The Fed's decision to lower both the federal funds rate and discount rate by half a percent vaulted the markets northward with the Dow putting in its greatest advance in years. The move by the Fed was a bold statement that with Bernanke at the helm the Fed will do whatever is necessary to support the markets as well as the economy. Thus, the Fed has emphatically declared it will fill the punchbowl of liquidity to overflowing after removing it from the economic party over the last few years.
Continuing with loose monetary policy, Treasury Secretary Henry Paulson told Congress today that the federal government will hit its debt ceiling on October 1st, and urged Congress to raise the debt limit to protect the 'full faith and credit' of the country. Paulson urged the Senate to pass legislation approved earlier in the month by the Senate Finance Committee to increase the national debt limit to $9.82 trillion dollars, an increase of $850, which is the fifth increase in the government's borrowing since George Bush took office in 2001.
In another about face, the Bush Administration reversed their policy by allowing Fannie Mae and Freddie Mac, the nation's two largest providers of mortgage financing, to expand their investments in order to support the mortgage markets. The Office of Federal Housing Enterprise Oversight (OFHEO) will allow both Fannie and Freddie to increase their mortgage portfolios by 2% a year beyond their existing cap of roughly $1.5 trillion. The new rules would allow Fannie Mae to add $12 billion of mortgage assets and $22 billion for Freddie Mac.
These monetary and fiscal moves were conducted to stem the ongoing collapse in housing. RealtyTrac on Tuesday said foreclosure filings jumped to 243,947 in August, up 115% from August 2006 and up 36% from July. The company reported that foreclosure filings were under way nationwide in an average of one in 510 homes, with bank repossessions in August coming in at 42,789, up 60% from the 26,842 bank repossession reported in July. The hardest hit areas continue to be Nevada, California, and Florida, where fillings were under way in one in 165 homes, one in 224 homes, and one in 243 homes respectively.
"The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable rate loans are beginning to reset now," said James Saccacio, chief executive of RealtyTrac.
"Another significant factor in the increased level of foreclosure activity is that the number of REO filings (bank repossessions) is increasing dramatically, which means that a greater percentage of homes entering foreclosure are going back to the banks."
Further evidence that the housing recession has not bottomed has been pouring in all week. The Commerce Department reported Wednesday that construction of new homes fell by 2.6 percent in August to the slowest pace in 12 years, and on Tuesday the National Association of Home Builders (NAHB) reported that its index of builder confidence fell in September to equal the lowest level on record. Commentary by DismalScientist on the NAHB report is given below:
The market for new homes is virtually dead. The seasonally adjusted numbers are the lowest on record for September for every subcategory, as they have been for each month since spring began. The number of optimistic responses to the survey is the lowest for any time in the 22 years of the survey, regardless of the season. The bottom of this market will not be reached until there is another significant decline in the cost to prospective buyers, both in house prices and mortgage rates.
The worst of the housing recession may be over with the year-over-year (YOY) rate of change falling to previous cyclical lows of -40%, though the bottom is still nowhere in sight with housing starts down only half of the normal decline towards the average bottom, seen in previous cycles near 893 thousand units (red line below).
Figure 1
Source: Moody's Economy.com
The move by the Fed yesterday was an attempt at averting a recession that is becoming more and more likely with each passing month. Housing has clearly spilled over into the general economy with a contraction in both employment and retail sales. In fact, we are on the verge of a recession right here and now according to both employment and retail sales numbers. In the past three recessions the economy had either just entered or was about to enter a recession when the three month moving average in monthly payroll gains turned negative. Also seen in the last three recessions was the 12 month moving average for the YOY change in retail sales dipping below 4%.
Figure 2
Source: Moody's Economy.com
When looking at the figure above, it's hard to go along with the mid-cycle slowdown mantra when the two above indicators look nothing like they did in the mid 1980s and mid 1990s mid-cycle slowdown periods. In the mid 1980s period, retail sales bottomed near 5% with the change in employment dipping below 100,000 only slightly and briefly before both reaccelerated. Both employment and retail sales were even stronger during the mid 1990s mid-cycle slowdown with a recession averted. However, the three month moving average for the current change in monthly employment is 44,000, declining sharply from last month's reading of 108,000 and retail sales on the verge of falling below the 4% level with a current reading of 4.14%. If both trends continue we may enter a recession as early as the fourth quarter of this year as recessionary risks increase.
The housing tailspin that is showing no signs of slowing has been forecasted for years by Yale University economist Robert Shiller. In written comments to lawmakers today, Shiller said the housing downturn could spiral into "the most severe since the Great Depression" and could lead to a recession with the loss of the housing boom.
Also raising the recessionary alarm is Moody's Economy.com, who reported their probability of recession indicator rising to 40% last month, up from the 15% probability reported in July and at the highest levels seen since the last recession in 2001.
Figure 3
Source: Moody's Economy.com, DismalScientist
Commentary from Moody's Economy.com is provided below:
Looking ahead, the U.S. economic expansion is holding on by a thread. Weakening housing markets and the unraveling in the subprime mortgage market are weighing on the economy. With the risks to the economy increasing appreciably in August, the Fed was forced to take action to help steer the economy through these choppy waters. Yesterday, the FOMC lowered both the fed funds target rate and the discount rate by 50 basis points to 4.75% and 5.25%, respectively, both decisive moves. The committee also maintained the easing bias it introduced in mid-August when it lowered the discount rate and set the table for a September ease. The actions by the Fed may help reduce the probability of recession in September but this will largely be determined by reactions in financial and money markets.
And so the tug-of-war between the bulls and bears will continue in the financial markets as bulls have the Fed behind them, while the bears have a decelerating economy and housing recession to give them fodder for their flame. Ongoing economic data as well as broker earnings will likely temper Wall Street enthusiasm in the weeks ahead. For instance, Morgan Stanley, the second largest U.S. investment bank, said today its third-quarter profit fell 17% as it was forced to write down nearly billion in loans. Though equity-trading revenue for the company rose 16% to .8 billion, the company took a 0 million loss from quantitative investments that use computer modeling for trading.
Lehman Brothers reported Tuesday its quarterly earnings fell 3.2% on write-down's linked to mortgages and leveraged loans, though its shares still rose as its results beat expectations and reporting the worst of the credit crunch was over. Bear Stearns and Goldman Sachs report tomorrow with Merrill Lynch reporting next month.
Merrill indicated in a securities filing last week that credit market conditions "have continued to remain challenging in the third quarter," and expects to make "requisite fair valuation adjustments." Despite the sizable 0 million hit Morgan Stanley took on write-down's, Merrill's might actually exceed that number as it has been the largest underwriter of CDOs since 2004.
With the Federal Government pushing to expand its debt ceiling by 0 billion, the Federal Reserve lowering interest rates by half a percent, and the balance sheets at Freddie and Fannie being increased by 2%, its no surprise to see gold pushing through to its highest levels in more than 27 years and the long end of the yield curve rising as bond vigilantes prepare for the next round of reflation.
The markets having been outright shouting for the Fed to return the punchbowl back to the markets and they got their wish, though they will face the undesired consequences of inflation in the not too distant future. But that's something Wall Street will have no problem overlooking, at least until after year-end bonuses come in with the markets putting in another positive year. As the saying goes, "Eat, drink and be merry, for tomorrow we die."
Today's Market
The markets extended yesterday's gains and overlooked a negative report from Morgan Stanley and a bullish energy report that showed crude oil stocks falling 3.9 million barrels after the previous week's 7.0 million barrel decline. The news pushed the spot price of West Texas Intermediate Crude (WTIC) up to record levels at $81.93 a barrel.
The best performing sector was utilities (+1.42%) with the consumer discretionary sector putting in the worst performance on the day, rising 0.28%.
The Dow Jones Industrial Average rose 76.17 points to close at 13815.56 (+0.55%), the S&P 500 rose 9.25 points to close at 1529.03 (0.61%), and the NASDAQ tacked on 14.82 points to close at 2666.48 (+0.56%).
Treasuries fell with the yield on the 10-year note rising 4.4 basis points to close at 4.524%. The dollar index was up on the day, rising 0.10 points to close at 79.31. Advancing issues represented 63% for the NYSE and NASDAQ, reflecting a healthy advance.
