The story of the noose that choked credit

Banks and corporations have been going through their own credit crunch which is why risk aversiveness has been an underlying theme in this recessionary charade.

Commercial Banks heavily rely on nontransaction deposits for funding.  These include small and large time deposits:

Repurchase agreements are an important source of bank funds and the most important lenders are corporations which means corporations are lacking idle funds and taking on a more defensive position:

Also Securitization made credit available on a mass scale:

Commercial Paper market had also become a major source of corporate funds:

We are not going to see any growth whatsoever unless funds get allocated from savers to borrowers, and by the looks of it our situation is morbid at best. Show me the money!

Durable Goods and Core-New Orders

So what exactly are durable goods?
They are products that have a life expectancy of at least three years (i.e. Macbook Pros, General Motors automobiles, washing machines,  hair dryers?, IPhones, Gulf Stream V's ect.)  From this we get the accurate sense that many important sectors of the economy are tied to durable goods production (i.e. employment, industrial production, profits, and productivity).  Also this report serves as a behind the scenes sneak preview to the comprehensive factory orders report, which includes both durable and nondurable goods.

This report is based on results obtained from 3,500 manufacturers representing 89 industry categories.  All the numbers are seasonally adjusted  but not annualized, and its only in nominal terms(aka the dollar amounts are not adjusted for inflation).  To estimate real changes in durable goods orders compare the growth rate over time with the performance of the producer price index.

The report can be found here.
This release is divided into 4 main sections: new orders, shipments, unfilled orders, and total inventories.

Table 1: Durable Goods Manufacturers' Shipments and New Orders

New Orders Decreased 1% or 2 billion to 190.45 billion. A persistent decline in new orders is ominous as it suggests that some factories may go unused.  But we have to keep in mind that this data can be misleading because of a single large military purchase or transportation order.  So we will also want to look at at the rows excluding defense (still a 0.7% drop in new orders) and transportation (.6% drop in new orders) and we find that the drop in new orders is less with these more volatile components removed.

Now with a little bit of common sense we can calculate new orders excluding defense and transportation.  Let's call it "Core-New Orders" which like core cpi excludes the most volatile components.

"Core-New Orders"(in millions) for June:

132,536 = 190,490 - ((190,490 - 144,571(excluding transportation)) + (190,490 - 178,455(excluding defense)))

In May they were:

132,678  = 192,455 - ((192,455 - 145,420 (excluding transportation)) + (192,455 - 179,713 (excluding defense)))

The percentage change from last month was:

(( 132536 - 132678 ) / 132678) x 100 = -.11%

Certainly this is not as dramatic of a fluctuation as the standard new orders measure.  Therefore this helps us realize that new orders hasn't fallen off the cliff and that although consumer demand is cutting back it is not as devastating as the standard number has you believe.  Something I found interesting is the two conflicting titles that WSJ put out today.  Real Time Economics highlights the positives:
Economists React: Encouraging Details in Durables

and WSJ Economy makes it clearly sound like a volatile downward turn:
Durable-Goods Orders Slide

Revised to be relevant and useful: TIPS and Inflation Expectations

In a previous post  I calculated expected inflation using some bond that was maturing in 2012 but we want to get a more accurate (and relevant) picture of expected inflation.  To do this we can go to the Federal Reserve and observe statistical release H.15 which are selected interest rates.  For example, 10 years from July 22nd expected inflation is:

E(p)= i - ir
Where E(p) is expected inflation,
i - nominal interest rate ( interest rate paid on nominal treasuries)
ir - real interest rate (remember the inflation index bonds are supposed to reflect these)

Looking at the statistical release if we want the 10 year inflation expectations we must look at the 10 yr bonds.  We will find that for July 22, 2010:

i (Nominal Treasury) = 2.9%
ir (Inflation indexed Treasury) = 1.78%

2.96% -1.78% = 1.18% 
E(p) = 1.18%
Therefore expected inflation for the next 10 years as of July 22nd is 1.18%

Initial Unemployment Claims: Still Super High

Initial claims for unemployment insurance remains super high like Oakland, California:

This is super bad. The number of people filing for unemployment benefits has remained at a high level which is a sign that our economy is still feeling the pain.  Initial claims are still above 400,000 which is indicative of an economy that's still losing steam (womp! womp!). 

TIPS: A Gauge Of Inflation Expectations

Treasury Inflation Protection Securities or TIPS, are indexed bonds or bonds whose interest and principle payment are adjusted for changes in the price level.  The interest rate on these bonds provides a direct measure of a real interest rate. 

Using the Fisher equation:

i = ir + E(P)
where:
i - nominal interest rate
ir - real interest rate
E(P) - expected inflation

We can re-arrange the terms to get:

Expected inflation rate for the next 10 years  =  ( (i) - Ten Year Treasury Constant Maturity Rate, monthly) - ((ir)- 10 Year TIPS, Monthly)

Using FRED:

So the expected inflation rate for the next 10 years is around 3.2%.

Housing Market Summary: May not be in a Depression but this is still depressing

The housing market is barely breathing with housing starts and new one family houses sold at all time lows:

The S&P/Case-Shiller Index shows a dramatic decline in home prices nationwide:

 I could not resist throwing Detroit and Cleveland on there.  It is going to be a long time before the consumer comes back in Detroit and Cleveland.  Nationwide home prices seem to be stabilizing at a level not seen since 2003.  The de-leveraging consumers that believe their home prices won't fall any further may start to feel financially healthier.  Although I don't imagine the de-leveraging ending anytime soon. 

What does a debt deflation entail and are we headed for one?

The process of debt deflation goes a little something like this:
Unemployment increases this leads to a sudden drop in income and more people filing for unemployment insurance.  Suddenly people feel poorer and both home spending and consumer spending decline.  Producer Prices then fall because business are cutting back on inventories.  Furthermore, lower import prices also puts downward pressure on consumer and producer prices.  Last but not least home prices continue to fall.  Consumer prices then decrease due to lower input costs (via producer price index declines and import price declines) -  this lower price level causes the real value of the debt burden to increase.  This increased financial strain will lead to the next round of defaults and further reduction in consumer spending. This leads to more unemployment and even worse some unemployed 27 weeks or longer are no longer eligible for unemployment insurance.  This leads to a further decline in incomes leading to more cash strapped households on the brink of desperation and another round of defaults as some (newly unemployed or uninsured laborers) are unable to make their debt payments.
                                         
Debt Deflation in the Economy:

Recession Hits ----> Unemployment (Increases) + Unemployment Insurance (Increases) ---> Income (Falls) -----> Spending (Falls)([Consumer Spending (Falls) + Home Spending (Falls)] )------>  Price Level (Falls) ([ Producer Prices (Fall) + Import and Export prices (Fall) + Home Prices (Fall)]-----> Consumer Prices (Fall)] ) --> Real Debt Burden (Increases) --> Defaults (Increase) ---> Consumer Spending (Falls) --> Further Unemployment (Increases) + Unemployment Insurance (Fall)]---> Income (Falls) ----> Defaults (Increase) + Consumer Spending (Falls)---> and on and on


Lets look at the most recent evidence:

 Unemployment has increased and those receiving unemployment insurance has decreased:

This is surely to have some more effects on the already depressed consumer and home spending:

The Producer Price Index has declined as of late to reflect the sharp cut back in production from businesses reaction to the lamesauce consumer demand:

Import prices have fallen recently:

Home spending and home prices continue to be trending downward:

Price deflation leads to an increased real debt burden and as we have seen defaults continue to be on the rise.  As we have just seen some data suggest that this may be occurring and the fact that severe financial crisis do sometimes lead to debt deflation leaves me very worried.  We would be experiencing a full-blown debt deflation right now if it wasn't for two things: sticky wages and unemployment insurance.  The inflexible nature of wages allows those who do have jobs to keep spending.  This - in addition to unemployment benefits - has prevented the severity of the crises from reaching the debt deflation stage.  The governments ballooning debt has not been the work of bailouts but of unemployment insurance payments.  This has represented a massive transfer of debt from the private to the public sector and the extension of these benefits have proved undeniably important for keeping our economy afloat.

Academia May Not Be For Me Afterall...

Greg Mankiw just discouraged me from taking a serious look at academia or from taking academics seriously for that matter.  In other news a man with a sweater vest blog just jumped off the top of Schott Hall today.  Hopefully the crises has taught these academics a thing or two.  On a second thought: after reading this post I can only assume that some academic economists probably didn't even know a recession occurred. 

The TED Spread: A Look At Financial Stress

The TED spread is the spread between the interest rates on interbank loans and short-term U.S. government debt.  A rising TED spread is usually a precursor of a declining stock market because it means liquidity is being withdrawn.  It is considered an indicator of perceived credit risk in the economy. When the TED spread increases it is a sign that lenders believe that the risk of default on interbank loans is increasing.  This spread is also one of the components that make up the St. Louis Fed's Financial Stress index.  The TED spread has been elevated upward since hitting a low back in March, indicating that perceived default risk is slowly increasing.  This can be due to a host of issues ranging from Europe's fiscal woes to the recent onslaught of generally poor economic indicators.  The spread can be observed via Bloomberg.

FRED Graph Round-Up: Veggie Tales, Financial Woes, Manufacturing Blues, U.S. Debt and Financial Stress

FRED is an amazing resouce that cannot be taken for granted.  FRED offers customizable graphs and allows the user to manipulate hundreds of time series data.   Anything from vegetable import prices to foreign capital flows can be observed and presented in an attractive way.

Vegetable import prices keep rising as indicated by the following graph:

We can see that foreign investors are starting to see the U.S. as a financial safe haven.  As Europe's fiscal woes ensue the United States is starting to look relatively safer:

 The recession has hit manufacturing employment in the already ailing Michigan pretty hard:

A look at federal spending and revenue reveals that federal expenditures keep rising while total tax receipts have dropped significantly due to the persistently high unemployment and general contraction in business activity.  The difference is payed for by issuing treasuries thus increasing our federal debt.

The St. Louis Financial Stress Index measures financial stress and is updated each Friday.  Notice how the index has been elevated recently:

GeoFRED: There's A Map For That

GeoFred offers many different data sets and map options.  Want to see the housing price index by state? There is a map for that. Interested in manufacturing employment by state? There is also a map for that:

Research & Development: An Investment or Expense?

Apparently R&D is counted as an expense and not as an investment in the official calculation of gross domestic product (GDP).  This was first brought to my attention by the Levi Institute Multiplier Effect Blog.  One would think that research and development would be counted as investment which makes up a valuable component of GDP.  According to the Bureau of Economic Analysis (BEA) counting R&D as an investment would have increased GDP 2.7% from 1998 to 2007.  The new research from the Bureau of Economic Analysis concludes that:

"By treating R&D as investment, real GDP increased at an average annual rate of 3.0 percent over the period 1998-2007.  As in previous periods, growth in R&D investment continued to track business cycles.  R&D’s contribution to growth slowed in 2001 and 2002, recovered in 2003, and outpaced the expansion through 2007.  In 2002, business sector R&D subtracted from growth, but was more than offset by contributions from the government and nonprofit sectors."

R&D should be counted as an investment because it leads to innovation and growth.  R&D has been overlooked and should be treated more seriously as increased R&D spending leads to greater productivity growth.  It would also be valuable to track its role in business cycle fluctuations. 

Roubini on Double Dip

check this out

Weekly Claims For Unemployment Insurance: Keep Your Eye Out For Criminals

Weekly Claims for Unemployment Insurance tracks new filings for unemployment insurance benefits.
Figures on new filings for unemployment benefits are released every week and are based on reports from state agencies.  Because of this it is considered a good coincident indicator, or an indicator that actively reflects what is going on in the economy.  Its also considered forward-looking because first-time claims can influence future economic activity.  If a large number of workers are losing their jobs every week and applying for unemployment insurance, this will eventually doom consumer sentiment, slash spending, and cause business to cut back investments.  If the number of people filing for unemployment benefits increases every week or remains at a high level, it indicates that the economy is struggling. 

The report can be found here.  First look at the Unemployment Insurance Data for Regular State Programs.  The general rule of thumb has been that if first-time claims stand above 400,000 for several weeks, it is a symptom of an economy that losing traction and in danger of slipping into recession.  Also this pace usually drives the unemployment rate higher.  For their to be any meaningful jump in payroll employment, first-time claims must remain below 350,000.  For July 3rd initial claims stood at 454,000 down -21,000 from 475,000 on June 26 from last week.

We want to look at the four-week moving average to smooth out the volatility of the weekly numbers. This was 466,000 for July 3rd which is down 1,250 from 467,250 June 26.  The numbers have continued to remain at a very high level which is a bad sign for consumer confidence and spending.

 Insured unemployment vs. total unemployment:

Looking at this graph we can see the growing disparity between those unemployed and those receiving unemployment insurance benefits.  Jobless workers collecting unemployment insurance at least have some money to spend, which can dampen the harmful effects of an economic downturn.  If total unemployment rises at a faster rate than those collecting unemployment insurance, it means a growing proportion of people out of work may have to get by without any state financial support.  This can lead to more people turning to the underground economy or crime for money.  Furthermore, the stress facing many state budgets has led to a massive reduction in police forces.  I'll be keeping my eye out for the hamburglar.

Step into the shoes of the Federal Reserve

Short-term interest rates are at their all time lows and inflation is not a problem.  Historically low short-term interest rates usually fuel the demand for credit, which usually leads to debt buildup and expansion.  The Fed and other central banks are walking on a very tight rope (although it may not seem like it).  Raise rates and attempt to prevent investors searching for the greatest yield from putting all their money in one place (in effect creating another destabilizing bubble somewhere).  Or put another way: raise rates and brace yourself for deflation, increased bankruptcies, greater liquidity problems, less demand for goods, and higher unemployment.  The popular (and I think correct) thing to advocate is to keep the federal funds rate at the zero bound and handle asset inflation with the Fed's new pistol: regulation.  A pistol as opposed to an M-16 because the first round of regulation legislation seemed less than adequate.  Many observers of the great recession have chosen to blame the Federal Reserve for keeping rates "too low for too long" in the past.  Where are they now? What would they have to say about this? It's easy to criticize the Fed in hindsight but can you blame them right now?  When we do have another bubble on this earth (and we will) and some famous economist claims that this is because the Fed kept rates "too low for too long" we must remember what kind of downside risks our economy is currently facing.  Before we blame the Fed in hindsight, we must remember what the newspapers, literature and economists were preaching at the time. 

For a great source of ideas on this topic Raghu Rajan has got it going on.

Overleveraged and Overburdened: American's Are Filing For Bankruptcy

In a previous blog post, I pointed out that the amount of credit card debt held by Americans has fallen substantially.  The reason for this is that more Americans are filing for bankruptcy to reduce the amount of debt that they owe.  This WSJ Real Time Economics post says it all.  A new report by the American Bankruptcy Institute says that bankruptcy filings have reached their highest level since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  Through the first six months of 2010 consumer bankruptcy filings increased to 770,117.

The explanation given and where bankruptcy will be heading:

"Years of rising consumer debt and low savings rates, combined with the housing and unemployment crises, are causing bankruptcy levels not seen since the 2005 amendments to the Bankruptcy Code," said ABI Executive Director Samuel J. Gerdano. "We expect that there will be more than 1.6 million new bankruptcy filings by year end."

Bankruptcy might be the way to go because it will lessen the burden on the true spenders in the country and thus we may see a pick up in consumption that is directly related to the increased bankruptcy filings.

 The latest data is not reflected in the graph but imagine one more bar for 2010 and imagine it being taller than that of the 2005 peak.  Everyone who reads this needs to check out the interactive graphs and resources that the American Bankruptcy Institute provides.

Strategic Defaulters: Villians or Heros?

The WSJ Real Time Economics blog is one of my favorites because it highlights things like this.  Credit firm Experian and consultancy Oliver Wyman note that 355,00 people defaulted on their mortgages in the first half of 2009 even through they could pay.  This ties in nicely with one of my previous posts about credit card defaults.  Defaulting lightened the financial burden of these defaulters which consequently allows them to spend more.  But as the WSJ points out:

"Still, the data highlight the fact that the supply of strategic defaulters isn’t endless. Reneging on debts can provide a boost, but it’s no way to build a lasting recovery."

So should we look down on these people for reneging on their obligations to pay? Or should we look to these people to spend their way to our recovery?