David Wessel wrote an excellent article in today's Wall Street Journal about the need to stimulate the economy. While everyone agrees that the economy is slowing and needs a boost, Wessel wonders if it is better for the Fed to continue cutting interest rates, or if a tax cut would be more effective. He pretty much rules out hope for a tax cut arguing that Congress is unlikely to agree to one.
That's too bad because the Fed cannot realistically cut rates anymore, and because tax cuts are indeed much more effective in stimulating economies. Even former Clinton-era Treasury Secretary Lawrence Summers is now pushing for tax cuts.
Why can't the Fed cut rates? Because inflation is rising. Since September, the Fed dropped both the discount rate and the fed funds rate by a hundred basis points each. Although it takes time for interest rate cuts to stimulate the economy, these recent cuts appear to be having little (if any) effect. They have, however, helped to trash the dollar. While U.S. exports have risen, which is certainly a good thing, so has the level of inflation. Higher inflation makes it very unlikely that the Fed will keep cutting rates.
Many economists are hoping that lower interest rates will soon revive the housing market. But the Fed's actions have not lowered mortgage rates. Furthermore, the housing market will remain in the doldrums for quite some time. There is simply too much inventory on the market. And no rational person would buy a house if he expects the price to keep falling--even if he could get a zero percent mortgage.
That brings us back to tax cuts, which of course are not popular with the liberal set. Liberals argue that tax cuts typically benefit only the wealthy. Yet if tax cuts must be implemented, liberals would rather see those in the lower income brackets get the cuts.
But how is that possible? After all, by definition tax cuts only benefit those who actually pay taxes. Because our income tax code is so progressive, those in the lower income brackets hardly pay any tax at all. How many Americans realize that the bottom 50% (by income) of our population pay only 3% of all individual income taxes? How could Congress possibly deliver a meaningful tax cut to this group? The only way to truly help those in lower income brackets is to implement policies that stimulate economic growth and create opportunities for all members of society.
For many working Americans, the tax burden is much too heavy. The combination of federal income taxes, state income taxes, property taxes, sales taxes, and all those other hidden taxes can easily eat up more than one-half of income. Property taxes, in particular, have literally gone through the roof in many parts of the country. If politicians really want to stimulate the housing market, the most effective way would be to immediately cut property taxes and limit how high they could go in the future.
Thursday, December 20, 2007
Friday, December 14, 2007
Brain-Enhancing Drug Scandal
On the heels of Senator George Mitchell's report on the abuse of performance enhancing drugs in baseball, comes word that the phenomenon had been quite common outside the world of sports as well. New rumors have surfaced out of Sweden alleging that at least one-fourth of all Nobel laureates had at one time or another used brain-enhancing drugs to boost their intellectual capabilities. Critics claim their Nobel prizes were unearned and should be rescinded. One disgruntled scientist said, "These findings are truly unfair to all of us scientists with lower IQs who played by the rules. I think the world should immediately stop using whatever inventions those cheaters created!"
Tuesday, December 11, 2007
Ominous Warnings From the Fed
Today's Fed statement was filled with ominous warnings. It made references to slowing economic growth, the housing correction, softer business and consumer spending, strains in financial markets, elevated energy and commodity prices, inflation risks, and increased uncertainty. In other words, there is no good news to report.
Although the Fed cut the fed funds rate and the discount rate by a quarter point each, the market was strongly disappointed. Many investors were hoping for bolder action, perhaps a half-point cut in both rates. At the very least, investors were expecting more clarity from the statement. They exhibited their disappointment by selling stocks. Almost immediately, the Dow shed more than 200 points.
The Fed's comments make it clear that the probability of recession is much higher than many economists (including those at the Fed) had been forecasting. Yet with higher food prices, and with oil prices still flirting with the $90 per barrel level, the Fed knows it cannot focus solely on core inflation numbers anymore. The Fed knows that high food and energy prices will inevitably work their way into the core figures.
The Fed is truly between a rock and a hard place, officiating a game of tug-of-war between slowing growth and inflation. My view is that the Fed did the right thing by cutting the fed funds rate by just a quarter point. A steeper cut would have contributed to the dollar's weakness. However, I believe the Fed could have been a more aggressive with the discount rate. Given the slowing economy and the real potential for recession, there is no need to keep the discount rate a half-point above the fed funds rate.
Although the Fed cut the fed funds rate and the discount rate by a quarter point each, the market was strongly disappointed. Many investors were hoping for bolder action, perhaps a half-point cut in both rates. At the very least, investors were expecting more clarity from the statement. They exhibited their disappointment by selling stocks. Almost immediately, the Dow shed more than 200 points.
The Fed's comments make it clear that the probability of recession is much higher than many economists (including those at the Fed) had been forecasting. Yet with higher food prices, and with oil prices still flirting with the $90 per barrel level, the Fed knows it cannot focus solely on core inflation numbers anymore. The Fed knows that high food and energy prices will inevitably work their way into the core figures.
The Fed is truly between a rock and a hard place, officiating a game of tug-of-war between slowing growth and inflation. My view is that the Fed did the right thing by cutting the fed funds rate by just a quarter point. A steeper cut would have contributed to the dollar's weakness. However, I believe the Fed could have been a more aggressive with the discount rate. Given the slowing economy and the real potential for recession, there is no need to keep the discount rate a half-point above the fed funds rate.
Friday, December 07, 2007
Cruisn' For an Economic Bruisin'
Because I have been swamped, I haven't had an opportunity to post to my blog lately. I arrived home early this morning from the 12th Forbes Cruise for Investors, which went through the Panama Canal. A cruise, of course, is lots of fun. But it was also work for me and the other speakers. We started in Costa Rica on Nov. 30, went through the Canal, and stopped to visit St. Lucia. I disembarked in Antigua. The cruise is still proceeding on its was to Miami where it will end in a few days.
On my half of the cruise were Steve Forbes, Gary Shilling, Bob McTeer, Pete du Pont, and John Goodman. Rich Karlgaard served as the host. Gary, who has been right about the housing market all along, is still bearish on the economy and stocks. It was good to be around someone who is more bearish than myself. It made me feel like a good guy. The other speakers were more optimistic.
While on the ship, I learned about the Bush adminstration's plans to freeze certain subprime mortgage resets. Clearly, there are obvious moral hazard problems with doing something like this. It will be seen as a bailout of those who made imprudent decisions. Even so, I don't believe that even this measure will prevent housing prices from falling further. Freezing monthly payments may slow foreclosure rates modestly, but it won't solve the problem.
Given the continuing troubles in the housing market, I am posting below my comments from the December issue of the Forbes Growth Investor. This commentary was released to our subscribers several days ago:
It is not a pleasant topic, but the time has come to talk about recession. Although the probability of recession has obviously risen by a significant amount in recent months, most economists, including those at the Federal Reserve, are still betting the U.S. will be able to avoid one. Yet almost all economists, even those at the Fed, have lowered their projections for growth.
Minutes from the Fed’s Oct. 30-31 meeting reveal the new thinking. Most notably, the Fed is now projecting that economic growth will range from 1.6% to 2.6% for 2008, down from the 2.5% to 3% projection made just four months earlier. It is important to realize that the Fed is predicting anemic growth, but not recession. This, however, does not provide much comfort.
Not long ago, the so-called real estate experts claimed that housing prices never fall on a national basis. Those who said things were different this time were ridiculed. That argument is now settled. Not only have prices fallen; they are still plunging. The quarterly S&P/Case-Shiller U.S. National Home Price Index fell 1.7% sequentially in the third quarter, the biggest drop in its 21-year history. This index is down 4.5% year-over-year, and the rate of decrease has accelerated. This means that more than $11,000 of value has been erased from a home that was worth $250,000 a year ago. Of course, in some parts of the country, the story is much worse. In Tampa, you can now fetch just $222,250 for a house that was worth $250,000 a year ago.
Given losses of this magnitude, it is no surprise that foreclosures are up. Particularly hard hit have been homes financed with subprime adjustable-rate mortgages. The Fed estimates that monthly payments on more than two million such mortgages will be reset by the end of 2008. We will see many more foreclosures between now and then.
The real estate market is in a downward spiral. Falling property values contribute to foreclosures, and rising foreclosures contribute to falling property values. When a house is foreclosed, all the houses in that neighborhood lose value. In fact, Global Insight, an economic consultancy, recently estimated that property values will fall by $1.2 trillion in 2008. Foreclosures are being blamed for about half that amount.
In recent years, local governments have reaped a windfall in revenues by taxing all those inflated properties. That game will come to an end as homeowners demand that assessments be brought down to more realistic levels. Financial institutions are just starting to write down the values of their securitized subprime mortgage portfolios. Citigroup provides just one example of how devastating this can be for stockholders. The stock started the year at $55 per share. It is currently the biggest loser in the Dow Jones Industrial Average year-to-date.
Given the extent of the housing debacle, and a stock market that could potentially go much lower, why wouldn’t the economy go into recession? The Fed’s lowered growth projections are still too rosy. Perhaps the Fed is betting that the shrinking dollar will cause a huge boost in exports. We are certainly seeing some of that already. While it is true that a weak dollar can help prop up the economy in the short run, over the long run the U.S. is better off having a currency that everyone wants to hold. It's time for Treasury officials to do more than just give lip service to a strong dollar policy.
On my half of the cruise were Steve Forbes, Gary Shilling, Bob McTeer, Pete du Pont, and John Goodman. Rich Karlgaard served as the host. Gary, who has been right about the housing market all along, is still bearish on the economy and stocks. It was good to be around someone who is more bearish than myself. It made me feel like a good guy. The other speakers were more optimistic.
While on the ship, I learned about the Bush adminstration's plans to freeze certain subprime mortgage resets. Clearly, there are obvious moral hazard problems with doing something like this. It will be seen as a bailout of those who made imprudent decisions. Even so, I don't believe that even this measure will prevent housing prices from falling further. Freezing monthly payments may slow foreclosure rates modestly, but it won't solve the problem.
Given the continuing troubles in the housing market, I am posting below my comments from the December issue of the Forbes Growth Investor. This commentary was released to our subscribers several days ago:
It is not a pleasant topic, but the time has come to talk about recession. Although the probability of recession has obviously risen by a significant amount in recent months, most economists, including those at the Federal Reserve, are still betting the U.S. will be able to avoid one. Yet almost all economists, even those at the Fed, have lowered their projections for growth.
Minutes from the Fed’s Oct. 30-31 meeting reveal the new thinking. Most notably, the Fed is now projecting that economic growth will range from 1.6% to 2.6% for 2008, down from the 2.5% to 3% projection made just four months earlier. It is important to realize that the Fed is predicting anemic growth, but not recession. This, however, does not provide much comfort.
Not long ago, the so-called real estate experts claimed that housing prices never fall on a national basis. Those who said things were different this time were ridiculed. That argument is now settled. Not only have prices fallen; they are still plunging. The quarterly S&P/Case-Shiller U.S. National Home Price Index fell 1.7% sequentially in the third quarter, the biggest drop in its 21-year history. This index is down 4.5% year-over-year, and the rate of decrease has accelerated. This means that more than $11,000 of value has been erased from a home that was worth $250,000 a year ago. Of course, in some parts of the country, the story is much worse. In Tampa, you can now fetch just $222,250 for a house that was worth $250,000 a year ago.
Given losses of this magnitude, it is no surprise that foreclosures are up. Particularly hard hit have been homes financed with subprime adjustable-rate mortgages. The Fed estimates that monthly payments on more than two million such mortgages will be reset by the end of 2008. We will see many more foreclosures between now and then.
The real estate market is in a downward spiral. Falling property values contribute to foreclosures, and rising foreclosures contribute to falling property values. When a house is foreclosed, all the houses in that neighborhood lose value. In fact, Global Insight, an economic consultancy, recently estimated that property values will fall by $1.2 trillion in 2008. Foreclosures are being blamed for about half that amount.
In recent years, local governments have reaped a windfall in revenues by taxing all those inflated properties. That game will come to an end as homeowners demand that assessments be brought down to more realistic levels. Financial institutions are just starting to write down the values of their securitized subprime mortgage portfolios. Citigroup provides just one example of how devastating this can be for stockholders. The stock started the year at $55 per share. It is currently the biggest loser in the Dow Jones Industrial Average year-to-date.
Given the extent of the housing debacle, and a stock market that could potentially go much lower, why wouldn’t the economy go into recession? The Fed’s lowered growth projections are still too rosy. Perhaps the Fed is betting that the shrinking dollar will cause a huge boost in exports. We are certainly seeing some of that already. While it is true that a weak dollar can help prop up the economy in the short run, over the long run the U.S. is better off having a currency that everyone wants to hold. It's time for Treasury officials to do more than just give lip service to a strong dollar policy.
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