Housing

Pending problem?

Leave a comment

Sam Zell, the largest property owner in the country outside the government, was being interviewed along with a CEO of a housing developer (KB homes, I think). He was adamant that a pending problem was that developers, like the CEO across the table, make donations to charities that turn and give the money to otherwise unqualified buyers for their down payment. This essentially allows underqualified buyers to get into homes with no money down. Zell’s point was there is significant potential of default with these buyers and this is a questionable business practice. The CEO said it was 20% of his sales and if we want to see more people own homes this type of arrangement is needed.

Risk doesn’t go away, it only gets transferred. Who is holding this risk? Certainly not the builder.

Economics

Econ update

Leave a comment

Busy week ahead in this increasing shrinking world of ours.  Monday is UN inspection reporting day followed by Tuesday, the State of the Union address by President Bush and the first day of the Fed Meeting.  Wednesday is the UN Security council meeting and the Fed announcement and Thursday we get trailing GDP.  Friday we take an aspirin and decide again what the heck is really going on! J

The World Economic Summit is going on in Davos, Switzerland.  Leaders there are preoccupied, as the rest of us are, with the situation in Iraq.  President Bush’s State of the Union address Tuesday night, the day after Hans Blix reports to the UN, may or may not be eventful.  The more secluded event is the closed door UN security council meeting Wednesday.  So as we near a war the experts might fret, but top finance ministers and business leaders at the World Economic Forum are showing surprisingly little concern over the soaring euro and tumbling dollar.  Policymakers appear to be assuming that the U.S. currency will regain its balance once market turmoil triggered by geopolitical uncertainty passes.

A rising Euro can crimp exports and disrupt business profits. The dollar certainly has taken a drubbing, falling for seven straight sessions on worries about Iraq. Since last June, it has tumbled 11 percent on a trade weighted basis . The euro, meanwhile, has surged, ending Friday at $1.0815, up 3 percent since Jan. 1 and a huge 25 percent over the past year.

At first blush, that would seem a boon for the European Central Bank, which aims to get inflation below 2 percent this year. The problem arises if the euro’s upward march continues.  A 20 percent appreciation would bring euro zone inflation to around zero, even tip it into deflation, which is very tough for central banks to stop.

The ECB did cut rates by 0.50 percentage points to 2.75 percent in December. But some economists say that is not enough.  The argument being that the strength of the euro has more than offset the easing of the European Central Bank. A further surge in the euro could be very damaging to the European economy.

Here at home, the Federal Reserve policymakers will probably hold interest rates steady when they meet this week, hoping war jitters now restraining the U.S. economy will give way to a healthy recovery.

While many economists think economic activity nearly ground to a halt in the final three months of last year, most believe the pause will prove temporary and that the recovery will regain momentum as the new year wears on.

Fed officials gather on Tuesday and Wednesday to discuss the outlook and plot interest rate policy. They are expected to announce their decision on rates and offer a brief summary of their economic views around 11:15 pst on Wednesday.

Confronting data that showed the economy slowed abruptly as summer turned to fall, the central bank slashed the benchmark federal funds rate by a sharp half-percentage point in early November to a fresh four-decade low of 1.25 percent, saying the move should help the economy through its “current soft spot.”

But the stretch of weakness has lingered and many economists think U.S. gross domestic product expanded at no better than a 1 percent annual rate in the fourth quarter. In fact, a few believe the economy may have contracted which would have meant a double dip recession.  Fourth-quarter GDP data do not come out until Thursday, the day after the rate-setting meeting but of course the Fed will have the data.

While economists say the dismal performance at the end of last year raised the odds the central bank could lower rates again, seemingly no one expects the Fed to cut rates this week.  We shall see.  I think I have a better handle on predicting the winner of the Superbowl and I won’t even bet on that!

Federal Reserve

Monetary policy

Leave a comment

Many (including myself) think that the Fed would be quite content with inflation of 2%.  This would imply that the current rate of monetary growth (10.5 %) is too high to be sustained.  [This rate of monetary growth would imply a much higher rate of inflation than we have currently.  But monetary policy works with a lag.]  But the Fed is currently focused on trying to revive economic growth. Once that goal is accomplished, it will act to slow the rate of monetary growth (and also raise interest rates) to insure the containment of inflation.  All of these calculations assume, however, that the potential growth rate of the economy is 3.5%, as assumed in the above equation. As you are probably aware, there is a lot of controversy about what the correct estimate of U.S. potential economic growth is. Until a few years ago, most economists (and central bankers) thought that the long-run potential growth of U.S. real GDP was somewhere around 2.5%.  Now, due to the recent surge (from 1997 to 2000) in productivity growth resulting from the application of information technology, many have upgraded their potential growth estimate. If, in fact, the potential growth rate were 4.0% (near the annual rate at which the economy grew between 1997 and 2000), then the equation of exchange would imply that the Fed can expand the money supply at a 6% clip while still maintaining inflation of 2%.  Several Fed Governors have stated that they believe potential real GDP growth may now be near 3.5%, implying that monetary growth of near 5.5% would be appropriate to keep inflation near 2%.  (All of this assumes, of course, that the velocity of money is constant, an assumption which a number of economists question.)

The Federal Reserve does not explicitly set monetary growth targets, but over most of the past decade the Fed has kept M2 growth at an average of around 5-6% per year.  The European Central Bank sets an explicit target for M3 growth of 4.5% per year.  Recently, M3 in the euro zone has been expanding higher, indicating that monetary policy is pretty easy.  This flies in the face of public criticism that the ECB has kept interest rates too high. 

Some central banks, such as those in Canada, Britain, Sweden, Australia, and New Zealand, operate monetary policy by setting strict inflation targets.  The thinking is that it is very difficult to hit monetary growth targets and, even then, to know how changes in the money supply will impact the economy.  So central banks should continually adjust monetary growth to hit a desired inflation rate. There is some good logic to this trial-and-error approach, given the imprecision of monetary policy in practice.