One issue rarely talked about is how the weak dollar is going to impact foreigners buying real estate.  For the most part, I’m not sure how much of an impact this will have on residential real estate.  With commercial real estate we may see a good amount of buying if the dollar continues to get pounded.  Yet it is important to look at what currencies make up the U.S. dollar index:

Source:  Akmos

By far the largest weighted currency is the Euro.  Yet many of the countries within the basket that make up the U.S. dollar index are facing their own demons.  That is why I am hesitant to think the dollar will simply fly off a cliff while every other currency goes up and foreigners suddenly get an urge to buy up every Real Home of Genius on every corner of America.

What is fascinating is how connected the U.S. dollar and stock market have become.  I was unable to find charts that overlay the S&P 500 and the U.S. dollar index so I matched them up to give you a clear perspective of what is occurring:

As the chart above highlights, the dollar had been falling hard for all of 2007.  When the market peaked late in 2007, both the dollar and stock market fell in the U.S.  This was the brief period of decoupling or belief in this misguided notion.  This lasted until the dollar bottomed out at 70 in early 2008.  But after that, the world re-coupled and the U.S. dollar soared up until the March 2009 stock market low.  For this period, the stock market was tanking but the U.S dollar was going up.  To twist your mind further, since the March low the stock market has moved lockstep in opposite directions from the dollar.  It is a near perfect match!

Unfortunately the U.S. Treasury and Federal Reserve are doing everything they can to damage the dollar.  In fact, the only reason real estate isn’t correcting faster is because of the artificial money being pumped into the system.  Forget about jobs (26 million Americans are unemployed or underemployed).  Ignore manufacturing:

Right now the market is one giant easy money casino.  In fact, saving money is now on par to stuffing it into your mattress.  For example, let me tell you about U.S. Saving I-Bonds.  I’ve bought a few of these in the past as additional diversification to my investment portfolio.  The idea with I-bonds is they will keep up with inflation and pay a fixed rate.  Well over time, that fixed rate has slowly disappeared:

Okay, well at least we have the compounded inflation rate right?

That’s right!  The CPI had deflation.  So for the first time ever the I-bonds are now paying the awesome rate of 0.00%.  Bwahahaha!  The U.S. Treasury issues these products.  If they really wanted Americans to save they could up the fixed rate.  Instead, they cut the amount of these you can buy to $5,000 a year from the previous $30,000 a year and then make the rate so unattractive that putting money in your shoes seems like a wise investment move.  Get the hint?  They don’t want you to save.  They want you to blow every penny you have on cars, homes, and every other consumer hamster gimmick you can think of.  Only problem, the consumer hamster is reaching retirement and is loaded up with Prozac and Red Bull and is about to collapse.

I would show you the big bank savings rate but suffice it to say they are offering basically 0 percent.  However, banks are now making good dough on the difference between what they borrow and what they lend even with historically low mortgage rates:

Thanks to the trillions in taxpayer subsidies, banks are able to borrow for virtually zero and lend out at much higher rates.  So any rate above zero is a gain.  And since banks can now be picky regarding customers, they are experiencing some crazy yields.  If you want an idea why banks made enormous profits this decade just look at the Fed funds rate.  Yet this is now all coming at a cost.  The U.S. dollar has lost over 40 percent of its value since 2002.  How this will play out in housing will be interesting to see.
The U.S. Treasury and Federal Reserve seem to want an outcome that does the following:

a.  Slowly devalues the dollar

b.  Encourages home buying and selling putting a floor on prices

c.  Reviving the financial and real estate industries

d.  Back to happy days

I doubt that is going to happen.  So much focus has been devoted for 21 months since the recession started on the banking industry bailouts that I think the Fed and U.S. government have forgotten that you need good paying jobs to make a sustainable economy.  It is interesting to follow the rhetoric of Fed officials about pulling stimulus out of the market.  They claim success but for who?  Sure banks and their profits are back up but has the economy fundamentally corrected?  It just shows you how out of touch they are with those on the ground.

With commercial real estate and Alt-A and option ARMs coming on stage in 2010 in a big way, I still think we haven’t seen the end of this recession.  Technically we may be out of it already but that is because of the massive stimulus juice.  We are assured a double-dip with the trillions in bad debt still on the books.  If you travel the country you will find some strip malls that are simply empty.  Some newly build CRE has never been occupied.  Will it ever?  Those loses are still coming forward.

One of the many unintended consequences of the U.S. Treasury and Federal Reserve is falling rents created by the $8,000 tax credit, rising unemployment, and problems with CRE.  For example, many failed condo conversion projects are simply going back to being apartments thus adding inventory to the already saturated market.  Also, many people are consolidating households to make ends meet.  Given that owner’s equivalent of rent is the biggest component in the CPI, we may see additional pressure on the downside here.  In other words, the needed inflation won’t show up in the data.  Let us watch this closely because the reporting agencies might try to play fast and loose with the data here.

With lower rents there is less incentive to buy in today’s market.  You need to remember that over 40 years of data shows us an average 30 year mortgage rate of 9 percent or nearly twice as high as the current rate.  You might be able to buy that home at the low rate with massive tax credits but what happens when you sell in 3, 5, or 7 years?  You think the Fed can keep rates this low with the coming baby boomers drawing like crazy on Social Security, Medicare, and other entitlements?  Just saying, but zero percent seems awfully low for all that risk.

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The most widely followed measure of inflation in the U.S. is the Consumer Price Index (CPI).  As the chart above indicates, we have seen our first year over year decline in the CPI since the 1950s.  Now keep in mind, last year we had the massive oil bubble which means we will probably have year over year declines for a few more months simply because oil nearly touched $150 per barrel last year. For our purposes we are going to look at consumer prices as our measure of inflation and deflation since this impacts most people in a more understandable way.  Now before going forward, it is important to look at what areas are contracting during this recession:

Now this is important to highlight.  The 12 month adjusted data tells us the following:

Categories with decreases:

Transportation

Energy
Categories with increases:

Medical care

Education

Food

Categories neutral or slightly up:

Housing

Apparel

Recreation

Now keep in mind this is over 12 months.  Yet if we look at the latest data, we start seeing that food and housing are now starting to decline.  A large part of this is because of the excess housing on the market and the BLS measures owners’ equivalent of rent (OER) which has been coming down.  After all, with 26 million unemployed or underemployed Americans hiking the rent may not get you new tenants in many markets.  Yet you will notice that in the last 3 months, every category aside from medical care and education has come down steadily.  The evidence so far is we have been experiencing deflation.

Now we are going to examine five major sectors of the economy and look deeper into the deflation and inflation debate.

Sector #1 – Housing Prices

(Deflation or Inflation) = Deflation

I’m not sure how anyone can argue that housing prices have seen any sign of inflation during the current recession.  The largest line item for Americans is housing and it has been contracting at a furious pace.  The reason the BLS over the past 12 months has seen a slight up tick is because of the OER measure.  Initially when the bubble burst, people shifted to renting which either neutralized prices or even slightly increased rental demand.  However, now that unemployment is raging and people are losing their jobs, the rental market is now being hammered which is now showing up in the CPI data.

Housing bottoms normally take two forms.  First, you will see a bottom in housing starts:

This is for 1-unit private housing starts.  As you can tell, the market has completely collapsed.  Yet if you squint, you can see a tiny yellow weed sprouting up.  Of course, this is the non-sense of green shoots, as if superman will suddenly emerge with a construction hat and save the day by building homes again.  In the case of housing starts, we may have hit a bottom but just put that into context in the chart above.  We still have the Alt-A and pay Option ARM disaster waiting for us and this will assure us more cheap inventory for years to come.  So in this sense, we may have already reached a bottom with housing starts but the thing many forget is we will never see peak bubble action like we did earlier in the decade.  Demographics and the flood of inventory via foreclosures assure us ample supply.  The second bottom takes the shape of lower prices and we are still falling in every sense of the word:

Prices are still going down.  The Case-Shiller Index is the best measure since it looks at same home repeat sales.  You have a few people like Jim Cramer talking about housing bottoms but they are looking at the median price.  The problem with looking at the median price is that it is artificially high in the mania phase and low when a flood of distress homes hit the market.  A perfect example is California where over 50 percent of homes sold are foreclosure resales.  Ironically, now that you are seeing more price cuts in mid to higher priced areas you will see the median price go up or neutralize.  Yet overall, prices are still heading lower.  This is something that I have examined in detail when I discuss the 10 Reasons why California will not see a housing price bottom until 2011.  I am looking more at the Case-Shiller data instead of the median price which can fluctuate wildly.

It is rather clear to any observer that we are seeing deflation in the housing market.  There is little debate here.  It is hard to envision any price pressure to the upside with such a horrible job market.  In normal times, people pay for their mortgages with jobs and not high flying banana republic mortgages like pay Option ARMs and Alt-A products.

Sector #2 – Auto Sale Prices and Sales

(Deflation or Inflation) = Deflation

There is little doubt that we are seeing deflation in the automotive sector.  With General Motors and Chrysler hitting rock bottom with bankruptcy, there is little pricing power here.  Certainly auto workers, a large employment sector aren’t seeing wage increases.  First, in 2008 the auto companies’ weak foundation was exposed with the oil bubble.  After all, who wants to drive around an urban tank with a V-10 engine on the 405 freeway?  It isn’t like you are driving in the Serengeti running away from rabid hyenas in treacherous terrain.  I would see one person in these behemoths stuck on the freeway idling in their tank as the $4.50 gallon of oil just evaporated into the atmosphere.

Some people feel bad about what occurred but keep in mind these companies prided themselves on cheap oil fueling their tanks forever and the high profit margins on these vehicles.  Even after the oil bubble imploded, the damage had already been done.  There was no coming back.  Now you can find many of these urban safari all-terrain vehicles on eBay and Craigslist selling for 50, 60, or 70 percent off their once MSRP.  Looking for a Cadillac Escalade?  You can get a 2002 with all the trimmings for a little under $17,000:

The fascinating thing that occurred during this bubble is the notion that everyone was rich and therefore should have the artifacts of the wealthy.  The poor had access to middle class credit.  The middle class had access to upper class wealth.  The upper class spent like a new Gilded Age was here.  The Escalade is a perfect example.  I would drive around areas in Los Angeles County were people were living in run down apartments but out in front you would see an Escalade.  Once again you can thank easy financing here.  You would have people living in giant McMansions with a $700,000 mortgage when they were only pulling in $100,000.  Early last year on the blog, I talked about people going broke on a $100,000 salary.  At the time, people had a hard time believing this.  Now, this is virtually a daily thing and many of these people are the folks living it up with the ticking Alt-A and Option ARM time bomb.

The fact of the matter is, auto sales have fallen off a cliff:

With all the attention being given to the housing bubble, we sometimes forget to mention that we also had an automotive bubble.  What allowed the automotive bubble to explode?  Easy and dubious financing once again.  Since the early 1990s auto sales never went below the 14 and 15 million annual sale mark.  This lasted well into May of 2008.  Think about that.  The stock market was already crashing and housing imploding yet we were still over 14 million auto sales per year!  Nuts.  The chart above is rather clear.  Annual sales have been cut virtually in half in one year.  So the dynamics in the auto industry reflect housing prices to some extent.  Lower prices.  What people also fail to examine is cars last much longer than they did in the past.  There is no reason to replace a car every three years with a new model.  A good car with proper maintenance can last you a decade.  Suddenly many people have no choice but to fix and hold onto their current car.

The Federal Highway Administration lists 247,264,605 motor vehicles in the United States.  From this number 134,000,000 are automobiles and 110,000,000 are trucks.  As of 2000 there were 105,000,000 households.  So basically we have two cars per household here and this does not include buses and public transportation.  So it isn’t like many people need new cars.  People are holding on to their cars more tightly and as you can see from the sales chart above, people are voting with their wallets.  Easy financing built up the housing and auto industries for the past decade.

Sector #3 – Cost of Education – Higher for Public but non-Elite Private will Implode

(Deflation or Inflation) = Deflation for non-Elite private and inflation for Public

As we highlighted early in the article, only two areas are now seeing inflation.  Those are medical care and education.  Education I hate to say is also experiencing a bubble with easy financing.  How many people do you know who went or sent their kids to a private non-elite college paying $40,000 a year in tuition to pursue a career that wouldn’t pay more than $30,000 a year?  Clearly, many of these people would have never been able to afford the tuition cost if it wasn’t for easy access to student loans.  That of course is now changing.  The Chronicle of Higher Education had a fascinating article examining this trend:

“Is it possible that higher education might be the next bubble to burst? Some early warnings suggest that it could be.

With tuitions, fees, and room and board at dozens of colleges now reaching $50,000 a year, the ability to sustain private higher education for all but the very well-heeled is questionable. According to the National Center for Public Policy and Higher Education, over the past 25 years, average college tuition and fees have risen by 440 percent - more than four times the rate of inflation and almost twice the rate of medical care. Patrick M. Callan, the center’s president, has warned that low-income students will find college unaffordable.

Meanwhile, the middle class, which has paid for higher education in the past mainly by taking out loans, may now be precluded from doing so as the private student-loan market has all but dried up. In addition, endowment cushions that allowed colleges to engage in steep tuition discounting are gone. Declines in housing valuations are making it difficult for families to rely on home-equity loans for college financing. Even when the equity is there, parents are reluctant to further leverage themselves into a future where job security is uncertain.”

I am not surprised at all by this.  It was stunning to see many people go to private schools to study a career that was fading and dishing out $50,000 a year to pursue their “dream” field.  Again, this notion of having access to everything right now is the fuel that made people feel that they needed the “dream house” and the “dream car” and the “dream vacation” only to wake up in a debt induced nightmare.  Few of the fields like engineering, education, or medicine appeal to Americans because why go into these fields where you have to learn “math” when you can go into selling real estate for six-figures a year with only a GED.  Of course that game is now over and probably many of these private institution catering to these dream degrees will fade as well.

What we will now see is value added for certain educational fields.  No longer will a B.A. in Basket Weaving land you a promising job into the middle class.  I do want to make a distinction here.  Private elite colleges will still have some pricing strength because of their names.  And many public schools will have fierce demand because they are lower priced and offer a lucrative option to many.  Take for example the University of California and California State University systems here in California.  Both institutions are hiking tuition by 10 percent (again) and they are actually taking less students:

“(Daily Sundial) An even larger proposed budget cut is anticipated for the entire CSU system.

The original planned budget reductions, which would have fallen just below the $100 million mark, could now reach as high as $400 to $700 million.

For CSUN, this large discrepancy would mean cuts of up to $49 million, far from the first figures of just under $7 million.

“California is dealing with a budget shortage of more than $24 billion. A financial meltdown,” said Erik Fallis, the media relations specialist at the CSU chancellor’s office. “As a consequence, the CSU is facing an unprecedented cut in state support.”

Unprecedented is the key word in these latest figures. When Gov. Schwarzenegger announced the first proposals in 2008, CSUN had already pooled money in reserves in preparation for this type of situation, said Harry Hellenbrand, CSUN’s provost and vice president for academic affairs.

According to CSUN’s budget update web site, if the CSU budget for the upcoming year is cut by approximately $600 million, all campuses will have to reduce their incoming students by 40,000 instead of the projected 10,000.

While tuition increases and class reductions are obvious, other solutions to curtail the budget aren’t definitive.”

There you have it.  We are assured that the UC and CSU will be hiking fees for the next few years because of California’s horrific budget planning and $24 billion budget deficit.  And with California’s 11.5 percent unemployment rate (the highest in record keeping history) you can rest assured that many will go back to school to pursue a degree (or another one if they have fallen into a career with little viability.  So in education you will see a split in the market.  Public universities will accelerate tuition hikes, curtail enrollment, and become more like private elite institutions.  Non-elite private colleges will have the hardest time adjusting since people will begin questioning the value of degrees and also, lack of loans will slow enrollments down.

Sector #4 – Employment – Wage Cuts – Hours, Furloughs, and Layoffs

(Deflation or Inflation) = Deflation

There are few things more deflationary than unemployment.  Would you work one month for free if your employer asked you to?  Well if you work for British Airways, they have already asked this question:

“(Yahoo!) British Airways is asking thousands of its staff to work for free for up to four weeks, spokeswoman Kirsten Millard said Tuesday.

In an e-mail to all its staff, the airline offered workers between one and four weeks of unpaid leave — but with the option to work during this period. British Airways employs just more than 40,000 people in the United Kingdom.

Last month, the company posted a record annual loss of £400 million ($656 million).”

Now think about that.  This only adds more pressure to prices on the downside.  When you yank the pay of an employee either through cutting hours or asking them to work for free, they have less money to spend.  This is also happening in the U.S. where companies are furloughing people or cutting back on overtime.  In our country where nearly 70 percent of GDP is consumption based, what do you think this will do for spending?  Of course people point to the trillions in bailouts but I haven’t seen any of that money rolling my way.  Have you?  Unless you are part of the crony banking syndicate you are basically bailing out those who created and financed this mess in the first place.

With 26,000,000 unemployed and underemployed Americans, there will be more pricing pressure on the downside.  This chart below shows how weak the market is in terms of pricing power:

Some people point to the 1970s of a time where inflation raged and we had price jumping up in the face of recession.  This was the so-called stagflation.  Yet much of this was again based on energy but also, the nature of globalization wasn’t as big as it is now.  We still had some control.  Now, we have essentially out sourced our entire manufacturing base and became a service driven economy.  Nothing was more prominent than when GM filed for bankruptcy, Wal-Mart announced it would be hiring 22,000 more people.  Trading $20 an hour jobs for $10 an hour jobs.  That is deflation in wages.

But if you notice the above chart, both aggregate hours worked and inflation are both plunging.  What does this tell us?  That deflation for the moment it taking hold of consumer prices and wages.  Aggregate hours is a more sensitive indicator than overall employment since it looks at aggregate weekly hours worked.  In fact, this may be a good indicator of when things may start turning up since companies may not be hiring people early in the recovery when it comes but instead, using the British Airways example will start paying those employees who took the month off for the month.

Even major strongholds like state governments will be cutting wages and not hiring as much:

“LOS ANGELES, June 21 (Xinhua) — In response to California’s budget crisis, more than half of the state senators have agreed to reduce their 116,208-dollar salary this year, most taking a five-percent cut starting July 1, it was reported on Sunday.

During budget negotiations last week, Senate President Pro Tem Darrell Steinberg took the lead by offering to have his salary reduced by five percent, according to the Los Angeles Tims.”

Now of course this is a joke especially here in California where we have one of the most dysfunctional politicians up in Sacramento.  But tens of thousands of state workers have already been furloughed in effect taking a 10 percent pay cut.  Does that sound like inflation to you?  And the power of the unions which once had a say in pricing power has little clout in a global marketplace.  How are you going to compete with China and India and their wages?  You can’t.  Plus, Americans like cheap goods.  Unless we do boneheaded moves like the Smooth-Hawley Tariff Act we can expect more pricing pressure to the downside.

Sector #5 – Stock Market Losses

(Deflation or Inflation) = Deflation

The stock markets are off by 40 percent from their 2007 peak which shows the depth of the collapse since we have had a virtually non-stop rally since the March 2009 lows.  I’ve been re-reading Charles Kindleberger’s The World in Depression 1929 – 1939 which is a fantastic read about the global collapse during the 1930s.  It is a dense read but worth it if you really want to understand the multiple factors that led to the Great Depression.  Some are arguing that the current pains we are feeling are because of the stock market crash.  I tend to believe the crash of the stock market is a symptom of the global debt bubble we went through.  This is what Professor Kindleberger had to say about the stock market crash during 1929:

“In the light of the sudden collapse of business, commodity prices, and imports at the end of 1929, it is difficult to maintain that the stock market was a superficial phenomenon, a signal, or a triggering, rather than part of the deflationary mechanism.  One should not be dogmatic about it, but it is hard to avoid the conclusion that there is something to the conventional wisdom that characterized the crash as the start of a process.  The crash led to a scramble for liquidity on the part of both lenders to the call market and owners of stocks.  In the process, orders were canceled and loans called.  The action of the Federal Reserve in buying securities in the open market and lowering the rediscount rate in New York brought credit markets quickly into good order.  By this time, however the deflation had been communicated to fragile commodity markets and durable goods industries.  The stock market crash is less interesting for the irony it permits the historian, bemused by the foibles of greedy men, than for starting a process that took on a dynamic of its own.”

In our current case, the stock market crash was merely reflecting the collapse in the credit markets and the housing bubble bursting.  The stock market did not create this recession but is merely reflecting  the reality on the street.  When we hit the peak in 2007, it reflected the peak of euphoria.  When it busted, it reflected the panic.  The current jump is optimistically betting on a second half recovery which fails to adequately analyze the commercial real estate bubble bust which is going to hit us and the immense amount of toxic assets still in our system.  Even if we dump all these toxic assets onto the taxpayer, they will fail and guess who will end up paying for it?  In the end, prices will still need to find a bottom.

Let us take a look at the Dow World Index:

Now if we look at the Dow World Index, we see that prices nearly fell by 60 percent to the March bottom.  And since that bottom, it has rallied by 47 percent but is still off by 40 percent.  The bottom line is that the world is in recession.  This is not isolated.

Looking at these five major sectors you realize that deflation seems to be the major issue at our door.  And what people fail to realize is that American households have lost a stunning $13.87 trillion in wealth from stocks and real estate.  So even though the Fed and U.S. Treasury are saving their crony banking buddies, the bottom line is the average American is still suffering.  The Atlantic has a great break down why most Americans feel like they are getting shafted in the current scheme of things:

So while American households just lost $13.8 trillion only $700 billion or so will be felt by the average American.  The rest of the trillions will go to bailout and patch up the Swiss cheese balance sheets of the Wall Street cronies.  By this time during the Great Depression we were already marching people down to the Pecora Investigations bringing justice to those who brought the economy to a halt.  Today, we are still giving more and more power to those who are largely at the helm of this mess.  So for the time being, demand destruction is leading to price deflation.

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The U.S. Treasury and Federal Reserve have created an artificial system and the stock market is reacting to these new conditions.  These conditions now assume rock bottom low rates and financial institutions being continuously bailed out.  Yet this paradigm is not helping the American public that now has 25,000,000 unemployed or underemployed family, friends, or colleagues.  Think of the implication of the GM bankruptcy.  Right when the announcement was made there were details of laying off thousands of workers and closing numerous dealers.  The market rallies and unemployment this Friday will shoot up by another 500,000.  This disconnect is so obvious and shows the priorities of those pushing legislation.

Before we get ahead of ourselves, why would a bankruptcy of GM, a DJIA component lead to a strong rally?  First, let us look at the weighting of each of the 30 components:

The above is a reason I take very little stock with the DJIA but it is still widely regarded in the mainstream media as an accurate reflection of the overall stock market performance.  A better measure would be the Wilshire 5000 but how many times have you heard that market index in the media?  Let us focus on the above list I compiled a little further.  You notice that GM and Citigroup are all the way at the bottom?  That is why even if GM and Citigroup went straight to zero (GM practically did) it had very little impact on the DJIA.  Yet in reality, the bankruptcy impact is gigantic in the real world since it means tens of thousands more Americans out of work and a giant of American manufacturing giant was unable to stand on its own two feet.  So what do we hear on June 1^st?

“(CNN Money) According to a statement released Monday, General Motors, which filed for bankruptcy on Monday, will be replaced by Cisco Systems (CSCO, Fortune 500); Citigroup (C, Fortune 500) will be replaced by The Travelers Companies (TRV, Fortune 500).”

How convenient.  Of course, we have already experienced this with the removal of AIG and having it replaced with Kraft.  A government cheese recipient taken out by a true cheese maker.  The DJIA is a horrible indicator of longer term prosperity.  During the boom times bubbly stocks are put in, keep in mind the index is maintained by humans and as we have now found out, humans make all kind of errors including missing peaks and troughs.  Don’t believe me?  Let us take a look at some grand timing:

Microsoft added on November 1999

Intel added on November 1999

AT&T added on November 1999

Bank of America added on February 2008

Chevron added on February 2008

These are just a few examples.  First, you’ll notice that Microsoft and Intel (big companies no doubt) where added at a bubble point for technology stocks.  So when the tech bubble burst, the index took a much bigger hit because of these additions.  Next, we have the timely addition of Bank of America on February 2008!  When Bank of America was added it was trading around $45 per share.  Now it is trading at $11.37 and this is thanks to the crony banking system bailout.  Chevron was added right before our massive oil bubble.  So as you can see, the addition of companies to the DJIA is not exactly a good reflection of the economy.  In fact, some of the additions are indicators of bubbles and late party arrivals.

Now let us examine the list again.  First, the recent stock market crash was the deepest and widest since the Great Depression.  If we look at the DJIA, you will see why this is true.  First, 2 of the top 3 companies on the list were oil companies.  Well logically when the oil bubble burst these would get hammered as they did.  Next, there are many financial services companies on the list.  This during the boom distorted the market and made the DJIA bubble up over 14,000 yet this mark was a reflection of the bubble.  Now with the banking industry having Uncle Sam as number 1 on its Fave 5 menu, of course the DJIA tanked because it was heavily weighted on bubble industries.  Bank of America?  JP Morgan?  American Express?  Citigroup?  This list starts reading like the TARP recipient list.

It should be abundantly clear that the DJIA is not a good indicator of what is occurring on main street.  Yet it is something that is always referenced so it is important to understand what is truly reflected here.  Let us refer to the list again.  If you look at the top 10, three of these companies (Wal-Mart, McDonalds, and Coca-Cola) reflect the massive consumption economy that is the U.S.  Where are the major manufacturing companies?  In a way, seeing GM literally fall off the list is a testament to what our economy has become.  An almost completely consumption based economy.  Is it any wonder that Chinese students laughed openly when Timothy Geithner stated:  “Chinese assets are very safe,” referring to debt with the U.S. in a recent talk?  Politics aside, I’d laugh too.  Ben Bernanke and Geithner are busy selling off the U.S. to keep their banking cronies alive.  Where are the Pecora Investigations?  Why not demand the same stringent requirements of Bank of America, Goldman Sach, JP Morgan, and Citigroup as we do of Chrysler and GM?  Because those that operate the levers of power are either bought out or believe the banking oligarchy.

When you look at the Dow, it starts becoming abundantly clear what the U.S. Treasury and Federal Reserve think the country should look like.  And before you say that these places are independently operated, just look at former employers of our recent U.S. Treasuries.  They like the bubble era.  They want Americans to go back and buy cars on a yearly basis, purchase homes over and over, eat fast food, and purchase goods to numb the need to focus on reality.  That reality is for nearly 40 years we have spent more than we have earned.  Just look at this chart showing personal income growth and household debt:

From the 1950s to the 1970s, growth in income tagged along with growth in debt.  Yet this completely became disconnected in the 1970s.  From that point on, taking on debt at higher levels seemed okay.  In the last few years in this bubble, we just took it to the extreme logical conclusion.  Just think for a second how irresponsible it was to give someone making $30,000 a year a $50,000 luxury car simply because they can make the monthly payment for 7 years?  Or what about giving the person making $40,000 a year a $500,000 mortgage?  Not only did this happen, but it occurred so many times that we are now years later left to deal with the fallout.  Yet the notion that we will go back to this world is absurd and that is what the stock market is betting on.  Our lives are changed forever.  The fact that we have students in China laughing at our U.S. Treasury is one of the many indications that the gig is up.  Our biggest lender is laughing.  This is not a good sign.

When I look at the Dow, I don’t see a reflection of the U.S. economy but more of a horse race ticket for the gambling casino.  AIG doesn’t make sense anymore?  Remove it since it is now owned by the U.S. government.  Don’t like GM or Citigroup?  Out they go.  It is a list of convenience.  We would be better off tracking the Wilshire 5000 or at a minimum, the S&P 500 but even that list has taken an unusually heavy love to financials.  But in this case, you can’t blame the actual index.  It is merely reflecting a country that became obsessed with financial services and tossed manufacturing to the wayside:

The chart above is rather telling.  It is somewhat ironic that on the same day, it is announced that both GM and Citigroup will be removed from the DJIA.  With manufacturing already gone and financial services slimming down, you tell me what emerging field is going to get us out of this recession?  Maybe Travelers Companies and Cisco are closer reflections to what is a stable Dow component.  Too bad it took this long to realize which companies were simply running on cheap money.

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The Mortgage Bankers Association came out today stating that 12.07 percent of all mortgages were delinquent or in foreclosure.  This is the highest on record going back to 1972.  What is even more troubling is prime fixed-rate mortgages to the most creditworthy borrowers made up a substantial jump of the new foreclosures coming in at 29 percent.  One out of every eight Americans is now either late on a mortgage payment or in the foreclosure process.  That statistic is nuts.  Here is an observation from previous economic downturns.  This economic recession was largely driven by a global housing bubble fueled by easy access to the Wall Street casino.  Toxic mortgages which became a larger part of the overall market have pummeled housing prices into the ground.  This is where we are at (you are here in your mall map).  Yet in this stage of the recession, we are now seeing the double whammy of housing prices falling for more historical reasons like job losses and this is spilling over into the prime mortgage market.  That is not a good sign because the prime market is gigantic:

The above data is from the OCC and OTS Mortgage Metrics Report.  As you can see for yourself, 6.6 million in Alt-A and subprime mortgages is clearly a sign that there is still many toxic mortgages in the market.  This above data is for the combined national bank and thrift servicing portfolio and holds nearly $6.1 trillion in mortgages.  The largest part of this portfolio of course is the prime segment making up 66% of all loans.  So the rapid rise in prime defaults is extremely concerning.  Look at it this way.  Let us assume the remaining Alt-A and subprime loans implode at 25%.  That gives us 1.65 million more defaults and of course this is absurdly conservative on these toxic banana republic loans.  But what if we reach a 10 percent default rate with prime mortgages?  That will give us 2.2 million more defaults.  That is why the cracks in the prime market are going to cause deeper pain:

The rapid change of pace is also showing that many Americans are having a tough time making their home payments.  In fact, the current rate is blasting past even data we had from the fourth quarter of 2008:

I know many of you astute readers are saying, “hey DhB, don’t we have over $10 trillion in home mortgages in the U.S.?  Why only the $6.1 trillion figure above?”  Good question.  You need to remember another portion of the mortgage market is with uncle Fannie and Freddie.  The current aggregate amount of mortgage loans in the United States comes in at $10.4 trillion.  The large portion of that is prime (which you can take that for what it is worth given we nationalized, whoops, I mean took into conservatorship the two GSEs).  And as we all know with the optimistic stress test results and the U.S. Treasury PPIP focused largely on happy day scenarios – they ran weak historical default rates on prime mortgages.  How many times do we need to say that this isn’t a historical recession?  This is a housing bubble led recession.  That is unique.  We have never had an economy pumped up by housing and collapsing because of housing on this grand of a scale.  Housing either gained or suffered as an after effect of the economy.  This time it became the economy.  And we clearly see this with the growth in debt versus stagnant wages:

Every single recession since the 1950s saw household debt on a year over year basis decline during and after the recession.  This makes total common sense because a recession is a contraction in the economy meaning businesses are pulling back.  Not with the 2001 recession.  Alan Greenspan (Mr. $100,000 speaking fee) decided to lower the Fed funds rate to 1 percent and flooded the market with easy credit.  He also touted the virtues of adjustable rate mortgages fully knowing that the market was going the way of the Wild West.  He knew that by the time he left his post, the market would implode under another Fed chief as it did and is with Ben Bernanke.  The problem is we have reached a point of epic debt and there is no other bubble to be found.  We keep giving money to banks and they keep hoarding it:

While pay Option ARMs and Alt-A loans implode left and right leaving American homeowners with no buffer, banks have a tidy buffer of nearly $1 trillion in excess reserves and every other taxpayer funded bailout you can imagine.  Many of you know that I have never advocated for the government stepping in to help homeowners in trouble especially those with toxic mortgages.  Before shedding  a tear, in the U.S. we have a fantastic rental market and there is literally nothing wrong with renting.  So the worst that happens is someone doesn’t own a home but has the utility of renting a home.  Yet my biggest issue with the current environment is those people being kicked out into the street are also paying for the taxpayer bailouts of those on Wall Street.  What is worse, what about the prudent financial class in the U.S.?  What about all those tens of millions of Americans that lived within their means, didn’t lease a Mercedes, and buy a McMansion with a toxic mortgage?  This group suffered during the bubble mania because they were priced out since they didn’t want to walk the mortgage plank but are suffering again because they are now being asked (forced) to bailout the same crony banking system that caused this mess in the first place.

There is nothing more obvious that this last decade being a Mirage Decade.  This is clearly seen in looking at the homeownership rate in the epic bubble state of California:

From 1984 to 1999, the homeownership rate in California never cracked the 56% mark.  At the peak in 2006 we hit 60.2 percent.  Now, we are back to 58.3 percent which puts us back to 2001 levels.  And with the 135,000 Notice of Defaults hitting in Q1 of 2009, we are definitely heading back to 1990s levels.  So we have lost a decade already in terms of homeownership.  There is no stopping this trend in the near term especially with the rise of prime mortgages going bad.  Since we are in the eye of the hurricane and markets abhor a vacuum, many people have a necessity to rush out and buy something.  That is why you are seeing some strong activity in home sales.  But keep in mind that many of these home sales are distressed with 50+ percent in Southern California being foreclosure resales.  I would estimate that a large portion of these buyers are from the prudent class that are simply throwing up their arms in the air and saying, “up, down, up, screw it!  I want to own a place for my family so I’m diving in.”  I have no problem with that.  People can do what they want with their money.  But you are not buying at the bottom.  You are simply buying because prices have dropped at an astonishing rate.  Yet we need to remember that prices shot up for 10 stinking years!  We are in year 2 of prices falling.  Do you really think this is the bottom?  Unemployment is at 11% in the state.  Maybe at the lower end is bottoming but I doubt someone with a $100,000 sitting in the bank wants to buy some of those lower end bargains.

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Banks, take the blue pill.  Public, please take the red pill.  If I had to characterize the current economic environment, it would have to consist of two completely different sets of beliefs.  On one hand, you have banks and Wall Street receiving massive bailouts from the U.S. Treasury and the Federal Reserve, bailouts of the magnitude that would gear up for a Great Depression and imply that the banking system of our country is insolvent.  Then on the other hand, you have Wall Street and the crony banks trying to convince the public that this is a minor recession and all will be well in Q3 and Q4 of 2009.  The problem of course is that this is not your typical recession yet the public is being led to believe that all is well while bailouts are being dolled out by the truckload to the wrong locations.  The actions we are taking keeps in place the banking oligarchy and sacrifices the public under the guise that this is good medicine for the general economy.

Nothing proves this point better than the current nationwide foreclosure issue:

The latest housing data shows that nationwide we have just shattered all records for monthly foreclosure filings in one month.  Take a close look to the chart above.  Foreclosures are moving higher and higher.  We are now approaching the 2-year anniversary of this housing and credit crisis yet the core issue of housing is still not being dealt with.  What we are doing is bailing out banks while the public is left to deal with the fallout.  The hypocrisy is creating deep anger, as it should.  When TARP 1 came out, banks were given the first $350 billion with no questions asked.  That money of course has been squandered.  However, when it comes to modifying the mortgage of struggling homeowners, banks conveniently find every excuse to avoid reworking the mortgage.  And when I say reworking, I mean cutting the principal down not extending the term out to 40 years or cutting the interest rate by a point.  This is their idea of working with the public.

The foreclosure chart above tells us one thing.  We are not helping the public.  We are not solving the housing crisis.  The notion that bailing out banks would somehow trickle down to the public is absurd.  How many issues of systemic failure did we deal with?  AIG?  Fannie Mae and Freddie Mac?  Lehman Brothers?  The list goes on and on.  With the AIG bailout, we used systemic failure as the premise to funnel money through the firm as a conduit to Wall Street firms like Goldman Sachs.  Can’t allow them to lose a penny because that would be systemic.

And by the way, do you remember those estimates last year that the GSE bailout was actually going to give us a profit in the long run or at worst, cost us $25 billion?

“(WaPo) The Obama administration has clarified what it expects the takeover of Fannie Mae and Freddie Mac to cost taxpayers: $171.1 billion.”

Whoops!  Missed by a few hundred billion there.  Yet someone that lost their job and lost their home has already faced systemic failure.  We have in our country nearly 25,000,000 unemployed or underemployed Americans.  And somehow, the market is shocked that retail sales contracted?  Of course it contracted.  The public doesn’t have an unlimited credit card to the Federal Reserve and U.S. Treasury like the banks and Wall Street.  Ironically, it is the public that is now paying for the mess with no benefit at all.  We have now committed over $13 trillion in bailouts, almost one year of our nationwide GDP.  You would think that with so much money funneled into the system drastic changes would be occurring.  They are not because banks are hoarding money:

And the above makes a lot of sense.  If you look at the record number of foreclosures and defaults, banks are doing the right thing (according to their balance sheets).  They are operating for their own survival.  But that wasn’t how the bailouts were presented.  Can you imagine if they told the public the real reason for the bailouts,

“Hi everyone.  We are going to need to commit trillions of your dollars to bailout a banking system that failed you.  A system that didn’t exercise due diligence.  A structure that fueled the housing bubble.  What will you get in return?  You get to keep us going.  The system that failed you appreciates your support.”

What the public was told is that these bailouts were required to keep lending going and to ameliorate the housing situation.  Both of those objectives have failed as the charts above show.  The public is catching on and that is why they are now forced into saving (thus not spending on consumption showing up in drops in retail sales):

Doesn’t the excess reserve chart and the savings rate chart look the same?  Of course.  The public is doing the right thing and pulling back because this is the deepest economic crisis we have had since the Great Depression.  When the public starts waking up to this, that we are only bailing out the banking system and Wall Street, friction will start to rise and you saw some of this with the AIG bailouts.  But the public forgets quickly and this recent stock market rally is a testament to that.  Let us see how long that AIG anger lasted:

All it took to forget the bonus mess was one month.  In the last few weeks, cram-down legislation was introduced again and failed, again.  Why?  Because this isn’t your bailout, this is a bailout for the banks and the cronies on Wall Street.  It is social welfare for the banking oligarchs.  And guess what?  Our representatives from both sides of the aisle voted it down.  Wall Street and the banking system are the biggest contributors to both political parties.  Who are they really representing?

Our public officials have missed the ball so badly on this financial mess.  It went from Greenspan praising the glory of adjustable rate mortgages, to Bernanke saying subprime was contained, to Paulson saying we need to give money to banks, no questions asked or the global economy will implode like a supernova in the matter of a few years.  Let us take the glorious state of California for an example.  After having a record budget impasse, we finally passed a compromise in California that left both sides with a bitter taste and unsatisfied.  After only a few weeks of taking care of the 2008-09 budget, we find out that we have an $8 billion short-fall!  This only after a few weeks.  How in the world do you miss $8 billion?  Okay, so we’ll chalk the $8 billion miscalculation to bad weather.  Another few weeks pass and guess what?  Our Governator now tells us we have a $15 billion budget short-fall and if the propositions don’t pass on May 19^th, it will be up to $21 billion.  You want to know why they are so off?  Let us go back to the fall and see their projections:

They were projecting a peak unemployment rate of 9.4 percent for 2010!  Take a look how off they are on that one:

We are now up to an 11.2 percent unemployment rate.  Basically, they have been completely wrong in all their assumptions and that is why we have gone from an $8 billion shortfall to a $15 billion shortfall in a few weeks.  Utter insanity.  If you ran your household like this, you would be kicked out to the street.  They are operating under the second half recovery model that has caused the 30+ percent bear market rally.  This is not going to happen.  The new mantra should be, “things are getting worse more slowly.“  That is, unless you are a banking executive and then, you are getting saved on the taxpayer’s dime.  Where in the world are the freaking prosecutions?  Where are today’s Pecora Investigations?  How much more evidence does the public need to realize that the current trajectory is not good for our country’s long-term sustainability?  Over a year ago, I started mentioning that the U.S. is on path to a Japan like lost decade.  This week none other than noble-Prize winning Paul Krugman is saying the same thing in China.  We are zombifying our banks and setting ourselves up to a decade of stagnation.  Is this really what we want?  It isn’t too late to shift course and temporarily nationalize the banks and clean them up.  We still haven’t jumped into the horrific public-private investment program (PPIP) which will be another transfer of wealth to banks and Wall Street of an additional $1 trillion.  It will be a slow burn and before we know it, many will realize that they have been conned and this will make Bernard Madoff look like the epitome of conservative investing.

So where do we stand today?  We have a crucial choice to make here.  Do we want to make banking a utility like industry or bailout Wall Street and banks so they can go back to the global financial casino?  So far, the path we are taking is keeping the casino alive.  The issue of course is to find people at the levers of power in the government who are not soiled by banking industry money.  This is a challenge and that is why trillions in bailouts are going to banks and Wall Street while the public gets the shaft.  $100 to the banks, $1 for you.  At times, I sit back and wonder why the public isn’t in a bigger uproar?  Are they not angry that their money is going to bailout a crony oligarch banking system?  Then I remember those times in college where I would hear peers say, “I hate math, don’t want to deal with it ever again.”  Therein lies the problem.  Very few in the public really understand what is going on.  How many times have you seen CNN, MSNBC, Fox, or even CNBC go in depth about the Federal Reserve?  I’ll leave you with a quote from Henry Ford:

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

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