Thursday, July 15, 2010

Some Interesting Macro Observations

Some interesting macro observations the last few days. My takes in bold.
"In my view, the biggest problem with the economy right now is that everyone knows that the housing market and the mortgage market are artificial. The mortgage market is being propped by by Fannie, Freddie FHA, and the Fed. The housing market is being held in a state of suspended animation by government attempts to stave off foreclosures. This policy is keeping the foreclosure crisis in front of us rather than putting it behind us.
If it had been up to me, I would have put in place policies to accelerate getting people out of houses where they don't belong. I would have given subsidies to underwater borrowers to move, and I would have given them bonuses for leaving houses in good condition. I think that if we had a housing market with a reasonable relationship between where people live and what they can afford, then the economy would be humming by now."
My note: I think that's probably an exaggeration, but it certainly would have credit flowing better by now, which is a critical step to recovering. Debt levels probably would be much lower, as well, as banks would just be forced to eat credit losses instead of having an elaborate shell game between the government, banks and consumers, hiding who is solvent and who is not. There is a major timing effect (you want to have the economy starting to recover as the level of government spending drops, which it has been doing for a few months now) which anti-foreclosure efforts have been harming. Finally, there's also a major uncertainty factor - when people don't really know how much housing is supposed to cost, a lot of decisions get delayed or avoided. Mortgages are harder to get, producers of building materials have trouble hedging and thus don't spend on capital improvements or labor, and people wait to buy houses because housing prices could drop and at the very least will stay low for a while.
"The Eurozone has taken this affinity for financial structuring legerdemain even further, drawing on the most abused structure of the crisis, collateralized debt obligations, to create (as before) super duper AAA credits from less promising material. "
My note: One of the things that's been most interesting about watching the initial American response to the crisis and watching current American policy and European policy is that the initial response was actually pretty brutally open - it's hard to "cover your behind" if it's painfully apparent that you're insolvent and you need help. This transparency helped with devising good policy to move forward (TARP comes to mind). It seems that America has lost patience with the concept of insolvency and now everyone wants to "move on", before the problems have shaken out. This results in obfuscatingly bad policy. Europe has been even worse... for example, did you know that European bank stress tests assumed a worst case 3% default on Spanish bonds and 17% on Greek bonds? That's not a real stress test, that's probably more optimistic than even the base case is, unless Germany intervenes. However, it makes it look like "European banks have been stress tested and they're fine!", which prolongs the problem
My note: I don't quote the article because Pettis' entire take is, as usual, magnificent. I've written extensively here: I would also point out that the capacity overhang I mention in the article is no longer there in a lot of places - a lot of raw materials, and even labor. So we're starting to see limited inflation there. This is a crisis that is only just beginning to loom, and either the US is going to eat it and keep unemployment high or we're going to deal with it substantially. Obama's promise for doubling exports in 5 years is laughable, unless he intends accomplishing that through US inflation (which is certainly possible, if somewhat improbable, and hardly seems an accomplishment) - we would be lucky to have higher (real) exports in 5 years than we do now.

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