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While demand has been falling, it’s only down about 500,000 bpd year over year. World demand is growing faster than that and is still forecast to grow by about 1 million bpd in 2009, last I heard.

This means the demand for Saudi crude will stay more than high enough for them to continue to be swing producer/price setter.

Change in Gasoline Demand

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Karim writes:

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This displays a profound misunderstanding that is also likely shared by the McCain campaign.

From an email from the Obama campaign to supporters sent last night.

Friend –

The era of greed and irresponsibility on Wall Street and in Washington has created a financial crisis as profound as any we have faced since the Great Depression.

While not technically incorrect in terms of defaults and a few other financial measures, the financial crisis of the depression resulted in a collapse in GDP and double-digit unemployment. This financial crisis hasn’t even yet caused two quarters of negative GDP, and unemployment of 6.5% isn’t (yet) anywhere near the levels of recent recessions.

Congress and the President are debating a bailout of our financial institutions with a price tag of $700 billion or more in taxpayer dollars. We cannot underestimate our responsibility in taking such an enormous step.

The $700B is not the price tag for tax payers. The fiscal cost is equal to the losses government might take if they overpay for the securities they are purchasing.

Whatever shape our recovery plan takes, it must be guided by core principles of fairness, balance, and responsibility to one another.

Agreed, and a good working knowledge of public accounting would go a long way to getting there.

Please sign on to show your support for an economic recovery plan based on the following:

• No Golden Parachutes — Taxpayer dollars should not be used to reward the irresponsible Wall Street executives who helmed this disaster.

• Main Street, Not Just Wall Street — Any bailout plan must include a payback strategy for taxpayers who are footing the bill and aid to innocent homeowners who are facing foreclosure.

• Bipartisan Oversight — The staggering amount of taxpayer money involved demands a bipartisan board to ensure accountability and oversight.

Show your support and encourage your friends and family to join you:

http://my.barackobama.com/ourplan

The failed economic policies and the same corrupt culture that led us into this mess will not help get us out of it. We need to get to work immediately on reforming the broken government — and the broken politics — that allowed this crisis to happen in the first place.

Yes, like putting controls in place to minimize fraudulent loan applications. But I suspect lenders have already done that.

And we have to understand that a recovery package is just the beginning. We have a plan that will guarantee our long-term prosperity — including tax cuts for 95 percent of families, an economic stimulus package that creates millions of new jobs and leads us towards energy independence, and health care that is affordable to every American.

Increasing demand before cutting our crude and gasoline imports will result in deteriorating terms of trade and a declining standard of living.

It won’t be easy. The kind of change we’re looking for never is.

Particularly when no one in Washington seems to understand public accounting.

But if we work together and stand by these principles, we can get through this crisis and emerge a stronger nation.

Yes, worst case the fiscal ‘automatic stabilizers’ will get us through as they always have.

Thank you,

Barack

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On Wed, Sep 24, 2008 at 4:51 AM, Sean asks:

Do u think treasury will manage their new mortgage portfolio like a conventional manager – hedging the negative convexity with swaps and swaptions?

Good question!

I wouldn’t; they might.

It wouldn’t serve public purpose to do that. It would add to volatility.

Just doing the exchange reduces volatility as the government absorbs it, which I see as serving public purpose.

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(an email exchange)

Good find!

yes, this had to have contributed to the boom/bust and encouraged/sustained the rampant lender fraud that has resulted in the elevated defaults.

hopefully the pension funds have learned their lessons (the hard way, unfortunately but as always seems to be the case) and will dig deeper than just using the ratings agencies and diversification when they invest.

Warren

>   
>   On Wed, Sep 24, 2008 at 2:50 AM, Eric Tymoigne wrote:
>   
>   
>   All,
>   
>   I have finally found what I have been looking for a while.
>   
>   ERISA was amended on November 2000 to allow Pension Funds and Employer
>   benefit program to buy ABSs with investment grade below A, and to buy senior
>   tranches of CDOs as long as they have an investment grade of at least AA (at
>   least is how I interpret the sentence “the Amendment permits inclusion of
>   assets with LTVs in excess of 100%. However, securities backed by such
>   collateral (a) must be senior (i.e., non-subordinated) securities and (b) must
>   be rated in either of the two highest generic ratings categories by a rating
>   agency.”).
>   
>   All this, it seems to me that this is what has allowed, or at least initiated,
>   what we have seen in the 2000s. CDS, CDOs-squared, under-regulated
>   mortgage companies etc. were all there already but not until this came up did
>   the all thing got out of hand and subprime mortgage started to boom.
>   
>   Any thoughts?
>   
>   Best,
>   Eric
>   

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• MBA Mortgage Applications (Released 7:00 EST)
• MBA Mortgage Purchasing (Released 7:00 EST)
• MBA Mortgage Refinancing (Released 7:00 EST)
• MBA Mortgage Applications TABLE (Released 7:00 EST)
• MBA Mortgage Applications TABLE 2 (Released 7:00 EST)
• MBA Mortgage Applications TABLE 3 (Released 7:00 EST)
• MBA Mortgage Applications TABLE 4 (Released 7:00 EST)
• Existing Home Sales (Released 10:00 EST)
• Existing Home Sales MoM (Released 10:00 EST)
• Existing Home Sales YoY (Released 10:00 EST)
• Existing Home Sales Inventory (Released 10:00 EST)
• Existing Home Sales ALLX 1 (Released 10:00 EST)
• Existing Home Sales ALLX 2 (Released 10:00 EST)

MBA Mortgage Applications (Sep 19)

 
The MBA index of loan requests for home purchases fell 10 percent to 342.2.

Not good, but down from a larger spike last week, and still well above the lows.

Housing still looks to have bottomed albeit from very low levels.

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MBA Mortgage Purchasing (Sep 19)

 
A move down after a larger spike up, still off the bottom.

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MBA Mortgage Refinancing (Sep 19)

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MBA Mortgage Applications TABLE (Sep 19)

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MBA Mortgage Applications TABLE 2 (Sep 19)

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MBA Mortgage Applications TABLE 3 (Sep 19)

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MBA Mortgage Applications TABLE 4 (Sep 19)

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Existing Home Sales (Aug)

 
A bit worse than expected, prior revised up a bit. Still looks like it’s past the bottom.

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Existing Home Sales MoM (Aug)

 
Also worse than expected, and last month revised up.

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Existing Home Sales YoY (Aug)

 
Declines still dimishing.

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Existing Home Sales Inventory (Aug)

 
Good size drop as foreclosures get liquidated.
Along with plunging new home inventories and a lot of existing homes not livable, it looks to me like supply is starting to get thin.

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Existing Home Sales ALLX 1 (Aug)

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Existing Home Sales ALLX 2 (Aug)

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It would be counter productive to add the $700 billion to the budget deficit calculation if the proposal goes through and is executed, since Congress is likely to take measures to somehow constrain spending or increase revenues to try to ‘pay for it’. This would be highly contractionary at precisely the wrong time.

Note that if the Fed buys mortgage securities it doesn’t add to the deficit, while the Treasury buying the same securities does? And in both cases treasury securities are sold to ‘offset operating factors’; either way, Fed or Treasury, the government exchanges treasury securities for mortgage securities.

When any agent of the government buys financial assets, that particularly spending per se doesn’t add to aggregate demand, or in any way or directly alter output and employment.

Yet here we are listening to the Fed Chairman, the Treasury Secretary, and members of Congress talking about $700 billion of ‘taxpayer money’ and a potential increase in the deficit of $700 billion.
And no one argues with statements like ‘it is even more than we spent in Iraq’ and ‘that much money could better spent elsewhere’. Unfortunately for the US economy, this supposed addition to the deficit is likely to negatively impact future spending, perhaps at the time when it’s needed most to support demand.

I recall something like this happened in 1937, when revenues collected for social security weren’t ‘counted’ as part of the Federal budget, and the millions collected to go into the new trust fund
were in fact simply a massive tax hike. Unemployment went from something like 12% to maybe 19% (and stayed about that high until WWII deficit spending brought unemployment down to near zero). After that happened much was written regarding public vs private accounting and the cash flow from social security and other programs was subsequently counted as part of the federal budget calculation, as it is today, and for the same reason.

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Selling a convertible preferred that cheap – a 10% coupon with a below market strike???- seems to mean things aren’t all that rosy at Goldman???:

Berkshire will buy $5 billion of perpetual preferred stock that carries a 10 percent dividend. It also will receive warrants to buy $5 billion of common stock at $115 per share, exercisable within five years.

The market seems to like it, for the moment.

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(email to J. Galbraith – one of Obama’s economic advisers)

Hi,

The ‘bailout’ adds nothing to aggregate demand and should not be a factor regarding other spending initiatives.

Any chance you can straighten him out on this?

Warren

Obama: Wall St bailout may delay spending programs

by Steve Holland
NEW YORK, Sept 23 (Reuters) – Democratic presidential nominee Barack Obama said on Tuesday a $700 billion Wall Street rescue plan would likely delay some campaign spending promises, as the reality sank in of the costs of the mammoth bailout.

Obama, who faces Republican John McCain in their first face-to-face debate on Friday in Mississippi, said if elected he might have to phase in some of his plans such as an overhaul of the U.S. health care system.

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Congress seems confused over who are the bad guys that need to be punished.

They seem to be leaning towards punishing shareholders if their management decides to accept any form of federal assistance under the new plan.

This puts management in a bind: sell a few securities to the Treasury and let shareholders lose value to the government, or muddle through and don’t dilute the shareholders.

Management is likelty to do what’s best for management, and sell securities to the Treasury and sell the shareholders up (down?) the river. Just like they do when they issue a convert when stock prices fall, to shore up capital.

But Congress also thinks management needs to be punished with some form of salary and bonus caps. This would discourage management from utilizing whatever new facilities Congress comes up with. Which also makes shares less valuable.

Looks like a lose/lose for the shareholders?

It seems to me if Congress finds anyone at fault (whatever that means) it would be managers rather than shareholders.

What have shareholders done wrong, even in theory? It’s a stretch to come up with anything.

And who are the shareholders? Pension funds, ira’s, individuals? Why are they the objects of Congressional wrath?

With each government intervention, shareholders have been a favorite target to justify the utilization of ‘taxpayer money’ (whatever that means with an asset purchase).

Congress isn’t looking at who’s at fault, they are only looking to minimize risk to ‘taxpayer money’, even if that means taking funds from innocent shareholders.

Congress can be counted on to do what they think is best for them politically. So with something like 75% of the voters owning shares, it seems odd that they are the target.

And, of course, none of this address aggregate demand which is the key to output and employment (the drivers of corporate prosperity) and share holder value.

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Karim writes:

Most of testimony explaining actions of recent weeks. Direct comments on economy below. Focus on enabling financial conditions to improve ‘for a protracted period’ means that in Bernanke’s mind that hikes are off the table for a ‘protracted period’ and cuts may be on the table if inflation cooperates.

Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse.

While perhaps manageable in itself, Lehman’s default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit–where available–to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets–a flight to quality–sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth.

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• ICSC-UBS Store Sales YoY (Released 7:45 EST)
• ICSC-UBS Store Sales WoW (Released 7:45 EST)
• Redbook Store Sales Weekly YoY (Released 8:55 EST)
• Redbook Store Sales MoM (Released 8:55 EST)
• ICSC-UBS Redbook Comparison TABLE (Released 8:55 EST)
• Richmond Fed Manufacturing Index (Released 10:00 EST)
• Richmond Fed Manufacturing Index ALLX (Released 10:00 EST)
• House Price Index MoM (Released 10:00 EST)
• House Price Index YoY (Released 10:00 EST)
• House Price Index TABLE (Released 10:00 EST)

ICSC-UBS Store Sales YoY (Sep. 23)

 
Holding steady off the lows.

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ICSC-UBS Store Sales WoW (Sep 23)

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Redbook Store Sales Weekly YoY (Sep 23)

 
Steady and off the lows as well.

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Redbook Store Sales MoM (Sep 23)

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ICSC-UBS Redbook Comparison TABLE (Sep 23)

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Richmond Fed Manufacturing Index (Sep)

 
Worse than expected and looking very weak.

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Richmond Fed Manufacturing Index ALLX (Sep)

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House Price Index MoM (Jul)

 
Weaker than expected but still off the lows and seems to be working it’s way irregularly higher.

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House Price Index YoY (Jul)

 
Losing 5.3% year over year is a lot for this index.

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House Price Index TABLE (Jul)

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As this goes down, the value of AIG (and probably Lehman) goes up.

• IG On-the-Run Spreads (Released 5:02 EST)
• IG6 Spreads (Released 5:02 EST)
• IG7 Spreads (Released 5:02 EST)
• IG8 Spreads (Released 5:02 EST)
• IG9 Spreads (Released 5:02 EST)

IG On-the-Run Spreads (Sep 22)

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IG6 Spreads (Sep 22)

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IG7 Spreads (Sep 22)

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IG8 Spreads (Sep 22)

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IG9 Spreads (Sep 22)

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>   
>   On Mon, Sep 22, 2008 at 7:40 AM, Dawn wrote:
>   
>   Amen! 30% of homes in Riviera Beach are in foreclosure because mortgage
>   companies wrote loans to anyone with a heart beat. We are now stuck with
>   three fairly new housing developments along Congress Avenue that are quickly
>   turning into ghettos.
>   

Hi Dawn, good to hear that from someone on the inside!

Somehow the mainstream has mysteriously ignored the prime role of fraudulent applications, loan officers working on a commission basis, etc. all to make loans by misleading the lenders and the ratings agencies.

>   
>   Do you think banks would be amenable to providing low money down/low
>   interest rate mortgages to municipal employees with at least a five year
>   employment history, proper credit, etc? Mortgage payment could be deducted
>   from pay checks. This would allow police officers, firefighters, etc to have a
>   vested interest in the community and help the banks get the real estate off
>   their books.
>   

Yes, I don’t see why not?

They are still in business to make profits by making loans to credit worthy borrowers. Try speaking to the local lenders and mortgage bankers?

Thanks!

Warren

>   
>   Thx
>   
>   Dawn
>   

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This is what was submitted:

Treasury fact sheet on asset plan

Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets. Removing troubled assets will begin to restore the strength of our financial system so it can again finance economic growth.

While this won’t alter bank capital, bank asset sales shrink balance sheets and ‘make room’ for new lending.

In fact, that was the ‘originate to sell’ model.

This will support output and employment only to the extent it has been constrained by limited capability of banks to lend.

The major effect of having these problematic assets on the books has been in the secondary markets, including interbank lending, which have lesser and only indirect consequence for output and employment.

Supporting the housing agencies ability to lend at lower rates to any credit worthy borrowers directly supports housing and other sectors.

What banks need most is an increase in aggregate demand sufficient enough to increase employment and output.

This proposal for the Treasury to buy bank assists will have little direct effect on aggregate demand.

The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions.

The question of price is problematic.

This is vague as the Treasury doesn’t have clarity on how this might work. It is doubtful that Congress will either. Reverse auctions can result in gross overpricing, which they do not want to happen.

And note the congressional discussion on salary caps for institutions that sell assets to the Treasury – no telling how that will shake out!

The dollar cap will be measured by the purchase price of the assets. The authority to purchase expires two years from date of enactment. Asset and Institutional Eligibility for the Program. To qualify for the program, assets must have been originated or issued on or before September 17, 2008. Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets.

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Under this proposal from treasury, they would ask for offerings from the banks and then take the lowest prices for up to $50 billion at a time.

This means they will be paying more and more for each round of purchases, driving up the prices from current market value.

And if the plan is to spend the entire $700 billion they could drive prices up through the roof.

They would need to limit the prices they are willing to pay somehow.

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1. Money fund issue:

   Remove the $100,000 cap on insured bank deposits. This adds no risk to government. And it will eliminate the need for money funds which the cap created in the first place.

2. Broker/dealers:

   Let them go. If they don’t survive, at worst their assets will be distributed by the bankruptcy court if it goes that far. They do nothing that I know of that serves public purpose and/or the real economy that banks can’t do. And the banks are already regulated and supervised.

3. Insurance companies:

   Policy holders should be government insured and insurance company assets, and capital regulation should be updated. You will know insurance regulation doesn’t go far enough if there are too many government losses to make policy holders whole.

   AIG got short credit (sold insurance on securities at low prices) and lost all their capital as risk and the price of insurance went up. Looks to me like a failure of regulation that allowed that much risk.

4. Home ownership:

   Continue to fund the agencies via the Treasury to keep costs of funds at a minimum.

   Have the agencies ‘buy and hold’ new originations, and thereby eliminate that portion of the secondary markets. The secondary markets serve no public purpose, beyond working past flaws in the institutional structure that should instead be addressed.

   Increase and enforce criminal penalties for mortgage application fraud. Its functionally the same as robbing a bank.

5. Banks:

   Lower the discount rate to the fed funds target rate and eliminate the need for collateral. This is how it should have been anyway.

   Bank assets and solvency are already highly regulated, and how they are funded doesn’t alter the risk of loss due to insolvency for the government.

   An interbank market serves no public purpose. Eliminate it out to six months by offering discount lending out to 6 months.

   In addition to the FOMC setting the fed funds rate target, it can also set the rate for 3 and 6 month borrowing at the discount window. This both gets the job done and also replaces the TAF and TSLF type of experiments.

6. Growth and employment:

   Offer (directly or indirectly) a Federally funded $8 per hour full time job to anyone willing and able to work that includes health care benefits. An employed buffer stock is a more effective stabilizer and price anchor. It’s also less costly in real terms, than the unemployed buffer stock we currently maintain.

   Eliminate the various payroll taxes as needed to sustain demand.

   Implement needed infrastructure upgrades and repairs.

   Eliminate health care as a marginal cost of production. People aren’t more likely to get ill if they are employed; in fact, the opposite is likely the case.

   The current system distorts pricing, and results in a suboptimal outcome for the economy’s ability to sustain prosperity.

If you in general agree with the above, please forward this to all your contacts in high places asap, thanks.

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On Fri, Sep 19, 2008 at 9:44 AM, Scott asks:

These moves HAVE to be bad for the dollar, no?

Not much effect per se.

Immediate effect is higher interest rates/stronger stocks which very near term helps the USD.

But it seems saudis are hiking price which, if it continues, will again send the dollar down.

Also, the Fed showed some concern about exports softening, which they probably attribute to the recent USD strength.

So seems the Fed and Treasury probably don’t want the dollar to get too strong.

Major equity short covering rally in progress.

When it runs its course, the US economy will still be weak and higher crude prices will be problematic as well.

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(an interoffice email exchange)

>   
>   On Fri, Sep 19, 2008 at 9:50 AM, David wrote:
>   So creating liquidity for toxic assets RTC style.
>   

maybe, jury is still out on how that might work

>   
>   Make the government a little money and inspire confidence in banks, ok.
>   
>   We are thinking that this is overtly inflationary for financial assets (maybe all
>   assets?)
>   

supports a lot of equity value by removing a large element of risk, but cost to shareholders still unknown

fixed income going higher in yield, prices there going down

>   
>   Should I expect this to re-inflate the commodity asset bubble in the medium
>   term???
>   

not directly. crude price up to the Saudis.

>   
>   Do you think the dollar’s rally will help cap any commodity asset price rise???
>   

yes, in the competitive markets. crude is not a competitive market. saudis merely set price and let quantity adjust

>   
>   PS- I expected to come in today to $110+ crude, $8+ gas, and $900+ gold.
>   

as above. crude up even with dollar up, but gold down.

warren

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My take is an RTC type solution only works when the government owns the institutions, so this will probably be different.

I suspect it will be more like Japan, where the government bought a new class of preferred stock in the banks to add capital.

Whatever they will do will cause credit spreads to come in, which will make the assets of AIG far more valuable and probably result in a ‘profit’ for the government.

Unsold Lehman assets will also appreciate.

More comments below:

Paulson, Bernanke Push New Plan to Cleanse Books

by Alison Vekshin and Dawn Kopecki

Government Options
Options that U.S. officials are considering include establishing an $800 billion fund to purchase so-called failed assets

I see this as problematic as above and as below.

and a separate $400 billion pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, said two people briefed by congressional staff. They spoke on condition of anonymity because the plans may change.

This puts money funds on par with insured bank deposits. Seems no need for both.

Instead, better to remove the $100,000 cap on bank deposit insurance to allow large investors use bank deposits safely. There is no economic reason for the low cap in any case.

Another possibility is using Fannie and Freddie, the federally chartered mortgage-finance companies seized by the government last week, to buy assets, one of the people said.

That’s already in place. They already have treasury funding to buy mortgages.

“We will try to put a bill together and do it fairly quickly,” House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said after the meeting. “We are not in a position to give you any specifics right now” on the proposals, he said when asked about the potential cost.

The likelihood of the government taking on yet more devalued assets, after the seizures of Fannie, Freddie and AIG and the earlier assumption by the Fed of $29 billion of Bear Stearns Cos. investments, may spur concern about its own balance sheet.

We need to get past this concern about government solvency. It’s simply not an operational issue.

Debt Concern
The Treasury has pledged to buy up to $200 billion of Fannie and Freddie stock to keep them solvent, while the Fed agreed Sept. 16 to an $85 billion bridge loan to AIG. The Treasury also plans to buy $5 billion of mortgage-backed debt this month under an emergency program.

“It sounds like there’s going to be a giant dumpster for illiquid assets,” said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, which oversees $22 billion in assets. “It brings up the more troubling question of whether the U.S. government is big enough to take on this whole problem, relative” to the size of the American economy, he said.

This is ridiculous and part of the problem that got us to this point.

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