Wednesday, February 28, 2007

Sluggish Durable Goods Orders

Financial Times reports sluggishness in durable goods orders in the U.S.:

The thin order books also prompted Wall Street economists to revisit their forecasts for growth for the first quarter, following already severely reduced expectations for growth last quarter.

Haseeb Ahmed, an economist at JPMorgan, said: “The weakness in orders points to softness ahead for manufacturing and sluggish capital spending. The weakness was broad-based and points to clear risk to our forecasts.”

The fall in orders was led by big drops in demand in volatile sectors such as aircraft, which fell 59 per cent.

Demand for capital goods excluding defence and aircraft orders fell 6 per cent, while orders for motor vehicles and parts dropped 5.1 per cent. However, there were signs of renewed vigour among American consumers, who defied expectations and saw increased confidence this month, according to a private survey by the Conference Board.

There were signs of tentative stability in the housing market as sales of existing homes rose by 3 per cent last month, the biggest rise in two years.

Sunday, February 18, 2007

Subprime Debt Obligations

Gretchen Morgenson has written a rather complete story about the growing failures in the subprime debt obligation market.

In the last three years, for example, big banks and brokerage firms almost doubled the amount of residential loans they issued, going to $1.1 trillion last year from $586 billion in 2003.

Many of these loans have been packaged into collateralized debt obligations and sold to pension funds, hedge funds, banks and insurance companies. For example, 81 percent of the $249 billion in collateralized debt obligation pools in 2005 consisted of residential mortgage products.

...Mortgage-related activities at the major firms generate an estimated 15 percent of total fixed-income revenue, according to Brad Hintz, an analyst at Sanford Bernstein.

...UBS said that 76 percent of adjustable-rate interest- only loans written in 2006 had low documentation, while 57 percent had loan-to-value ratios greater than 80 percent. No surprise, then, that 3.16 percent of these loans are already delinquent by two months or more.

The exposure to these debt obligations is quite widespread.

In her article, published in International Herald Tribune, Morgenson wonders why the "wreckage" in the subprime segment has not rattled capital markets more than one might expect. While Moody's Investors Service has downgraded only 1 to 2 percent of subprime loans issued from 2001 to 2006, it now appears that more mortgage back securities will be downgraded.

Relying on rating agencies to analyze the risk in collateralized debt obligations may be unwise, however. Back in May 2005, Alan Greenspan noted the complexity of collateralized debt obligations and the challenges they pose to "even the most sophisticated market participants." He warned investors not to rely solely on rating agencies to identify the risks in these securities.

Morgenson concludes with an ominous paragraph:

So far, the pain from subprime defaults has been muted. Market participants are cheered that lenders are finally tightening their loan standards, albeit a bit late. Unfortunately, the damage of the mortgage mania has been done and its effects will be felt. It is only a matter of when.

Friday, February 16, 2007

Mortgages, Mortgage Back Securities and Repurchase Safeguards

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Not only subprime lenders but also most other lending institutions package and sell their mortgage loans to investment banks who often slice and dice these loan pools to issue mortgage-backed securities of varying risk levels. Occasionally, as HSBC seems to have done with some loans, the bank may keep these loans on its own books. This is a very risky proposition. However as was also the case with subprime loans purchased by HSBC, most investment banks purchasing these loans include repurchase clauses in the mortgage pool contracts. After adding $1.76b to bad debt costs, HSBC has sued some subprime banks who have failed to abide with repurchase clauses. (See "Mortgage Hot Potatoes: Banks Try to Return High-Risk Loans To the Originators," The Wall Street Journal, Thursday, February 15, 2007. page A4.)

In economics, such repurchase clauses are called transaction "safeguards," which if set correctly, will lead to a better hybrid transaction model. They discourage subprime lenders to take unreasonable risks and put them in a risky position if they do take extreme risks. The investment bank purchasing the loan pool may at any time (coinciding with a trigger, perhaps) want to exercise the repurchase option.

Sunday, February 11, 2007

The Home Owner Vacancy Rate

You may have wondered why I earlier wrote about vacancy rates.

In macroeconomics, vacancy rates help facilitate micro-transactions that give rise to significant macro-effects. So, unemployment, as I explained earlier, is a type of vacancy, i.e. each unemployed person represents the vacancy of a person who can be assigned to a job.

More recently, what motivated me to write the entry on vacancy rates was a page-one article by Michael Corkery appearing on Monday, February 5, 2007 edition of The Wall Street Journal: "Vacant Homes for Sale Cloud Economic Hope: Data Pointing to Glut Are Worst in Decades; Impact of Speculators". Of course, WSJ followed this article by another on Saturday, giving advice on how to buy foreclosed homes.

Corkery's article focuses on the rise in the home owner vacancy rate, a "measure of how many homes for sale in the country are empty," which "has climbed to its highest level since the Census Bureau began tracking it four decades ago." This has occured "even after a 13% decline in new home starts in 2006," writes Corkery. The expected behavior of the speculators proves to be of great significance:
Meantime, J.P. Morgan economist Haseeb Ahmed said the overhang of vacant housing stock could erode existing home values as sellers slash prices to move their vacant properties. Economists fear that many vacant homes are owned by speculators who are stuck with investment properties that they can't sell and may be under increasing pressure to drop their prices. "We are concerned that there could be downward pressure on prices for awhile," Mr. Ahmed says ...

What's troubling is that speculators may not act like typical home sellers. When they sell their vacant home in a down market, they don't necessarily purchase another home. By contrast, people selling the homes they live in will most often buy another house -- thus fueling a healthy market of buying and selling.

Not surprisingly, buildings with five or more units -- which include condos that were magnets for speculators -- had the highest rate of vacancy. The vacancy rate among these units rose to 11% in the fourth quarter from 7% in the first quarter. For single-family homes, the vacancy rate rose to 2.3% in the fourth quarter from 1.8% in the first quarter.

Friday, February 09, 2007

Optimal vs. Natural Vacancy and Unemployment

There is a similarity (as one thinks of self-silimarity and self-similar transformations in non-linear differential equations) between "vacancy rates" as seen in the world of real-estate economics and "unemployment rates" as seen in the world of macroeconomics.

This should become clear when we look at optimal vs. natural vacancy and unemployment rates.

Optimality can be defined once we know what it is we are optimizing.

Naturality (to coin a word) can be defined when we know what vacancy rates or unemployment rates a particular market's transactions dynamics will create given its parameters of routine operations.

In a non-monopolistic real-estate market, optimal vacancy rate is 0. All landlords would like to have all of their units rented throughout the year. If tenant X moves out on January 31, the landlord would like tenant Y to start paying rent on February 1. In a monopolistic or oligopolistic market, say in the market for prime office space in San Francisco, optimal vacancy rate might be non-zero. For the monopolist, what matters is an optimal level of profit, not demand satisfaction. Similarly, optimal levels of unemployment are said to occur when Gross Domestic Product (GDP) of an economy is maximized. Of course, the solution to this optimization exercise depends on how we measure GDP. (The general concept also holds at the level of families as socio-economic units. One family may measure their gross domestic product to include things like childcare and nurturning and another may not. Their "optimal" money-driven employment rates will be different.)

For a given real-estate market, natural vacancy rate occurs in order to support the routine movement and migration of tenants from one site to another. For example, if finding a new property proves slow in a particular real-estate market, that market will have a higher "natural" vacancy rate. Similarly, the natural unemployment rate occurs in order to support the routine movement and migration of workers from one job to the next.

We can also talk about natural vacancy rate of positions within an organization or a company. There are always some number of unfilled positions due to the natural rate at which they are vacated and filled and the time lag involved in filling a position.

I should end this entry by noting that in a real economy, there's usually a relationship between all the various kinds of "vacancy" rates (employment, rental-property, etc.) but that relationship has not been the focus of what I've written here.

Thursday, February 08, 2007

chiemgauer, urstromtaler, landmark, kirschblüte and kann

We know about Open-Source Software but can we also talk about Open-Source Currencies. A report by International Herald Tribune's Carter Dougherty reminds us that we can.

Inspired by a long-dead German theoretician, Silvio Gesell, the currencies mine a hoary conflict in economics — usually pitting the mainstream against subversive outsiders — about whether paper money is a neutral medium of exchange whose purchasing power should be scrupulously guarded, or an instrument that could be manipulated to fulfill capitalism's untapped potential.

Dougherty notes that these currencies are encouraged to be used more quickly. For example, "in the case of the chiemgauer, the notes lose 2 percent of their value each quarter if people do not spend them in time."

Some 21 such currencies exist in Germany. Some 31 more are in preparation and "Gerhard Rösl, an economist with the University of Applied Sciences in Regensburg, has also located similar experiments in Denmark, Italy, Scotland, Spain and Italy."

The main effect of these local currencies is an increase in the "velocity of money" in the local economy where they are used. The automatic devaluation rate of the chiemgauer, apparently increases its circulation by a factor of 3 compared to central bank issues used in the same market. The factor will obviously depend on a number of macroeconomic variables.


By "Open-Source Currencies," I mean currencies that are not sourced from central banks. These are often sourced, openly, from private non-bank or non-profit institutions.

You may wonder about the words in the title of this blog entry. They all refer to currencies issued by non-bank institutions.

Wednesday, February 07, 2007

The Cost of War

On Monday, February 5, 2007, The Wall Street Journal carried a very interesting article on the President's budget proposal, focusing on its very large military component.

The heading of the article ("How War Expense Didn't Strain The Economy") and the graph on the front page seemed to be saying that there was nothing to worry about. They seem to say that the U.S. is spending less, per-capita, on military than before. However, reading the article gives a totally different sense.

The subtitle is a bit more subdued ("Foreign Lending; Lessons From LBJ; How Long Will It Last?"), and the story has a rather thorough analysis of macroeconomics of war. There is little wonder here as Greg IP, WSJ's macroeconomics correspondent contributed to the article written by Deborah Solomon. (To access it online, you'll need a subscription. Personally, I find the paper edition much easier to read. An online subscription also seems to give a much faster download rate of WSJ pages.)

The article notes, in one of its early paragraphs, that it is unknown for how long foreigners will finance U.S. budget deficit.

Interest rates rose when Lyndon Johnson raised the level of government borrowing to fund the Vietnam War.

This time, interest rates haven't risen as much, because foreigners, particularly in Asia, are eager to lend to the U.S. economy at fairly low rates. The economy as a whole is a heavy borrower from the rest of the world....

Mr. Bush's ability to sustain spending and tax cuts depends largely on the willingness of foreigners to continue lending the U.S. money. Mr. [Menzie] Chinn, the economist, says that at some point, global investors will lose their appetite for ever-larger amounts of American debt. That would trigger a decline in value of the U.S. dollar and an increase in interest rates.

"So far it's not a problem because foreigners are willing to lend, but you've got to wonder what happens when the rest of the world says, 'We're tired of taking paper that loses value pretty quickly,' " says Mr. Chinn.

And, of course, war can bring an economic relief and an infusion.

The Bush era upturn in defense and homeland-security spending came not during a 1960s-style boom, but in a lull in the U.S. economy, which had tumbled into recession even before the Sept. 11, 2001, attacks. That meant the economy had plenty of slack to absorb increased government spending without sparking inflation. Lee Price, an economist who until recently was research director at the Economic Policy Institute, a liberal Washington think tank, says defense spending created 1.3 million private-sector jobs between 2001 and 2005 while all other private-sector employment fell by 1.2 million.

However, such relief is short-term and short-lived, if "lived" at all. After all, a bumb drop, is only a bomb drop and nothing productive comes of it as an economic tool. Hence, Nobel laureate Joseph Stiglitz' prediction.

Some academic economists are beginning to gauge what the sums spent on Iraq could have financed -- a down payment on a Social Security fix, for instance. Nobel laureate Joseph Stiglitz predicts Iraq will cost at least $1 trillion, assuming troops are withdrawn by 2010. "Half that sum would have put Social Security on a firm grounding for the next 75 years," he wrote last year in a paper. "If we spent even a small fraction of the remainder on education and research, it is likely our economy would be in a far stronger position."

Sunday, February 04, 2007

Saving on Taxes

Apparently, Alexis de Tocqueville once observed: “In no other country in the world is the love of property keener or more alert than in the United States.”

So, with the housing prices going down, people are scrambling to recover some of their losses and make better with what they have. Some are looking into setting up a qualified personal residence trust, or a QPRT.

Here's an example form a report in Financial Times:
Assume, for example, that a second home owned by a grantor aged 65 is worth $500,000 and the IRS’s assumed interest rate is 6 per cent. If the grantor establishes a 10-year QPRT, the total value of his or her retained interest is $287,760. The taxable gift is only $212,240.

If the grantor survives the 10-year term and the residence appreciates 4 per cent a year to $740,122, the potential estate tax savings at 50 per cent will be $263,941.

According to the same report "a QPRT makes the most sense when there is a vacation home that a grantor would like to keep in the family."

Thursday, February 01, 2007

IT Costs and Platforms

When cost-conscious IT departments evaluate hardware upgrades to support a new OS, they may settle for an alternative OS which can bring new advantage to their hardware platforms. Consider the case of European car manufacturing giant PSA Peugeot Citroën. I wrote about it some more below, in my previous blog entry.

Economics of Open Source

InfoWorld reports
European car manufacturing giant PSA Peugeot Citroën has agreed to one of the Continent's largest-ever deployments of open-source Linux software on desktop computers.

As part of a multiyear contract with Novell, the French company will install Suse Linux Enterprise Desktop on up to 20,000 computers in addition to 2,500 servers, the U.S. software vendor said Tuesday.

This is an amazing blow to Vista and a great win for Linux.

Here, we are witnessing the economic impact of Open Source Software in a very real way. Peugeot is no little company. Migration to Vista would carry with it a hardware migration which many find unnecessary for most of their work. This happens when complementary technologies do not move in lockstep. How could day? The very nature of innovation and technological change has many effects that prevent such lock-step movement. So, here, we see how Linux has begun to fill a gap at the centers of industry.