I’m obviously not a liberal, and a lot of the time I don’t fully subscribe the things that Paul Krugman talks about… However, the guy is flat out brilliant and you know, in this post I think he has a pretty darn good point.  I’m going to copy in a few of the things that he talks about here, if you’d like to read the whole article (you should), go to http://www.nytimes.com/2008/11/14/opinion/14krugman.html and check it out.

We are already, however, well into the realm of what I call depression economics. By that I mean a state of affairs like that of the 1930s in which the usual tools of economic policy — above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates — have lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.

My thoughts: Well yes, you have a point there. We are in a really difficult spot. With a 1% fed funds rate, you really can’t do anything else on that front, and with money that cheap and things still going down the tubes, it’s a fairly backwards place to be. Furthermore, we are going to experience a very ugly negative feedback loop as we lose more jobs, and those job losses lead to more defaults, and more job losses, and less spending, and more job losses… well you get the point.

Krugman goes on to talk about normal economic policy responses and how they are ineffective because of the state of affairs in the world and makes a very compelling argument:

Finally, in normal times modesty and prudence in policy goals are good things. Under current conditions, however, it’s much better to err on the side of doing too much than on the side of doing too little. The risk, if the stimulus plan turns out to be more than needed, is that the economy might overheat, leading to inflation — but the Federal Reserve can always head off that threat by raising interest rates. On the other hand, if the stimulus plan is too small there’s nothing the Fed can do to make up for the shortfall. So when depression economics prevails, prudence is folly.

You know, that actually makes sense. If we do something really, really drastic (Krugman suggests a $600B stimulus package) and it is too much, then we simply tighten things back up and get into a normal mode again.

Don’t get me wrong here, there a systemic issues that need to be mopped up in regards to credit and savings, but taking drastic action seems to actually make a bit of sense.

What a mess we are in.

I’m not quite sure where to start with this post, simply because there is so much good information available about what is happening out there today.  I can say however, that I am not looking forward to the next few years of economic developments.

The house of cards is tumbling down.  We are in the midst of a global, massive, de-leveraging unlike anything we have seen before.  What is really frightening about that, is the simple fact that no-one really fully understands what that will do to our economic system.  Banks around the world are being propped up by governments and hoarding any and all assets that they can get there hands on.  Consumers (globally) are tapped out, and we are staring down the face of deflation, a really, really bad thing to be staring down when your saddled with debt.

Let’s assume for a moment that for the next few years ecnomic activity falls off a cliff (very likely) and we experaince a bout of deflation across the globe.  The problem with deflation is that generally earnings go down during deflationary times, however debt doesn’t get forgiven with the deflationary index.  Meaning, if I owe $100,000 today, that may feel like $105,000 tomorrow and possilby $115,000 in just a few years (in today’s dollars).  The payment for this debt doesn’t go down either, further tapping the consumer and of course further straining the economy.

Just about every one out there belives that we are headed into a deep recession, and sadly I have to agree.  The years of easy money, extreme growth and stupid risk are behind us; hopefully, we will learn from this and de-leverage as a whole generation.  The abuse of credit in the United States is sickening, from families to the Government. 

So, what happens from here?  Well, the good news is that I’m pretty sure the world isn’t going to end tomorrow.  Your friends are still your friends, however your 401k is probebly a little lighter!  My prediction is that we have 2-5 years of hard core recession.  This could be horribly understated pending the results of our upcoming election and policy implementations over the next few years.  I expect unemployment to continue to grow, drastically.

Housing should begin to recover, sometime in the next 2-3 years.  This could of course change dramatically if the Government decides to come in and tweak with the system.

After the recession, I think we have a fantastic economic boom.  This will likely be fueled by an across the board growth of “Green” technologies and the efficiancies gained from them.  Hopefully, during the time before the next boom we are able to develop a modern regulatory framework for our financial system.  Something that can respond to new financial instruments, however something that also allows the market to function.

Off balance sheet items must be removed.  The “CDS” Market must be centralized and cleared properly.  Accounting standards must be solidified and transparancy must be restored.  Transparancy in finacial markets = trust.  Our system is built on this and until it can be restored we are in for a world of hurt.

Anyhow, just my quick thoughts.  I’ll try to rant some more about this on the blog.  I talk about it all day to folks in the office and at school.  By the time I get to the keyboard, by brain is drained of ecnomic babble

Lately the biggest news on television has been about the Real Estate market and the sub-prime mortgage mess that our country is currently in.  Given that the “American Dream” is to own a home, and that most average homeowners have a vast amount of there net-worth and personal financial wellbeing tied to their homes, I figured this would be a nice topic to start discussing.

First, let’s get some things straight.  I own a home; in California.  In fact, my home is only 20 miles or so away from the foreclosure capital of the entire United States, Stockton.  The market value of my house has fallen like a rock over the last few years and it currently shows no sign of stopping.  Thank God.

What? You might be screaming to yourself, you’re happy that the value of your house is plummeting? Well, I’m not happy about it, but I’m happy that the market is beginning to correct itself.  Just a few years ago, I was talking with some co-workers about the median income in my city and how the current home prices were simply unsustainable.  We did some quick back of the napkin math and figured that most people could choose to either 1. buy a home and starve to death, or 2. rent and eat plenty.  Over the long term, the reality is that option 1 just isn’t going to cut it.

Now, I’m no central banker, or hard core economist.  I’m just a guy who happens to understand some of the basic economic principals out there and can add 2+2 to get 4.  When you only make 40K a year, and your about to  (when your 0% down option ARM resets) have to pay 28K a year in mortgage obligations, the math just doesn’t work – period.

Since the math doesn’t work, the prices must fall, or buyers must “dry up” – again basic economics here, no buyers  = lower prices – supply and demand at work.  Right now, my house is bleeding about $1,000 a day.  I don’t expect that rate of “burn” to continue, simply because foreclosures are accelerating the price decline.  Most of the folks that I know who have normal mortgage payments as a percentage of their income are not planning to sell at all in this market.  Supply and Demand will begin to turn once the foreclosure inventory is worked through.

Anyhow, back to why I’m happy.  The market has to get real in order to continue to appreciate.  Seriously, do you really think that it is healthy to have the appreciation of your home be 2x your annual salary on a year over year basis?  That is not sustainable and must be corrected.  The quicker the correction – the better.  When prices can move back down to a level were there are strong numbers of buyers, we will be close to a bottom.  The cheap inventory can be worked off, and then supply and demand will take over again.  Prices will begin to move up and that will be a fantastic thing.

Personally, I think the market is getting very close to a bottom.  Inventory is moving and prices are beginning to show some signs of stabilization.   I wouldn’t be supprised if there were another 6-12 months of weakness, but after that I think we wil be in very good shape.

So, what does this mean to an existing home owner?

That depends… Ideally you were purchased a house with some equity and didn’t buy at the peak.  If you don’t have equity, or you bought at the peak you might simply be out of luck and will just need to wait the market out.  This is healthy.  It sucks, but it is healthy – repeat that to yourself every night

If you happen to have a home that still has some equity in it, you might have a fantastic opportunity in front of you. Over the next year or so there are going to be some fantastic deals out there.  Bank owned homes that are out there for the taking will be all over the place.  If you can work together to put together a solid down payment and can part with your home at an emotionally “low” price, you may be able to take advantage of the market and
“move up” on the cheap.

If you’re like me, you pretty much aren’t going to do anything.  In fact, I’m going to be renting my place out while I go to Chicago for Grad School.  Why?  Because the market sucks and I am not prepared to sell my house for its current “market value.” Just a few years ago I was saying – there is no way I’d pay that much for my house… Based upon the current “market value” I’m saying there is no way I’d sell for that little.  We are in the process of swinging the pendulum back and forth, eventually it will come back to the middle and it will be time to sell and move to a new home.

If you’re in the market… Please, please, please, please, please…. Don’t buy a with a stupid mortgage.  ARM’s are not horrible, you just have to understand what they are and what the risks are.  I happen to have an ARM, it is a 7/1, I like it a lot and am VERY pleased with it.  Even in this market, I’m not worried one bit.  Make sure that you have enough equity to purchase, preferably 20% down.  10% will work with an 80/10/10 setup, but do the math and make sure you’re not going to be house poor.

A side note to current homeowners and those looking to purchase.  YOUR HOUSE IS NOT YOUR ATM.  Use that equity wisely.  Do not buy Starbucks Coffee or new shoes with it.  If you are going to tap your home equity (assuming you still have any left), do so with careful consideration, please

Things will get better… It just takes time.  Markets are very efficient.  Buyers and Sellers are not stupid and this whole process will work itself out.  Ideally the government won’t meddle to much and screw things up.  A true bottom needs to be found so that price stability can return and the market can begin to appreciate.

Whatever…

Yes, today was a rough, rough day in the markets. No question about it. I’ve got a couple of things to talk about, so lets start with my current position on the Russell 2000- RUT(652.82 +2.06) – and why I’m not worried yet.

The economy is getting softer, that is a fact. The Russell 2000 is a bunch of small companies that are not nearly as globally connected as the big boys in the S&OP 500 or the Dow. When things get soft, the RUT tends to take it in the chin.

If you watch the charts of the SPX, DJI and RUT together you can see that the Russell typically moves a lot faster than the Dow or the S&OP 500 (see above). Over the past couple of months as volatility has jumped, you can also see that the RUT has moved even faster.

So, this morning we get a weak job number and the recession talkers are all ears. The market begins to drop and the RUT really takes it on the chin: recession = weakness in small companies. So, if the recession talks are in the wind, I’d expect the RUT to drop. This is why I’m not worried yet…

Today, the RSI on the RUT hit 23, anything below 30 is typically a signal of an oversold situation. 23 is really a sign that we should get a slight bounce next week. On Thursday the indicator was at 32, quickly working its way down – this drop was big… Watching the normal pattern of the RUT, I completely expect this bounce.

Anyhow, back to the trade. The RUT trade is at 670, about 50 points away from our current point in time. That is another 7% drop or so, I just don’t see it happening – at least not in the next 2 weeks!

So, since I’m still optimistic on my trades, lets talk about my optimism on the economy and why I think it is still good.

First off, the bad…

• Demand is down – homes are declining in value
• Job growth at 1% or less each year
• Interest rates are dropping rapidly

Now lets get to the good…

• After inflation, after tax income is up 2%
• August initial jobs were at -4K, revised +93K
  • This number gets revised every time
  • I’d expect that our current jobs number will come up quite a bit
• The vast majority of the reported job loss is in construction
  • DUH - housing is taking it on the chin, of course construction jobs are down.
• Q4 GDP likely to be 2.5->3% growth
• 5% unemployment rate – not to shabby

So, looking at all of this stuff what is going on? Well, the consumer is a little tight due to the housing market, and the economy is a little soft due to the gasoline(housing) being taken off of the fire. As a result of the softening housing market, a lot of construction workers are looking for jobs and the financial firms are having to write off sub-prime losses. However, the rest of the economy is in pretty good shape…

As the fed works this all out, it is in a really tough spot. Gold and oil are up, along with a bunch of other inflationary pressures. Ben and Co. need to make sure they get this right, the real risk here is … stagflation. Ouch.

If your not familiar with stagflation, basically it is low to no growth with rising inflation – bad news. Here is why this is a catch 22, taken from the wikipedia article on stagflation:

An important monetary mechanism to increase economic growth is by lowering interest rates, which reduces the cost for consumers to buy products on credit and businesses to borrow to expand production. While this can increase economic activity, it can also result in increased inflation. The monetary mechanism to reduce inflation is by raising interest rates, which increases the cost for consumers to buy products on credit and businesses to borrow to expand production. While this can reduce inflation, it can also result in decreased economic activity.

So, lets just hope we don’t end up with this mess.

A key to avoiding this is a strong dollar policy. The problem with that is of course, as interest rates go lower, so does the dollar. As interest rates go up, economic activity slows and the dollar becomes stronger. So, if the fed needs to turbo charge the economy, it needs to drop rates – but by doing so may accelerate inflation to a point of big troubles.

Personally, I agree with former federal reserve bank governor Wayne Angell. The federal reserve and the government need to team up and put together a policy that will lead to a stronger dollar. In my opinion the best way to do this is to lower corporate taxes while dropping interest rates. This gives us the chance to fix the credit crisis while bringing up the dollar by bringing more business to the United States.

I don’t see any other way around it. If President Bush can step up to the plate and put a solid corporate tax policy reform in place, we can pull out of this without any major issues. It would be one of the greatest soft landings in history. Something to applaud.

I don’t think it will actually happen, but I can hope right? I’m sure the folks in the federal reserve and the treasury department are talking about it. I’m confident that they can figure it out.

Stay tuned, it’s going to be a fun ride! Oh yeah, grab my feed!