust.com, is an advisor and has participated in each of the events. The purpose of the Tour is to explain in plain terms why budget analysts of diverse perspectives are increasingly alarmed by the nation’s long-term fiscal outlook.  Many events are scheduled for the remainder of 2007 and for 2008, including Atlanta, GA (October 1), Hartford, CT (October 23), and Baltimore, MD (October 29). I have never attended one of the Tour events, but would like to in the future. If you’re interested in finding out more about “The Fiscal Wake-Up Tour” you can visit their website.

Perhaps Senator Clinton should attend one of these sessions. Just an idea…

Cramer Follow-Up
Last Wednesday I told you how Jim Cramer of CNBC’s “Mad Money” went on NBC’s “Today” show and said not to buy a home right now or “you will lose money.” On Friday, Cramer went back on “Today” to talk about his comments, along with Charles McMillan, president-elect of the National Association of Realtors. Cramer was unapologetic. In fact, he had this to say:

Charles has to sell real estate, and I have to try to save or make people money. I can’t save or make people money by telling them to buy real estate.

At least he’s being honest. You can watch the conversation here on YouTube.

Parting Shot
Back on September 10 the Financial Times (UK) ran a story about how recession “is the word on everyone’s lips.” The Times noted that the word is usually avoided by Wall Street economists. David Rosenberg, chief economist at Merrill Lynch had this to say about its usage:

It is like looking a client in the eye and telling them that their child is ugly. It is not what people want to hear.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com

Will The Real Consumer Please Stand Up

Today the Bureau of Economic Analysis reported that consumer spending grew at its fastest pace of the year at 0.6% in August, up from a 0.4% increase in July. According to the BEA, real consumer durable goods spending, which includes big-ticket items such as cars, refrigerators, and flat-screen televisions, jumped 2.8%, also the highest level this year. Bernard Baumohl of The Economic Outlook Group told the Financial Times (UK) earlier today that there is a “remarkable dichotomy taking shape in the economy. Month after month we have seen nothing but dismal news coming out of the housing sector… But this is not to say that household finances are under stress.” Baumohl added, “Today we get fresh evidence that people are still comfortable enough with the economic outlook to spend, and spend liberally.”

I’ll admit that I was surprised by today’s positive report. Recent consumer sentiment studies suggested a pullback in spending was likely. In Wednesday’s post I talked about how the Conference Board, a business membership and research group, announced just this week that U.S. consumer confidence had declined to its lowest level in nearly 2 years in September due to a weaker job market and uncertain business conditions. Even their August Consumer Confidence Index, with a cutoff of August 22, indicated that consumer sentiment was eroding significantly. It left me thinking, are consumers saying one thing and doing another?

I still believe that we’re going to see a significant slowdown in consumer spending. And it will be sooner rather than later. Peter Dunay, an investment strategist at Leeb Capital Management, told Forbes today that the rising costs of food and gasoline will divert capital away from other areas. Grain prices are surging, partly due to increased ethanol use and demand from emerging economies. Just yesterday U.S. wheat prices hit all-time highs, with some analysts fearing that a bubble might be in the making. Crude oil prices are hovering above the $80 mark. Accordingly, U.S. retail gasoline prices jumped 2.5 cents last week to $2.81 per gallon. Government reports show the national price for regular gasoline is up 43 cents from one year ago. Guy Caruso, who heads the Energy Information Administration (EIA), recently told Reuters that if crude oil prices stayed near their current high levels for the next few weeks consumers would pay more for gasoline. “We’ll start seeing a little bit of that (higher oil price) passed through” at the gasoline pump, Caruso said. As a result of these rising costs, Peter Dunay predicted that the additional money spent on food and gasoline will force consumers to draw from their savings (if any is left) for weekly bills. By the way, personal savings fell to $72.5 billion last month, compared with $89.5 billion in the previous month. Personal savings as a percentage of disposable income fell to 0.7% in August from 0.9% in July.

On Friday the latest Reuters/University of Michigan Survey of Consumers was released. The report echoed what the Conference Board had said earlier in the week. In addition, high food and fuel prices remained a major concern in September, especially for families with lower incomes, according to the survey. Richard Curtin, the survey director, said consumers are expected to become “more cautious spenders” in the year ahead. In a statement, Curtin added:

When asked to explain in their own words how their financial situation had recently changed, one-third of households with incomes below $50,000 said that higher prices had already devastated their family’s budget, and half of these families expected prices to increase faster than their incomes during the year ahead, reducing their living standards even more.

Consumer spending is the backbone of our economy. August’s report was positive despite negative consumer sentiment. A case of “actions speak louder than words,” perhaps? Maybe this time. Yet, my gut feeling tells me the words will soon turn into screams.

America Dreams

If you haven’t had your fill of housing yet, yesterday I came across an editorial from the Providence (RI) Journal that’s worth a read. Froma Harrop, an editorial columnist, wrote “American Dream gone nuts” back on September 12. Harrop talks about the mortgage crisis in the United States today. Here’s an excerpt from the very straightforward piece:

A news story on a Stockton family in trouble shows a luxury kitchen, bigger than that that in many restaurants. Read on. The couple had bought a more modest house in Stockton a few years earlier but decided to “move up” into a bigger model without waiting to sell their first home. They are now holding two mortgages and an equity loan for remodeling the newer house.

This is the American Dream gone nuts. A big part of the sales pitch is to portray home ownership as the most superb of investments. In truth, the return on real estate hasn’t been all that great.

You can read the editorial at the Providence Journal here.

Cramer Incurs Wrath Of Realtors

CNBC’s “Mad Money” host Jim Cramer is in the headlines again. Yesterday on NBC’s “Today” co-host Meredith Vieira asked Cramer, “So bottom line for now, housing sales will continue to drop, correct?” He replied, “Right, don’t you dare buy now. Don’t you dare buy a home now. You will lose money.” After seeing this, members of a New Jersey Realtor group contacted “Today” and complained that Cramer’s remarks were “misleading, inaccurate, and inappropriate” and that “the real estate market is regional” and “it’s a buyers market, so why wait?” Cramer, responding to the Realtors this morning on CNBC, compared them to Soviet-era news organization Pravda.

You can access this morning’s CNBC segment here to watch Cramer being brought to task for his actions. Funny stuff. Even funnier considering that today the Commerce Department announced sales of new homes dropped 8.3% in August to a seasonally-adjusted annual rate of 795,000, the slowest sales pace since June 2000.

Main Street Anxious Over U.S. Economy

Sifting through some of the latest data, I can’t help but notice that Main Street is becoming increasingly worried about U.S. economic conditions. The Conference Board, a business membership and research group, announced yesterday that U.S. consumer confidence had declined to its lowest level in nearly 2 years in September due to a weaker job market and uncertain business conditions. The consumer confidence index fell to 99.8 in September from a revised 105.6 in August, which is the lowest level since November 2005. In the Board’s press release, Lynn Franco, Director of The Conference Board Consumer Research Center, had this to say about the survey conducted among 5,000 households:

The Consumer Confidence Index is now at its lowest level in nearly two years (Nov. 2005, 98.3). Weaker business conditions combined with a less favorable job market continue to cast a cloud over consumers and heighten their sense of uncertainty and concern. Looking ahead, little economic improvement is expected and with the holiday season around the corner this is not welcome news.

Economists surveyed by MarketWatch confirmed that the drop in confidence points to slower consumer spending in the fourth quarter. MarketWatch reported yesterday that Nigel Gault, U.S. economist at Global Insight, told clients:

We often say that it is more important to watch what consumers do than what they say. But gloomy reports from Target and Lowe’s this week suggest that consumers have become more cautious. So in this case the signal from sentiment looks accurate.

A week ago today the Washington Post reported that a recent Reuters/Zogby poll indicated one in three Americans expected a U.S. recession in the next year, and less than a quarter thought home prices would rise. “There has been much, much, much more talk about a recession in the last 30 days than there had been before,” said pollster John Zogby, who attributed the increase to bad news on the housing and employment front. The survey of 1,011 Americans was conducted September 13-16, a week after the government’s employment report showed an unexpected drop in jobs in August, the first such decline in four years. The Reuters/Zogby poll revealed that 31% of those surveyed expected home prices in their area to stay level next year, while 35.5% expected prices to drop a little, and 8.5% predicted home values would drop significantly. Meanwhile, only 4.2% expected prices to rise a lot while 18.7% thought they would increase just a little. The rest were not sure. Zogby remarked:

That’s massive. Homes are seen not only as part of living the American dream, but they’re also seen as an investment. This sort of anticipation is very unhealthy because it drives behavior. This is like consumer confidence. When you add it all together, it is (the makings of) an economic slowdown.

As consumer spending accounts for two-thirds of the U.S. economy, these latest reports are worrisome, to say the least. Some economists and analysts had argued that business investment would make up for a decline in consumer spending. However, the Commerce Department reported today that demand for durable goods, those made to last at least several years, fell by a more-than-expected 4.9%. Excluding transportation equipment, orders declined 1.8%. According to Bloomberg, “The report suggests that business investment, which economists predicted would cushion the expansion from a slowdown in consumer spending, may instead weaken.”

Not good.

Hedge Funds Predict U.S. Recession In 2008

Hedge fund managers are predicting that the U.S. economy will enter into a recession next year, according to a Reuters article released last night. Rothstein Kass, an auditing and tax services provider, sponsored the survey which consisted of 239 hedge fund principals with a median $492 million in assets under management.

More than 61% of respondents said they believed a recession was “very likely” in 2008. 87% percent predicted that market volatility would continue or increase for the remainder of 2007. Not surprisingly, only 17% of those surveyed said an economic downturn would be bad news for their operations, with 66% suggesting that a recession would actually bring about investment opportunities.

The Wall Street Journal reported back on September 11 that hedge funds lost 1.3% last month, which was their worst performance since May 2006 and the first losing month this year, according to Hedge Fund Research Inc., a Chicago hedge-fund research firm. Funds of funds, or funds that invest in other hedge funds, did even worse, losing 2.1% in August.

Foreign Investors Worried About U.S.

From the Persian Gulf to Beijing to Zurich, there is increasing skittishness about the health of the U.S. economy and the wisdom of our economic policies. Bernanke’s kowtowing to the powers-that-be on Wall Street did nothing to allay those fears.

-Dean Calbreath, San Diego Union-Tribune financial columnist, September 23

In the not so distant past, overseas investors gladly acquired American dollars and financial assets. However, more and more evidence is surfacing that these investors are starting to question the wisdom of investing in the United States. The decision by the Fed last week to cut its benchmark interest rate by a half point to 4.75%, and the subsequent downward pressure on the U.S. dollar that it generated, raised eyebrows overseas. While the move was intended to calm the recent financial turbulence in the United States, it also caused foreign investors to sell dollars and move their cash into other markets where interest rates are rising and whose economies appear better off. Earlier today the dollar index, which measures the greenback against a basket of six currencies, touched a new 15-year low of 78.213. Jim Awad of W.P. Stewart Asset Management told the Wall Street Journal on September 23, “Washington wouldn’t mind an orderly [dollar] decline — [but doesn’t] want a headline emotional decline. That would force foreign investors to unload dollar-denominated assets and tie the Fed’s hands [on] interest rates.” So far this year, the dollar is down 8% against a weighted basket of major currencies, according to the Federal Reserve. Dean Calbreath of the San Diego Union-Tribune remarked on September 23 that:

The U.S. dollar has plummeted to the extent that- if you judged our economy by the euro rather than the dollar- it is as if we have been in a recession for the past seven years. Judged by euros, the Dow Jones industrial average is still well below the highs it hit in 2000.

In fact, Jack Ablin of Harris Private Bank noted in the Wall Street Journal last week that while growth in the S&P 500 is up almost 8% in dollars year-to-date, it is only a miniscule 1% when denominated in euros.

Prior to the Fed’s action on interest rates, the evidence already existed that overseas investors were shying away from U.S. financial assets. In July, foreigners sold a net $9.4 billion in U.S. Treasury bonds, one of the largest sell-offs on record. As of last year, foreigners held 45% of U.S. Treasury bills, 33% of U.S. corporate bonds, and 19% percent of U.S. agency notes. Declining foreign investment in the United States could have a broad impact on financial markets and American consumers. An Associated Press article from September 25 discussed what might happen:

If foreigners’ buying habits change, that could have a broad impact on financial markets- and U.S. consumers, too. For instance, if they sell their U.S. Treasury holdings, or don’t buy new government bonds or notes, then Treasury prices will go down and yields will go up. That will likely send mortgage rates higher since they are pegged to the 10-year Treasury note. That could unravel any good that has come from the Fed’s rate-cutting action and put the economy in a precarious spot. It makes you wonder why this administration isn’t doing more- or anything- to help the dollar.

For years the enduring myth among foreign investors had been that it was profitable to hold on to U.S. dollars and financial assets. However, faced with the harsh reality of seeing their holdings decrease in value and receiving a lower rate of return, I can understand them having second thoughts about partnering with Uncle Sam.

CNBC Losing The Poms?

Every now and then in my research I come across comments that CNBC was guilty of being a cheerleader for the stock market boom of the nineties. One business news anchor in particular, Maria Bartiromo, aka “The Money Honey”, seems to be the recipient of much of the flak. Personally, I am always suspect of business news channel programming due to the presence of network sponsors whose bottom lines depend on rosy economic news and bullish investment commentary. Turn on a business channel during the day and you’ll see numerous commercials for brokerages, for example. I wonder if there’s not hesitation to “bite the hand that feeds you”?

Yet, I was surprised last week when I came across some commentary by Diana Olick, CNBC’s real estate reporter, on their website. A few days ago a survey was released by Reuters/University of Michigan that looked at homeowners’ perceptions of their own homes’ values. According to the survey, a record 26% of U.S. homeowners say the value of their homes has fallen during the past year. Additionally, 21% of homeowners polled in September expect the value of their home to decline in the year ahead. Ms. Olick said that all the “Alert” desk folks at CNBC said, “Omigod, this is huge.” Her respose was, “I don’t agree. I say it’s not huge enough.” Diana points out that the latest S&P/Case Shiller survey, which covers the nation’s top 20 metropolitan areas in addition to a full national index, shows falling home prices now and, given the trend, in the near future. Given the evidence, Ms. Olick asks:

So why do 74% of Americans not get it?… With all the trouble in the credit markets, continued adjustable-rate mortgage resets, and rising foreclosures, not to mention continued sky-high inventories, what exactly makes ¾ of Americans think they’re going to make big bucks on their homes this year?? This is precisely why homes aren’t selling. Sellers are stubborn; they just don’t get it. Prices during the boom were unsustainable, affordability is now ridiculous, and continued price appreciation makes no economic sense in the current atmosphere. The boom-time price inflation in homes was thanks to a faulty mortgage system, which is now in the process of righting itself, and home prices rightfully have to fall in line. Do I like writing those words? Hell no! I own a home. I like money. I also like logic. Sue me.

Wow. Couldn’t have said it any better myself. Unfortunately for Diana, I don’t think she is going to be asked to any Realtor functions anytime soon.

Sunday Edition: September 23, 2007

Reminiscing
Wow! Can you believe that today is the first day of autumn? Summer always seems to go so quick (especially as you get older). The season is especially short in the Chicagoland area as the weather has gone from winter to summer and back again (bypassing spring and fall altogether) these past few years. I always try to venture north to Wisconsin (specifically, Burlington in the southeastern part of the state) in order to get my fall fix. Nicest people in the planet in Burlington- last week while I was in town preparing my boat for winter storage I drove to the McDonalds to grab a fast breakfast and almost ran over one of the workers in the drive-thru, who just smiled and wished me “good morning”. If the same thing had happened in Chicago, I’m sure his colleague would be telling me where to stick my Egg McMuffin…

Being the first day of fall, it also marks the end of the first season of Boom2Bust.com, which debuted Memorial Day Weekend. Since its unveiling, I’ve sensed a few more Americans are starting to question the economic health of the United States. I know… the government, the Fed (a private bank, in case you didn’t know), and Wall Street keep telling us everything’s fine. But that’s their job, and quite frankly, they’re very good at it. However, if you look beyond the rhetoric you may see some significant threats to our economic well-being:

• Inflation- If you believe the “official” data, then the latest inflation number is around 2%. But if you’re like me, you’re a little suspect of this number when prices for everyday items seem to indicate otherwise. According to the formula used prior to the Clinton administration the headline rate of inflation is running around 5.5% as of last month. If we use the CPI formula that was in place back in 1980, headline inflation is significantly higher.
• Employment- Employers cut 4,000 workers from payrolls in August, which was the first time in four years. Look back farther and you’ll see that U.S. employment growth has been trending downwards for more than a year. Especially worrisome is that since the beginning of 2007 more than 40,000 mortgage industry workers and 20,000-plus construction industry workers have lost their jobs, according to Chicago-based global outplacement firm Challenger, Gray & Christmas Inc. Also, the number of temporary workers hired fell in each of the previous 6 months, and was down 2% in July from the start of the year. Economists believe that businesses cut temporary workers first before turning to full-time employees.
• Housing- Considering housing-related employment accounted for about 1 in every 10 jobs in 2006, this sector must be followed carefully. The National Association of Realtors recently admitted that the worst housing slump in at least 16 years will extend into 2008 as tighter loan standards cut into home sales. The group has already cut its home-sales forecast 9 times this year. The NAR may report on September 25 that home resales declined 4.5% to an annual rate of 5.49 million, the lowest in 5 years, according to a Bloomberg survey. Two days later, the Commerce Department is projected to report new homes sales fell to an 828,000 pace, 4.6% less than in July. The National Association of Home Builders/Wells Fargo index of builder confidence for September dropped to 20, matching the January 1991 reading as the weakest ever. Levels lower than 50 mean most respondents view conditions as poor. The Case-Shiller U.S. National Home Price Index revealed U.S. home prices in the second quarter of 2007 fell 3.2% compared to the same period in 2006. The price drop marked the largest year-over-year decline ever recorded in the 20-year history of the index. The Case-Shiller index, which tracks multiple sales of the same homes, is considered by many observers to be the best gauge of national and metro real estate values. According to RealtyTrac Inc., in August the total number of U.S. foreclosure filings, including defaults, scheduled auctions and bank repossessions, rose 115% from a year earlier.
• Dollar- The greenback is broke, but probably not down and out- yet. Regardless, as of Friday the U.S. currency stood near a 31-year low against the Canadian dollar while the euro has continued to set new record highs against the dollar, climbing above $1.41 for the first time ever. If the dollar continues to weaken, as many analysts and traders expect, imports sought by U.S. consumers could cost more. A weaker U.S. currency, besides pushing up the price of foreign goods, also drives up the price of commodities priced in dollars, such as oil, and has a big impact on consumer spending (which accounts for around 70% of U.S. gross domestic product). Should the dollar decline sharply, we may see foreign investors dump their U.S. dollar-denominated assets, which would mean major trouble for the U.S. economy.
• Consumer Debt- Consumer and mortgage debt is running at over 120% of disposable income. U.S. consumer debt rose in July at a 3.7% annual rate to $2.46 trillion. The amount of revolving credit, such as credit cards, carried by consumers rose in July at an annual rate of 6.6%, or by $5 billion, which was the third straight month of significant gains. Revolving credit was up 6.4% in June and a whopping 10.9% in May. The U.S. personal savings rate was only 1% and 0.5% for the first and second quarters this year.
• National Debt- Last week Treasury Secretary Henry Paulson informed lawmakers that the U.S. government would hit its current debt ceiling of $8.96 trillion at the end of the month. The national debt is the total accumulation of annual budget deficits, which must be financed with borrowed money. Unless Congress votes to raise it, the country would be unable to borrow more money to keep the government operating and to pay debt obligations coming due. The proposed boost of $850 billion would be the fifth since President Bush took office in 2001.

Are you uneasy knowing all this? I sure am! Yet, these are just some of the economic threats that come to mind as we say goodbye to summer. I will be particularly watching derivatives in the coming months, as I fear these financial instruments have the potential for wreaking havoc in spite of their “reputation” of minimizing risk.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com

Jim Rogers Says U.S. In Recession

I recently received an e-mail from Euro Pacific Capital that talked about Jim Rogers’ interview on Bloomberg from earlier this week. Peter Schiff, president of Euro Pacific, had this to say about the Rogers exchange:

It is one of the most insightful, logical, no nonsense investment discussions I have ever heard. Jim talks about the fragile state of the US economy, the dollar, gold, the risks to the US stock market, Bernanke, and why he has moved with his family to Singapore. Among other things, he urges investors to sell their dollars and buy foreign currency.

I agree- the interview was superb. Rogers, the legendary investor and author, told Bloomberg that the U.S. economy is already in a recession, which will turn out to be “serious” and result in the collapse of the U.S. dollar and bond market.

The video is almost 20 minutes long, and can be accessed through Bloomberg here.

Home Values To Fall 50 Percent

On Tuesday, Yale economics professor Robert Shiller appeared on CNBC and talked about the direction of the U.S. housing market. Shiller told CNBC’s Maria Bartiromo that he believes a 50% decline in home values was possible in cities that have boomed a lot in real inflation-corrected terms. He suspects that the fall in prices will take place over a series of years. Likely areas to feel the brunt of the decline include California, Arizona, and Florida (Miami).

You can see CNBC’s replay of the video by clicking here.

Derivatives Expert Warns Of Economic Meltdown

Tonight I came across a disturbing article in MSN Money entitled, “Are we headed for an epic bear market?”. MSN Money’s Jon Markman interviewed Satyajit Das, one of the world’s leading experts on credit derivatives. Investopedia describes credit derivatives as:

Privately held negotiable bilateral contracts that allow users to manage their exposure to credit risk. Credit derivatives are financial assets like forward contracts, swaps, and options for which the price is driven by the credit risk of economic agents (private investors or governments).

For example, a bank concerned that one of its customers may not be able to repay a loan can protect itself against loss by transferring the credit risk to another party while keeping the loan on its books.

Das, who is also the author of a 4,200-page reference work on the topic, has designed and marketed the financial instruments for the last 30 years.

Now, Das is telling whoever will listen that the U.S. is on the verge of a bear market of epic proportions because of credit derivatives. According to MSN Money:

Massive levels of debt underlying the world economy system are about to unwind in a profound and persistent way. But either way, he foresees hard times as an optimistic era of too much liquidity, too much leverage and too much financial engineering slowly and inevitably deflates.

Das sees the current market volatility not so much a correction as a gigantic liquidity bubble that will take a long time to unwind (Japan 1990-2003?). He is also predicting that the next serious phase of the unwinding will begin later this year or early in 2008.

Can The Fed Save Housing?

Yesterday the Federal Reserve cut its overnight interest rate target by half a percentage point to 4.75%, the first reduction in four years. Many are claiming that this is exactly what was needed for the crippled U.S. housing market. Yet, some economists aren’t so sure that Fed rate cuts will be able to save the housing sector. An estimated 2 million homeowners face significantly-higher mortgage payments when their current loans reset over the next year. A rate cut will reduce the rates for adjustable-rate mortgages. David Wyss, chief economist for Standard & Poor’s, told CNN Money yesterday, “About 1 or 2 percent of the population is going to be seriously affected by these resets. That’s not trivial. One thing a Fed rate cut will do is reduce that reset shock fairly quickly.” However, many borrowers who now face adjustments in their mortgage rates are having problems because mortgage lenders have quit making loans in those riskier markets, making it extremely difficult for borrowers to refinance, regardless of interest rates. Richard Hastings, an analyst at New Jersey-based Bernard Sands LLC, talked to MarketWatch yesterday about the Fed cut and said, “It will help those who need it the least. But for those who need the most help, this does nothing for them. The Fed cannot help them at all.”

For homeowners who have been paying low teaser rates on their mortgages with the expectation that they would be able to refinance before rates reset, investors are no longer buying securities backed by such non-traditional mortgages, making it impossible for hundreds of thousands of these homeowners to refinance. In this case, “A rate cut even down to zero percent doesn’t make those attractive investments,” said Edward Leamer, director of the UCLA Anderson Forecast. Leamer told CNN Money on Tuesday that, “The Fed is in the situation where they should not be thinking about saving housing. They should be thinking about isolating the problem strictly to the housing sector.” Lee Hoskins, a former Cleveland Fed president and now senior fellow at the Pacific Research Institute in San Francisco told Bloomberg yesterday that, “Lowering the funds rate overall doesn’t boost housing. All this does is delay the day in which these wealth losses will finally be worked out in the marketplace, so I don’t regard this as a particularly good move.”

Meanwhile, the U.S. housing market slump is two years in the making, with more than 100 mortgage companies having gone out of business. Yesterday RealtyTrac Inc. reported that the total number of U.S. foreclosure filings, including defaults, scheduled auctions and bank repossessions, rose 115% in August from a year earlier, the highest ever in the RealtyTrac study that goes back to 2005. “This is just the beginning of a wave of new foreclosures,” Rick Sharga, executive vice president of marketing for California-based RealtyTrac, told Bloomberg in an interview. “There are lots of people who bought homes they could only afford at the teaser rates, and now have very few options.”

Consequences Of Today’s Fed Cut

Earlier today the Federal Reserve cut its overnight interest rate target by half a percentage point to 4.75%, the first reduction in four years. The statement released by the Fed indicated that the move was carried out to “forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions of financial markets and to promote moderate growth over time.” Not surprisingly, this resulted in the Dow Jones Industrial Average’s largest one-day jump since October 15, 2002, and biggest percent rise since April 2, 2003, finishing up 336 points, or 2.5%, at 13,739.4. Many applauded the Fed’s move, believing it will pre-empt major weakness in the U.S. economy. However, a few critics stepped forward and pointed out the drawbacks of today’s action. Art Hogan, chief market strategist at Jefferies & Co., told MarketWatch today:

The market is acting like [Federal Reserve Chairman] Ben Bernanke just cured cancer, and I can tell you, he didn’t. This is typical of the knee-jerk reaction to what we perceive to be good news.

As the result of today’s Fed cut, look for negative effects on domestic investments tied to interest rates, on foreign investment in the United States, and on the value of, and confidence in, the U.S. dollar.

Lower rates will hurt those individuals whose incomes are tied to short-term interest rates on money markets and savings. Lower rates=less income=less consumption=slowing economy. Carl Steidtmann, Deloitte Services’ chief economist, told MarketWatch, “That’s the downside for those households that have financial assets tied to the interest rates and are generating cash off of that.”

Another, more serious risk to the U.S. economy, is the potential decline of foreign investment here as the result of today’s action. Lower rates would make some U.S. investments, such as government-issued treasuries, less attractive to foreigners. David Wyss, chief economist for Standard & Poor’s, and Edward Leamer, director of the UCLA Anderson Forecast, told CNN Money today that a significant drop in foreign investment would be a big problem for the U.S. economy because that flow of funds has been the key to keeping long-term rates low. “Last year we had $1 trillion come in net foreign investment, most of it into the bond market, and most into private bonds, not Treasuries,” said Wyss. “If that money stops coming in, that’s going to be a big increase in borrowing costs.”

Should foreigners hesitate to invest in the United States, the decline in the value of the U.S. dollar could get even worse. American consumers could see higher-priced imported goods and a reduction in their spending power. Rollback prices at Wal-Mart would be a thing of the past. Speaking of the dollar, it dropped to a new record low against the euro and also fell against most of its other major counterparts on Tuesday. The dollar index, which tracks the greenback against a basket of six major currencies, broke below a 15-year low and dropped to 79.240, down from 79.645 before the announcement. The U.S. currency also hit a fresh 30-year low against the Canadian dollar. Gold was also a beneficiary of declining confidence in the U.S. dollar, as the precious metal continued its impressive run and moved past $735 an ounce in electronic trading late today, reaching its highest level since 1980. Peter Spina, an analyst at GoldSeek.com, discussed the rate cut with MarketWatch and said that “the decision is another nail in the coffin for the U.S. dollar and will further extend the gold price rally.”