Central banks lead subtle shift away from dollar

Tue Nov 3, 2009 4:31pm EST

By Steven C. Johnson - Analysis

NEW YORK (Reuters) - Central banks with trillions of dollars in reserves that are already stepping up euro and yen purchases will likely continue doing so in coming years, driven by worries over the stability of the greenback.

A record U.S. budget gap and the rise of dynamic developing economies like China suggest the dollar, down over 20 percent since 2002 on a trade-weighted basis, has further to fall.

Of course, the dollar comprises some two-thirds of global reserves and will remain dominant in most holdings, as attempts to dump it would destroy the value of central bank portfolios.

But with the speed of reserve accumulation increasing after a crisis-induced lull late last year, policy makers can choose to park more new cash in euros and yen without having to sell existing dollar assets.

"I think 2009 will be remembered as a watershed moment for currencies," said Neil Mellor, strategist at BNY Mellon, which has some $20 trillion in assets under custody. "I don't think there will be an imminent move, but it is quite clear there's a plan to shift reserves to a more balanced portfolio."

Barclays Capital research showed that central banks that report reserve breakdown put 63 percent of new cash coming into their coffers between April and July into non-U.S. currencies.

"There's an incipient desire to reduce the dollar share of reserves, and central banks will use any opportunity to do it, provided it doesn't cause the dollar to fall out of bed," said Steven Englander, chief U.S. currency strategist at Barclays.

International Monetary Fund data shows the dollar's share of known world reserves has been declining since it stood at 72 percent in 1999, the year the euro was introduced. As of the second quarter of 2009, it accounted for 62.8 percent.

To be sure, some of that shift is driven by the dollar's decline against a basket of currencies over that period.

But the Barclays data, which removes valuation effects, shows the second quarter was the only one in which central banks accumulated more than $100 billion in reserves and put less than 40 percent into dollars, down from a 70 percent quarterly average back to 2006.

Overall reserves rose 4.8 percent to $6.8 trillion in the second quarter, the IMF said, the first increase in a year.

CATCHING UP TO THE DOLLAR

Policy makers acknowledge the dollar will remain a linchpin of global finance for many years to come. But it has fallen steadily on a trade-weighted basis over the last decade, a troubling sign for China, Russia, India and other big U.S. creditors holding trillions of dollars of U.S. Treasury debt.

Worries about record deficits, run up as the United States borrowed hundreds of billions to stimulate an economy ravaged by financial crisis, has further diminished foreign demand for U.S. assets, making it likely the dollar will weaken further.

For a graphic of the dollar's declining share of known reserves and rising U.S. budget deficit.

And as others catch up to the United States, the dollar will share the stage with other currencies, said Barry Eichengreen, an economics professor at the University of California at Berkeley.

"The big beneficiary in the short run will be the euro, as only it has the requisite liquidity," he said. "But there's no reason why we shouldn't look forward to the advent of a multipolar reserve currency system."

The euro's share of known reserves hit 27.5 percent in the second quarter, from 18 percent in late 2000, IMF data showed. Analysts say it could exceed 30 percent in coming years.

The yen and sterling also stand to gain, while currencies from commodity exporters such as Australia may see more buying, Mellor said, particularly by energy-hungry emerging economies such as China, which holds $2.3 trillion in reserves.

Barclays' data showed claims in "other currencies" beyond the big four -- dollar, euro, yen, sterling -- rose more than 10 percent between April and July.

China does not report currency composition but is widely thought to hold around 70 percent in dollars.

Russia, the third biggest reserve holder with $419 billion in its war chest, says it holds some 47 percent in dollars and 40 percent in euros but wants to buy more of other currencies.

Central banks are also turning to gold, which Wells Fargo global economist Jay Bryson said may partly explain gold's surge to record highs.

Taiwan, the fourth largest reserve holder, has said it is considering buying more gold, while China said in April it had increased gold holdings by 75 percent since 2003. This week, India bought 200 tones of gold from the IMF for $6.7 billion.

DON'T COUNT DOLLAR OUT

Central banks do face limits on how they diversify their reserve holdings. Most currencies are simply not deep enough to accommodate massive sudden inflows and outflows.

Even a big shift from dollars to euros begs the question of which country's debt to buy. No European government bond market is as deep as the U.S. Treasury market, and bonds with the highest yields are from countries with the weakest economies.

"If you buy a 30-year Italian government bond, is Italy still going to be in the euro zone 30 years from now?" said Bryson. "Probably, but there is a risk there."

And while China's economy is on track to one day become the world's biggest, the yuan won't be a viable reserve candidate until China loosens controls and lets foreigners invest freely.

"That is a matter of decades, not years," said Anne Krueger, a former IMF deputy director now at Johns Hopkins University's School of Advanced International Studies.

Edwin Truman, a senior fellow at the Peterson Institute for International Economics and a former Federal Reserve economist, says it's "not so much a drift away from the dollar as it is a drift to other currencies."

"Will the dollar share of reserves be lower five years from now?" he asked. "If I had to guess, I'd say, 'yes.' Will it be because of a massive stampede out of dollars? Probably not."

(Editing by Leslie Adler)

Sorry, no jobs. This is California

Thu Oct 15, 2009 11:42am EDT

By Jim Christie - Analysis

SAN FRANCISCO (Reuters) - If you're looking for work, don't look in California.

The world's eighth largest economy is still finding its feet after suffering multiple economic shocks, including a housing slump, mortgage crisis and recession.

Employers in California, the most populous U.S. state, are expected to keep cutting staff in 2010 as the wider U.S. jobs market recovers.

As industries in other U.S. states prepare to rehire on signs of recovery, firms in California are still waiting for their economy to rebound.

The state has 12.2 percent unemployment, above the national U.S. level of 9.8 percent, and at odds with California's image as an oasis of opportunity in hard times.

California's economic engines -- Silicon Valley, Hollywood and gateway ports to Asia -- remain the envy of other U.S. regions but seem incapable of reducing Rust Belt-like unemployment rates.

That is largely because of the Golden State's housing and home building crisis.

In the 12 months through August, California's construction industry shed 142,000 jobs, or 18.5 percent of its work force, marking the largest decline on a percentage basis over the period of surveyed industry groups.

Those workers are struggling to find new jobs in construction or other trades, according to analysts.

House prices soared higher in California than in most other U.S. states earlier this decade and have crashed harder amid the credit crunch.

Developers are trying to unload unsold new homes and real estate agents are relying on selling foreclosures for a large share of business.

Tight credit and steep job losses have slimmed ranks of prospective home buyers, with many waiting for prices to drop further. At the same time, a number of other states are beginning to see home prices stabilize.

Tumbling personal, corporate and property tax revenues have put the brakes on government hiring as manufacturers wait for consumer spending to pick up before adding jobs.

"We're calling for a jobless recovery," said Jack Kyser, founding economist of the Kyser Center for Economic Research at the Los Angeles County Economic Development Corp.

California is not poised for relief from double-digit unemployment like the broader U.S. jobs market, which is expected to see joblessness peak at 10 percent in early 2010 and ease to 9.5 percent by the end of next year, according to the National Association of Business Economics.

Analysts expect California's jobless rate to climb well into next year even as other measures of the state's economy regain some of their luster.

Comerica Bank last week reported its California Economic Activity Index extended gains since March by rising to a reading of 101 in August and marking a "welcoming strengthening" of the state's economy, said Dana Johnson, the bank's chief economist.

"The key missing ingredient to a sustained and healthy rebound continues to be job growth," Johnson said. "It is the only component of our index that has not contributed positively since it bottomed five months ago."

Similarly, California purchasing managers expect manufacturing to grow this quarter -- without new jobs.

Chapman University's index tracking their views rose to 54.5 this quarter from 53.8 in the third quarter, a return to late-2007 levels and the second consecutive quarter of readings above 50, indicating expansion.

Job seekers, however, won't benefit. Chapman University's index report said output and new orders are projected to increase in the fourth quarter, but employment and inventories of purchased materials are expected to decline at a faster rate compared to the third quarter.

Manufacturers are reluctant to hire without definitive signs the recession is letting up, said Raymond Sfeir of the university's Anderson Center for Economic Research.

"They're trying to survive with as few workers as possible," Sfeir said. "They're not going to commit until they're more certain."

Small- to medium-sized companies need more than economic cues to boost payrolls, Kyser said: "They're having trouble accessing bank lending and are concerned about health-care reform and about environmental regulations out of Sacramento."

They're also waiting on consumers who have been stashing cash and paying off debt in a hurry instead of fueling job growth at shops, distribution centers, offices and factories.

"About every two weeks I do a 'mall crawl' to regional malls to see how many people are there and carrying bags," Kyser said. "They're out strolling around, getting out of the house. But they're not spending."

That doesn't bode well for Los Angeles County, California's most populous county. Kyser sees its jobless rate next year averaging 12.8 percent -- or worse. "That may be a conservative forecast because it's already at 12.3 percent," he said.

(Editing by Andrew Hay)

Heads or tails? It depends on how you flip it

By Jon Wilner and Mark Emmons

Mercury News
Posted: 10/16/2009 06:28:06 PM PDT
Updated: 10/18/2009 03:16:24 AM PDT

Everyone knows the flip of a coin is a 50-50 proposition.

Only it's not.

You can beat the odds.

So says a three-person team of Stanford and UC-Santa Cruz researchers. They produced a provocative study that turns conventional wisdom, well, on its head for anyone who has ever settled a minor dispute with a simple coin toss.

It also could have profound implications in America's favorite sport — pro football — because the coin flip plays an integral role in deciding games that go into overtime.

But first, here's what the researchers concluded: Using a high-speed camera that photographed people flipping coins, the three researchers determined that a coin is more likely to land facing the same side on which it started. If tails is facing up when the coin is perched on your thumb, it is more likely to land tails up.

How much more likely? At least 51 percent of the time, the researchers claim, and possibly as much as 55 percent to 60 percent — depending on the flipping motion of the individual.

In other words, more than random luck is at work.

The humble coin toss has been the subject of considerable study by researchers exploring concepts such as probability and statistics. There even was an unscientific look by a prisoner who once flipped a coin 10,000 times inside his cell.

"But they've all been wrong because people write down whether it comes up heads or tails, but they don't know how it
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started," said Susan Holmes, a Stanford University statistics professor who co-authored the study, which was published in 2007. "You have to know how it starts.''

And if you know that, the researchers believe, then you have a better chance of knowing how it will land.

The power of a coin flip

Tossing a coin long has been a choice for deciding trivial matters — like a dinner-table spat over the last piece of pizza. But coin flips also have played much more prominent roles. The Oregon city of Portland got its name after a best two-out-of-three penny toss by two settlers. (Boston was the losing name.)

There was a fateful coin flip on Feb. 3, 1959, that allowed early rock 'n' roll star Ritchie Valens to get a seat on a small plane that was supposed to carry him, Buddy Holly and two others to their next concert site. The plane crashed shortly after takeoff, killing all four.

The coin flip even is found in literature and cinema. Javier Bardem won an Oscar for his role in the 2007 film version of Cormac McCarthy's "No Country for Old Men" in which the villain tosses a coin to decide whether he should kill someone or let them live.

But nowhere in modern society does the coin flip loom larger than in sports — specifically the NFL.

A coin toss determines which team gets the football first in overtime if the score is tied after regulation play. And heading into this season, the team winning the overtime toss had won 63.3 percent of the games — and won the game 43.3 percent of the time on its first possession, preventing the other team from even touching the ball.

Consider the very first game of the season, on Sept. 10, when Tennessee quarterback Kerry Collins called the overtime coin toss and lost. Pittsburgh elected to receive the kickoff and marched down the field for the game-winning field goal. But before the coin flip, referee Bill Leavy, a former San Jose policeman and firefighter, had held the silver dollar out on his thumb. It would have been clearly visible to Collins if he had looked.

The Stanford and University of California-Santa Cruz researchers would suggest that Collins missed a golden opportunity to shade the odds in his favor.

Although the study's results would seem to potentially tilt the NFL's playing field, the league office in New York doesn't believe it has a problem. Officials were surprised that anyone had bothered to conduct a study examining coin-tossing odds.

They studied what?

At the 49ers training facility in Santa Clara, players had two initial reactions:

1) Don't those eggheads have more important things to do?

2) You're pulling my leg.

But the more the 49er players listened, the more they became intrigued. They quickly saw how — if the study were accurate — they might be able to gain an advantage.

Center Eric Heitmann, a Stanford graduate and 49ers captain, said: "I've never heard anything like that before, but I guarantee that I will be thinking about it each time I'm out there for the coin toss."

A sly smile even emerged on the face of linebacker Takeo Spikes, another 49ers captain.

"And if it works for us, I'll be the first one to support that study," he said.

That, countered kicker Joe Nedney, is just plain ridiculous. He wasn't buying the study one bit.

"There's so much variance in how a coin is flipped," Nedney said. "How could you possibly know how many rotations the coin makes?"

Researchers would say Nedney was not asking the right question.

The determining factor is not how high a coin is flipped, according to the study. Nor is it any other variable such as wind speed, air temperature or phase of the moon. It's not the size or the weight of the coin, either. (Legendary football coach Vince Lombardi was said to be a "heads" man because he mistakenly believed more metal on that side of the coin increased the odds of it landing up.)

It's all in the thumb.

"The way we flip coins creates a bias, and that makes it stay more time in the position it starts in," said Holmes, the Stanford professor.

Holmes co-authored the study with Persi Diaconis, her husband who is a magician-turned-Stanford-mathematician, and Richard Montgomery, a UC-Santa Cruz mathematics professor, in hopes of gaining a better understanding of the physics involved.

Using a camera from the Stanford engineering department that snapped 1,000 frames per second, they determined that the laws of basic mechanics play a large role. Coins flipped from a thumb don't merely rotate around their axis, but they also spin like a Frisbee.

The degree of that Frisbee spin depends on the motion of the thumb.

The more Frisbee spin, the longer the side facing up stays facing up when the coin is in the air.

And the longer the side facing up stays facing up, the better chance it will land that way.

"Some people flip in a more biased way than others," Holmes said. "There's always bias to the side that's facing up, and the variance depends on the motion of the flipper."

A firm landing surface, like a wood table, changes the equation. But grass — or the synthetic FieldTurf used in some NFL stadiums — mirrors the landing conditions used in the study and does not materially change the outcome.

If they had only known

That's why the results might have been of interest in the NFL — if anyone had known about it. Titled "Dynamical Bias In The Coin Flip" when published in 2007 in the Society for Industrial and Applied Mathematics Review, the paper drew a smattering of interest. But it flew almost entirely under the radar in the sports world — where the impact could be the greatest.

"We got a call from something called 'ASPN,' " Holmes recalled.

She meant ESPN. And no, she's not much of a sports fan.

Fans often grouse about what they see as the inherent unfairness of the NFL overtime system — usually after their favorite team loses a coin flip, and then the game.

Ray Anderson, a former Stanford player and the NFL's executive vice president of operations, said the league is well aware of the statistical edge favoring the team that wins the overtime coin toss. Almost every offseason, the NFL competition committee discusses changing its overtime rules. But the players largely are opposed to change because they worry that extending the length of the game would increase the risk of injury.

"So until there's something more telling or seems to really violate the integrity and spirit of fairness, it probably won't change," Anderson said. "There hasn't been anything dramatic enough to compel a change."

Not even research that claims the coin flip is not a 50-50 proposition?

"I really can't add anything on the study because I was a political science major at Stanford," Anderson joked.

The 49ers kicker Nedney, with tongue firmly planted in cheek, suggested that there could be other ways of determining who gets the ball first in overtime.

"We should start having it decided with Rock, Paper, Scissors," Nedney said. "Have the two captains out there battling the best two out of three. Or the referee should stand between the captains and say, 'I'm thinking of a number between one and 10.' "

Contact Jon Wilner at jwilner@mercurynews.com and Mark Emmons at memmons@mercurynews.com.

Will Renting Be The Undoing Of Home Prices?

CNBC ran a brief segment on the number of people who have decided to rent homes and apartments rather than buy them. The point of the reporting was simple. People who need to move out of their houses sometimes cannot sell them. Instead, they rent wherever they have moved and hope to sell their homes later when the market improves.
In addition, people who cannot sell their homes often rent them out to others to help cover mortgage and maintenance costs.

What has been lost in the review of home buying and renting habits is that some people who own a home will decide never to buy one again. The reaction to losing so much money on what is the largest investment many people will ever have will be, in many cases that they will not come back to the real estate market again. People who have suffered through anxious months not knowing if they will be able to pay their mortgages may decide that it is not an experience they want to repeat.

There are currently 3.4 million homes for sale in America. The average prices of these homes drops each month. Neither lower interest rates nor better prices are bringing buyers back into the market. Too many people believe that the market has not made a bottom. No one wants to own real estate that could lose another 15% of its value.
The renter does not have to lose sleep over the issue of whether his home will fall further in value. He does not have to worry about an ARM with an interest rate that might be set higher. Renters do not even have to worry about major repairs, the great enemy of the homeowner.

Renting was considered a fool’s way of living just a decade ago. A renter could not get equity in a property like the one that his homeowner friends had. A new house could double in value in ten years, offering the owner ready access to capital, a way to educate children and pay for vacations. With very few people willing to believe that those benefits are still a part of owning a home, the incentives to buy one have dwindled.

Realtors believe that the economy is at the root of the reason that people will not buy homes. That is true to some extent. People who are worried about their jobs or have seen their stock market holdings lose half of their values are not likely to be in the market. But, the shift may be more profound than that. Renting could become the norm for many people, especially those who cannot foresee a future when real estate is an asset which can rapidly increase in value again.

Wall Street Digest Hotline Update

This is The Wall Street Digest Hotline Update for Friday, February 20, 2009, at 6:00 p.m. EST.

Worries over a nationalized banking system pushed the Dow Industrial Average to an intraday low of 200. At the close, the Dow plunged 100 points, closing at 7,366, while the Nasdaq lost one point, closing at 1,441. The S&P 500 fell almost 9 points, closing at 770. Oil closed $0.54 lower at $38.94 per barrel, and gold closed $25.70 higher at $1,002.20 per ounce.

Wall Street has not reacted well to any measures presented by the Obama Administration to address the banking crisis, the credit crisis, and the deflationary slide of the housing sector.


Date News Event Dow Average

1/30 Fourth quarter GDP down 3.8 percent Fell 148 points

2/5 Obama/Geithner announce executive pay cap Fell 122 points

2/10 Geithner releases $2 trillion bank rescue plan Fell 382 points

2/13 House passes $787 billion stimulus bill Fell 82 points

2/17 Obama signs $787 billion stimulus bill Fell 298 points

2/19 Banks fear Nationalization Fell 89 points

2/20 Confusion after Bernanke speech (today) Fell 100 points


- 12 million home mortgages are under water.
- At least 344 banks have received TARP funds.
- Europe and the U.K. are sliding into a deep recession.
- GDP growth and profits growth will be negative in 2009.
- The Dow peaked at 14,164 on 10/9/07. Today the Dow is at 7,300 down 6,867 points or 48 percent.


Our Washington politicians will not be able to stop the next Great Depression from unfolding between 2010 and 2022, a period of 12 years. Pay off all debts. Sell all of your real estate, if possible.

During a deflationary depression the price or value of virtually everything will decline from current levels. Selling the personal residence is a very personal decision.

All of the bubbles including commodities, the stock market, and real estate will eventually burst and crash. Nothing can stop the 2010-2012 bear market and recession because all of the engines of economic growth have already turned negative.

The next Hotline Update will be on Tuesday, February 24, 2009, at 6:00 p.m. EST.

Price Drops to Continue

JANUARY 13, 2009, 9:07 P.M. ET


Home prices are likely to be lower in two years in more than one-quarter of the nation's housing markets, according to a new study by mortgage insurer PMI Group Inc.

The study "tells us ... that we are far from a rebound in prices," says PMI chief economist David Berson. The risk that home prices will be lower in the third quarter of 2010 increased in 97% of 381 metro areas, according to the PMI analysis, though in many markets that risk remains relatively low.

The markets with the greatest risk that home prices will be lower in two years include California's Inland Empire, the greater Miami area, Lake Havasu City-Kingman, Ariz., and Cape Coral-Fort Myers, Fla. Metro areas with the lowest chance of price declines include the Dallas-Fort Worth area, greater Houston and Pittsburgh.

In developing its risk index, PMI considers recent trends in home prices, housing affordability, unemployment rates and foreclosures, among other factors. The study included data through the third-quarter, but there was little sign of improvement since then, Mr. Berson says. Falling mortgage rates were a plus for the housing market, he says, "but offsetting that is the fact that unemployment rates are up everywhere, home prices fell further in the fourth quarter and the foreclosure rates probably increased in most places."
—Ruth Simon

U.S. mortgage applications slump to 8-year low

Wed Feb 11, 2009 7:28am EST

By Lynn Adler

NEW YORK (Reuters) - Demand for U.S. mortgage applications tumbled nearly 25 percent last week, with requests for loans to buy homes sinking to an eight-year low, the Mortgage Bankers Association said on Wednesday, as potential buyers hold out for better terms and government help.

The Mortgage Bankers Association's seasonally adjusted home purchase applications index slid 9.8 percent in the week ended February 6 to 235.9, its lowest level since the end of 2000.

Average 30-year mortgage rates slipped to 5.19 percent from 5.28 percent a week earlier, the trade group said.

The rate has fallen more than a full percentage point in three months, but is up about 3/8 point from early this year and seen heading lower.

"In addition to waiting for the rate, you have home prices continuing to come down, so why would I pay $200,000 today when I can pay maybe $180,000 in a couple months or even $150,000," Daniel Penrod, industry analyst for the California Credit Union League in Rancho Cucamonga, California, said on Tuesday. The government is "really pushing against some very strong forces."

U.S. Treasury chief Timothy Geithner on Tuesday proposed pumping $2 trillion into the banking system to sop up bad assets, restore credit and revive lending at lower mortgage rates.

Expectations that government steps could yank 30-year home loan rates near 4 percent, a proposed $15,000 home-buying tax credit and the outlook for still lower house prices has raised the incentive to wait.

Home prices through November tumbled at least 25 percent from their mid-2006 peak, according to Standard & Poor's/Case-Shiller Home Price indexes. The descent should persist, with a record number of foreclosed properties dragging down market values, analysts have said.

The Mortgage Bankers Association's loan refinancing gauge tumbled 30.3 percent to 2,722.7 last week, its lowest level since the November 21 week and a far cry from the 7,414.1 reached in January when 30-year mortgage rates fell to 4.89 percent.

Intensified government actions will help, Penrod said, but the needed elixirs are more bank lending and a more stable employment picture.

"There's no urgency to jump in until prices settle," Penrod said. "Given the current state of unemployment and the projections there is still downward movement coming in the first half of the year for non-foreclosure sales and prices."

U.S. employers slashed nearly 600,000 jobs in January, the biggest monthly cuts in 34 years, while the unemployment rate set a 16-year peak.

The $15,000 home buyer tax credit that is part of the economic stimulus program adopted by the U.S. Senate would create nearly 500,000 home sales and add 255,000 jobs in the coming year, according to the National Association of Home Builders.

Analysts had also been predicting that at least a third of home owners applying to cut costs by refinancing would be turned down because of more rigid lending standards, job loss or because their home values have fallen below the size of existing mortgages.

Borrowers with mortgages that surpass their appraised home price are called "under water," or "upside down."

"Even with the proposed tax break and the rates dropping way down, it unfortunately doesn't change the water level for those drowning in their home debt," Penrod said.

(Editing by Leslie Adler)

The Panic of 2008-2009

Michael Shulman
OptionsZone.com

Up, down, up, down – 800-point market gains, bookended by 400-point losses and punctuated with 200-point gains.

The dizzying market activity of 2008 is forcing investors to the sidelines to hide their cash (and contend with their newfound case of vertigo).

If you’re looking toward Wall Street for some reassurance that this whipsaw trading action will stop anytime soon, well, here is the growing mantra on Wall Street:

First housing failed, then the credit and equity markets, and now it’s the economy’s turn. A neat, three-step process for economic meltdown.

And now that we’re in this third leg, according to the Street, the markets are now nearing a bottom.

If you listen to the pundits, the markets will be heading up as soon as the Street sees a bottom in the recession – perhaps Q3 of next year – which means a sustainable market bounce in Q1, maybe Q2 of 2009.

Well, if you believe that, would you like to buy a bridge? (The one closest to Wall Street – the Brooklyn Bridge.)

Why do I say that? Because only a sucker could believe this nonsense coming out of Wall Street.

Let the suckers listen to the talking heads and invest (or not invest) accordingly

Analysts' Off-the-Wall (Street) Expectations

There are three fundamental reasons why Wall Street is dead-wrong on a quick turnaround for our economy and the stock market:

1. The Street sees a bottom in housing prices in early- to mid-2009.

If you do third-grade math on publicly available information for mortgages, housing inventory, the population and credit standards, you will see this will happen in mid- to late-2011. With this disconnect comes unreasonable assumptions about future bank write-downs and future consumer spending.

2. The Street sees a slowdown in write-offs and thinks the credit markets are already healing.

This is the reason it was surprised by Wachovia’s (WB) write-offs and why the talk is uneasy when it comes to Citigroup (C), the book of business Morgan Stanley (MS) got with Washington Mutual (WM) and what exactly Bank of America (BAC) is finding as it sorts through Countrywide’s balance sheet.

The Street is also in willful denial about the coming sharp acceleration in bad credit card, home equity and auto loan debt due to the recession. And, as long as write-offs continue and eat away at bank capital, lending will continue to contract.

3. The Street says the consumer is tapped out and will be for at least three quarters.

Consumers are not just tapped out – they are only beginning to suffer and will soon go into hibernation. The $800 billion in home equity draw-downs that supported spending in past years has nearly evaporated down to a few billion.

Consensus estimates now put future unemployment at 8% – I see it a couple of points higher – which means even less consumer spending; Our proprietary ChangeWave Research network surveys show some of the worst consumer and business spending plans in the past seven years.

Businesses are not getting the credit to expand or even stay afloat; they see fewer consumers spending and more cutting back; and export markets are imploding due to the credit crisis and the rapid rise in the dollar. GDP is contracting and will continue to do so faster than Street estimates.

The bottom line: We are not near the beginning of the end of this crisis; we are at merely at the end of the beginning.

Reality Has a New Definition

Over time, equity markets will face reality and come way down. But even if the market stays where it is right now, this does not mean we cannot make money through this crisis – you can.

So, let’s take a hard, fundamental look at the crisis – without ideology or willful optimism – and from there, you will see how profits can head your way once you join us at ChangeWave Shorts.
The Epicenter – Housing

The epicenter of this crisis – as I have been saying since February 2007 – is the U.S. housing market and declining home prices. The overhang of inventory and continuing foreclosures will continue depressing home prices.

Analysts see a bottom in a couple of quarters – I see it in a couple of years. Here is why:

* In the past, the magic number that signaled a bottom was a decline in housing starts below 1 million per annum. Current levels are well-below that – but foreclosures, most of them of relatively new homes, are at stratospheric levels. If you add new housing starts and while number of foreclosures above historical norms, you have a "synthetic" housing start rate that’s not too far from the days of the bubble.

* Why am I so certain that foreclosures will continue apace? Third-grade math – I looked at when subprime, Alt-A, option Adjustable-Rate Mortgages (ARMs) and other funky and less-than-creditworthy mortgages were granted and when these re-set.

We are nearing peak defaults among Alt-A and subprime mortgage holders – foreclosures will follow in around six months – but are about to be hit by a giant wave of defaults and foreclosures from option ARMs and the recession.

Option ARMs are those crazy mortgages that let you pick what kind of payment you make in a month and you can roll over interest into your principal. Then you hit a loan-to-value ratio and – boom!

Further, housing inventory of 1.5 million units, or 10 to 11 months, is going to stay at least that high for another year.

But markets are local, you say?
Fewer Buyers, Bigger Problems

The market for a specific house is local, but the dynamic that drives mortgage credit standards and lending is national. This translates into a 40%-50% reduction in the number of qualified buyers compared to 2006, independent of the impacts of a recession.

You can look up the data and do the math yourself – between 36% and 45% of buyers at the peak of the housing bubble had either subprime or Alt-A loans, and default rates for prime borrowers are more than triple what they were before the crisis. And standards have now overshot – a 50% reduction in eligible buyers may be generous, though it is probably more.

So, do the math – excess inventory facing a market at least half as big as it was just two years ago means continuing inventory issues and a continuing fall in home values. Defaults will peak in 12 to 15 months, foreclosures will top in 6 to 12 months after that, and inventory will hit the ceiling 6 to 12 months after that.

This puts us in the middle or end of 2011 when things get truly stable and prices see a bottom.
The Banks and the Credit Markets

If all banks had to sell their assets today, the U.S. banking system – using conventional accounting methods – would be technically insolvent, as are most banking systems around the world.

The situation is far worse than the during the banking crises of the 1930s – it is just that the government and the Fed have learned some, if not all, lessons from that disaster and have kept the system afloat by essentially printing money and injecting it into the system.

Several things are currently at work within the system and all aim at one goal – reducing the leverage among banks.

What is leverage? It is a measure of how much a bank lends (i.e., the assets it acquires) compared to the amount of its core capital fund or equity – pick your pleasure – of that bank. Traditional banks typically have a buck in a deposit account and lend out 11 or 12 bucks.

At the time Bear Stearns fell, though it was not a traditional bank but an investment bank, it was leveraged almost 35-to-1; the other investment banks were in the same neighborhood. And some foreign banks – notably the Germans – were leveraged at almost at 50-to-1. Over time, this is going to fall to in the range of 11-1 to 15-1.

How will this happen?

1. Banks will increase their equity and core capital, which will increase the denominator, and …

2. Banks will reduce lending and the assets they acquire, reducing the numerator.

This is well under way – but it’s the primary reason we are only about one-third through this mess.

And this is why we still have a long way to go:

Bank capital is actually decreasing due to write-offs. Despite Uncle Sam’s best efforts to raise more capital, core and equity capital will remain stagnant at best for quite a while.

Foreign investors have been badly burned by previous investments in the banks – and now Uncle Sam is in line ahead of the banks to get paid back for the preferred shares, as well as private investors such as Warren Buffett.

The banks, by de-leveraging, are reducing their ability to generate future profits – not to mention the end or reduction in many profitable activities, such as mortgage securitization, IPOs, mergers and so on – and their ability to internally generate profits to increase capital is virtually nil.

This lack of operating profits also reduces their abilities to pay dividends and attract capital. It is very possible that the banks will not be able to generate more than 25% of the operating profits we saw at the peak of their previous peak for at least five years.

How does this affect us?

The impact comes in the form of significantly less business and consumer lending. This process of de-leveraging will take time and there will be fits and starts as the banks get hit with higher-than-expected write-offs and a sharp recession.

We were down more than $3 trillion – with a T – in 2008. Expect more next year, as we could see a cutback as steep as $5 trillion. This cutback could make the recession longer and deeper and the recovery more difficult than at any time since the early 1980s.

Don’t shoot the messenger – I didn’t sell anyone a subprime mortgage. I’m just doing simple math.
The Recession

We have been in a recession since Q4 of 2007 and it is accelerating rapidly as credit contracts for consumers and businesses. Does this really matter?

I bumped into a Wachovia guy recently and he told me it is not doing any commercial lending greater than $5 million. Even applicants requesting less than that are probably wasting their time.

Minimum credit card payments are doubling, home equity lines are being cancelled or pulled in, and a regulatory change in credit card markets next year could end up killing more than $2 trillion in consumer credit lines. The recession is evidenced in both consumer and business behavior.

The consumer is going into hibernation – Go to a department store and check it out for yourself. The lines are shorter everywhere except Costco (COST) and Wal-Mart (WMT). The holiday season could be the worst in two decades, from stores to restaurants to travel.

Three months ago, while booking hotel reservations for a trade show, Mandalay Bay in Las Vegas was offering upscale suites (I am generally a Hampton Inn kind of guy, but my wife was traveling with me) in its new tower for about $375. I checked last night and those same rooms are going for $176.

My favorite hotel (because of smoke-free poker room) is the Mirage – and its rooms just broke below $100 on Expedia (EXPE).

As a consumer yourself, which deal would you choose?

In this case, with consumers vacationing closer to home (if at all), the hotel industry scrambling to fill rooms, and checked-baggage charges scaring customers away from air travel, we started looking at companies that would feel a peripheral pinch. As it happened, our ChangeWave survey research indicated that fewer people were using online booking sites like Expedia and opting instead to book directly through hotels and airlines.

The moral to the story: What looks like a no-brainer can turn out to be a big gainer!

Business is contracting – Speaking of the ripple effect of bad news and bad business, we’ve seen the mortgage industry – which is down by about 80% – lay off countless workers. Investment and big banks are also conducting huge layoffs. Residential construction is down two-thirds, automakers are laying people off, and so on.

But, you may ask, isn’t all the money that Uncle Sam and the Fed have pumped into the economy and the reduction in interest rates going to help?

No – the money has been pumped into the financial system but has not made its way into the economy. Why? We are in what is called a "liquidity trap" – money is being pumped into the financial system and banks are sitting on it to rebuild their balance sheets. The money is going into the front-end of the pipe – read: banks – but not coming out of the pipe at the other end (into the economy).

Until de-leveraging is at least two-thirds complete, this money will be sucked up and sat on. That means the recession will be long – until at least early- to mid-2010 – and deeper with 9% unemployment or more – than Wall Street expects.

This means sharp downturns in corporate profits that are much lower than even lowered expectations. As they come down, individual stock prices and the general market will come down.

The Equity Markets

Massive market movements have recently been described as the result of panic and massive liquidations by hedge funds. (Remember that bridge I wanted to sell you?)

Standard & Poor’s earnings estimates are down 30.5% since September and the market was down 38% in 2008. I don’t believe in this kind of a coincidence – but I do believe general markets will continue to drop. Let’s look at recent changes in estimates for the S&P 500 (SPX) for 2009:

* March 2008 – estimates of $80-$82

* September 2008 – estimates of $64-$67

* In the past few weeks we’ve seen estimates of around $50. This puts the S&P 500 at a multiple of around 18 times future earnings, which is historically the high end of the range for the S&P.

Now let’s do some math:

* In the higher range of S&P earnings multiples – 15, or an S&P 500 index of 750 in 2009

* In the middle range of S&P earnings multiples – 12, or an S&P 500 index of 600 in 2009

* In the low range of S&P earnings multiples – 9, or an S&P 500 index of 450 in 2009

This is all based on the assumption that earnings forecasts – and actual earnings results – are not lower.

Back to the now – the current market is trading at roughly 18 times 2009’s latest consensus forecast for S&P earnings. If the market adjusts to longer-term historical norms, we could see a trading range of 450-750 on the S&P 500, or declines ranging from 15% to 50%.

What should you do?
Get on the Short Side of Life

Everyone should be at least partially in short-side positions – and in this crisis, you can up your exposure. I accomplish this by buying puts, not actually shorting stocks.

What companies and market segments are the best places for a short side investment? Wherever we have the most compelling proof that Wall Street currently has it wrong and is setting itself up for a major downside surprise.

Right now, that means:

The Banks – They are way overvalued. It may take time for this to manifest in their respective stock prices, but it will happen. All announced government actions, over time, will be significantly dilutive to existing shareholders and eventually drive stock prices down based on the fundamental ability of these companies to generate earnings per share.

The worst of the litter? Citigroup (C), and look for Bank of America (BAC) and Wells Fargo (WFC) to deliver some unpleasant surprises to stockholders.

Homebuilders – They are furiously writing off properties and raw land to take advantage of a special tax rebate program that expires at year-end because, once this is over, their financial weaknesses will be very transparent.

Once one homebuilder goes bankrupt, credit lines will dry up and the stocks will take their last legs down. Take a look at Beazer Homes (BZH).

Consumer Spending – Going, going, gone. Let’s put it this way, Santa cannot afford the feed for the reindeer this year.

Many stocks are trading at 52-week or multiyear lows, but we are looking at a consumer recession that could rival that of the early 1980s. Even though put premiums may appear high, there are plenty of opportunities.

Take a look at the obvious quasi-luxury targets like Tiffany & Co. (TIF) and Nordstrom (JWN), as well as the less-obvious names like the Cheesecake Factory (CAKE).

Tech and Pharma – Healthcare, what many see as a "safe haven," makes me want to offer you that bridge yet again if you’re looking at buying some of these stocks.

Pfizer (PFE) is going to be creamed when its Lipitor patent expires in 2010. And the orthopedics guys are discovering that joint replacements are elective surgeries for many who cannot afford co-pays and deductibles; so, you may also want to check out Stryker (SYK) and Zimmer (ZMH) for big potential on the short side.
Swoop Down on Profits Like a Vulture

Wall Street is littered with broken companies today, just like a busy interstate is littered with carrion. The vultures have it right. They don’t waste their energy stalking prey; they take advantage of a feast when it presents itself.

Vulture investors – and I’m proud to be one – do the very same thing.

Wall Street Digest Hotline Update

This is The Wall Street Digest Hotline Update for Tuesday, January 20, 2009, at 6:00 p.m. EST.

Financial stocks led the market lower today. At the close, the Dow plunged 332 points, closing at 7,949, while the Nasdaq dropped 88 points, closing at 1,441. The S&P 500 fell almost 45 points, closing at 805. Oil closed $2.23 higher at $38.74 per barrel, and gold closed $15.30 at $855.20 per ounce.

Fears that the global banking crisis is worsening sent financial stocks plunging today, with many companies' shares down by double-digit percentages and Citigroup Inc. diving to a 17-year low.

U.S and British banks are still suffering losses from loans and are warning that those losses will not subside anytime soon. Regional banks as well as the big money center banks are struggling.

Evidence that the banking crisis is worsening overseas also rattled investors. Bank stocks also dropped in the aftermath of multibillion losses announced Friday by Citigroup Inc. and Bank of America Corp.

An $825 billion stimulus bill will not stop the next Great Depression to unfold between 2010 and 2022, a period of 12 years. Pay off all debts. Sell all of your real estate if possible.

All of the bubbles including commodities, the stock market, and real estate will burst and crash. Nothing can stop the 2010-2012 bear market and recession because all of the engines of economic growth will turn negative by mid-2010.

The next Hotline Update will be on Friday, January 23, 2009, at 6:00 p.m. EST.

Wall Street Digest Hotline Update

This is The Wall Street Digest Hotline Update for Tuesday, January 13, 2009, at 6:00 p.m. EST.

Falling commodity prices continue to weigh on the market. At the close, the Dow lost 25 points, closing at 8,449, while the Nasdaq gained 7 points, closing at 1,546. The S&P 500 gained slightly more than one point, closing at 872. Oil closed $0.19 up at $38.27 per barrel, and gold closed $0.30 down at $820.70 per ounce.

The economic news is bad and it will get worse. A global recession is underway. A global depression will unfold by mid-2010.

Deflation is the Fed's biggest fear, because deflationary psychology is difficult to reverse. "Why should I buy a home today, when it will be cheaper next month or next year?" As a result, home prices continue to fall. Four-percent mortgage rates would help if our regulators could get the banks to lend money. Home prices still have much further to fall. An 11.2-month inventory of homes for sale weighs on the market.

On Thursday, January 8th, President Elect Obama said, "We will spend our way out of this mess." Investors and consumers do not believe an $800 billion stimulus bill will produce prosperity. FDR tried that with the New Deal in the 1930s. It did not work. The Great Depression of the 1930s still lasted 12 years. The next Great Depression will unfold between 2010 and 2022, a period of 12 years. Pay off all debts. Sell all of your real estate if possible.

The Kress major market down cycles bottomed on December 22. I expect a bear market rally to unfold between January and July 2009. This rally may or may not post new highs in 2009. This will be a temporary bear market rally, not a new bull market. All of the bubbles including commodities, the stock market, and real estate will burst and crash by mid-2010. Nothing can stop the 2010-2012 bear market and recession because all of the engines of economic growth will turn negative by mid-2010.

The next Hotline Update will be on Friday, January 16, 2009, at 6:00 p.m. EST.

Apartments Try to Stay Afloat

JANUARY 14, 2009


The rapid reversal of fortunes in commercial real estate is taking down yet another sector: apartment complexes.

Owners and developers of multifamily buildings are trying to stay afloat as the deteriorating economy and escalating job losses create difficulties in raising rents and shortfalls in projected revenues from these buildings.

While sharp declines in retail and office sectors of commercial real estate have commanded attention in recent months, some analysts say deterioration in the multifamily sector is quickly catching up.

A downturn in this sector also drags in housing mortgage giants Fannie Mae and Freddie Mac, which are already hurting from ...

Commercial Sector Expects Things to Get Worse

JANUARY 14, 2009

Riverside-San Bernardino, Calif.

By MAURA WEBBER SADOVI | SPECIAL TO THE WSJ

California's Inland Empire, the two-county region that stretches east of Los Angeles, has gone from a booming development smorgasbord to a basket case in a few short years.

The Riverside-San Bernardino area's unemployment level rose to 9.5% in November, tying with Detroit to lay claim to the highest unemployment rate of any large U.S. metropolitan area, according to the Labor Department. Third-quarter home-foreclosure rates were the third-highest of the nation's metros surveyed by RealtyTrac and the area's median single-family home price fell 39.4% to $227,200 in the third quarter from a year earlier, according to the National Association of Realtors.

The Inland Empire's commercial real-estate market also is by no means the picture of health. Roughly one-fifth of its office market is now vacant, store rents are plummeting and a rising number of warehouses are emptying as retailers have filed for bankruptcies and imports into the nearby ports of Los Angeles have slumped.

Still, as in many parts of the country, for now the downturn of commercial property in this region isn't as severe as that of its residential sector and job market.

Home to about 4.2 million people, the Inland Empire was favored in recent years by new residents and many industrial investors drawn to its expanse of relatively affordable land near Los Angeles.

So far, the region's commercial market isn't yet topping out the nation's various misery indexes, but it appears likely things will get worse before they get better. "We don't know when and where the bottom is," says Tim O'Rourke, executive vice president with Jones Lang LaSalle's industrial group in Los Angeles.

Mr. O'Rourke says the Inland Empire industrial market is still viewed as having long-term promise due to the area's above-average population growth and location. But as retail bankruptcies mount, an increasing amount of distribution space is going vacant, including a warehouse in Rancho Cucamonga previously occupied by Wickes Furniture Co., he says.

Warehouse vacancies in the third quarter remained among the country's lowest, even after roughly doubling over the past 12 months, according to Boston-based Property & Portfolio Research Inc., a real-estate research firm. Harder hit are metrowide office vacancies, which rose above 20%, and fourth-quarter retail rents, which had the third-highest percentage decline of 76 major metros tracked by New York-based Reis Inc., a real-estate research firm.

Delinquencies on commercial mortgages packaged and sold as bonds, which represent nearly a third of the commercial real-estate debt market, suggest the Inland Empire's retail market is getting hit particularly hard by the downturn, as evidenced by delinquencies on commercial mortgage-backed securities, or CMBS. A study of delinquencies in the region's largest cities and towns showed four retail properties with delinquent CMBS loans valued at a total of $165 million, according to Richard Parkus, head of research on such bonds for Deutsche Bank.

There were no delinquent office, warehouse, apartment or hotel loans in the region, according to the CMBS survey. But the retail problems gave the market an aggregate commercial delinquency rate of 3.8% as of December, well above the overall national delinquency rate of 1.2%, Mr. Parkus says. "Retail is going to get slammed in the Inland Empire, and it's already starting," Mr. Parkus says.

That outlook for the office and warehouse sector is also looking tougher. Financial companies are still emptying office space, including about 265,000 square feet in Rancho Cucamonga to be vacated by a unit of Citigroup Inc. in March.

New supply also will raise competition for shrinking warehouse users. While most public companies have ended any speculative building in the area, some 7.4 million square feet of warehouse facilities are expected to be completed this year, the highest volume of major markets tracked by PPR in the U.S.

Write to Maura Webber Sadovi at maura.sadovi@wsj.com

Great Depression jobs parallel may not be far flung

By Pedro Nicolaci da Costa

NEW YORK (Reuters) - When economists tell us the current U.S. slump could never turn into another Great Depression, they all point to one thing: one of four Americans was out of work in the 1930s.

But since the definition of joblessness has changed over the years, this expert assessment might be too rosy.

As many as 25 percent of Americans were unemployed during the days of bread lines that symbolized the Depression, but that figure is more than three times the current 6.7 percent unemployment rate, the economists say. Even the most pessimistic estimates only foresee the rate rising barely above 10 percent.

"We are in a very, very different place than the U.S. economy was in the 1930s," James Poterba, president of the National Bureau of Economic Research told a recent Reuters Summit.

Or are we? Figures collected for Reuters by John Williams, from the electronic newsletter Shadowstats.com, suggest that, while we are not there yet, the comparison is not as outlandish as it might initially seem.

By his count, if unemployment were still tallied the way it was in the 1930s, today's jobless rate would be closer to 16.5 percent -- more than double the stated rate.

"I expect that unemployment in the current downturn, which will be particularly deep and protracted, eventually will rival, if not top, the 25 percent seen in the Great Depression," Williams said.

He and other critics have one particular sticking point with the current way of measuring unemployment: the treatment of discouraged workers.

Under President Lyndon Johnson, the government decided individuals who had stopped looking for work for more than a year were no longer part of the labor force. This dramatically decreased the jobless rate reported by the government.

"Both part-time workers wanting full-time work and discouraged workers tend to make the unemployment rate lower than it would otherwise be," says Robert Schenk, professor of economics at St. Joseph's College, Indiana.

The latest report, due on Friday, is expected to show another month of more than half a million job losses in December, and a jump in the unemployment rate to 7 percent.

However, some economists, including Kenneth Rogoff at Harvard University, now say joblessness could top 11 percent. Under Williams' methodology, that picture might look much more like the Great Depression.

(Reporting by Pedro Nicolaci da Costa; Editing by Kenneth Barry)

Apartment rents show first decline in over 5 years

Wed Jan 7, 2009 3:46am EST

BOSTON (Reuters) - Average rents for U.S. apartments fell in the fourth quarter, as a sharp economic downturn and rising unemployment left Americans unwilling to pay higher prices, according to data released on Wednesday.

Rents fell 0.4 percent in the final quarter of 2008, the first decline since early 2003, the study by real estate research firm Reis Inc found.

The vacancy rate rose to 6.6 percent, a level last seen in the first quarter of 2005, and up from 5.7 percent a year earlier.

While few Americans typically move in the fourth quarter, as they face the onset of the northern hemisphere winter and several national holidays, the decline in rents shows that landlords are moving quickly to try to keep vacancies down, said Victor Calanog, director of research at Reis.

"The quantity of rental apartments might not be suffering as much, but the price paid by households to occupy those rental units is buckling under the strain, with landlords lowering asking rents and raising the amount of concessions they are willing to provide," Calanog said.

The current global economic downturn can be traced back to the decline in U.S. home prices that began in the middle of the decade. That led to a collapse in the subprime lending market, which last year snowballed into a global credit crunch.

The slump is not confined to residential properties. Reis data released on Tuesday showed that office rents across the United States fell 1.2 percent in the fourth quarter, as a slumping economy drove vacancy rates higher.

Shares of major U.S. owners of apartment complexes including Apartment Investment and Management Co, Equity Residential and AvalonBay Communities Inc have been pummeled in recent months.

(Reporting by Scott Malone; Editing by Tim Dobbyn)