Commodity stocks led the decline as investors worry a sustained credit freeze will reverberate throughout the global economy. Basic material shares declined 3.19% and oil stocks slipped 2.86%. Not far behind were industrial shares, down 2.51%. Health-care shares were the relative winners, down just 0.45%.
Market Activity for September 23 2008
Back to this distressed-credit facility, Bernanke and Paulson were on the Hill yesterday attempting to persuade Congress that this plan – now known as the Troubled Asset Relief Program (TARP), I can see the play on words already from those of whom oppose this idea – needs to get done, but they received the cold shoulder from members of the Senate who have suddenly found reason to protect the taxpayer.This is laughable to me. These are the same people that seemed all to eager to advance a $170 billion rebate check scheme disguised as a “stimulus” package, which delivered no help whatsoever outside of a two month pop in consumer spending. Members of Congress have also talked about another “stimulus” package that would supposedly cost another $150 billion. So right there you’re looking at $320 billion. And I won’t even get into a welfare system that these individuals hold dear -- a tragedy that costs trillions and has destroyed inner city families, communities and schools. But we are supposed to believe that these people are now the protector of the taxpayer.
Again, everyone seems fixated on this $750 billion figure. What? Are all of these troubled loans worthless? Serious delinquent subprime mortgage loans now total 18%. Assume the number rises to 30% -- heck the government is going to buy these assets at a discount anyway (somewhere between distressed prices and a held-to-maturity value, at least based on the plan that has been proposed).
Personally, I doubt they’ll lose much money at all over the several years they take to sell off these loans. But assume they lose half. Ok, that’s $375 billion, or 2.5% of GDP. In my view, the cost to the economy will be far far greater than that if the credit markets remain frozen -- current accounting rules result in a write-down loop that has banks suddenly unwilling to lend as they hoard cash for fear their capital adequacy ratios will fall.
The major downside is the longer this gets dragged out the more it presents an opportunity for politicians to stuff this plan with all kinds of social projects that have nothing to do with freeing up the credit markets and in fact create impediments to the capital markets
Enough of that for now, there is some good news this morning as Warren Buffet is taking a $5 billion stake in Goldman Sachs via perpetual preferred shares that carry a 10% dividend yield. The deal includes warrants that give him the right to buy another $5 billion worth of stock with a strike price of $115 per share – exercisable any time for five years (the stock currently trades at $130).
It is being reported that Buffet really likes Goldman. Who wouldn’t with these terms? This is something the average investor could only dream off. In any event, it has juiced stock-index futures so it may provide some relief after a two-day beating.
In other news, House Democrats have conceded defeat and will allow the offshore drilling ban to expire – the majority had been blocking even a vote on the issue, but constituents have beat them into submission as gasoline prices remain elevated. Now it goes to the Senate; passage would be huge for energy prices over time and significant from a geopolitical standpoint as it will send a message we have finally begun to get serious.
On the economic front, the Office of Federal Housing Enterprise Oversight (OFHEO) released their latest index on home prices, which showed a 0.6% decline in July. Home prices have slipped 5.4% over the past 12 months, according to this measure.
The hardest hit areas were the Pacific (down 1.0% in July), New England (down 1.0%) and Mid-Atlantic (down 1.1%) regions. Interestingly, the South Atlantic (largely Florida) – one of the hardest hit areas -- has seen prices behave quite well over the past two months. That region saw prices fall just 0.4% in July, which followed a 0.2% increase in June. The Mountain region is also looking pretty good as the larger price declines that have taken place over the last couple of years may have run course – too early to tell, but the trend is looking much better.
Overall, this look at housing is the most broad of all the indicators and is why we believe it gives a more accurate picture than does the S&P Case/Shiller Home Price Index, which has prices down 16% year-over-year (this is the index that gets the headlines). Case/Shiller covers the 20 largest metro areas, half of which have been the hardest hit. While the OFHEO index has its flaws – it fails to capture the higher-end housing market – it does offer a much more diversified look.
Bottom line, when you factor in both of these reports along with the new and existing home sales data, it offers a pretty good feel of what has occurred nationally. Weight all of these indexes equally and prices have declined roughly 8.5% from a national perspective over the past year.
In a separate report, the Richmond Fed Index (manufacturing activity) showed the east coast market continues to see weak factory orders persist as the September reading came in at minus 18. This is quite different from the Chicago region (the largest manufacturing base) and ISM survey (the broadest look) which remains pretty upbeat considering all that is going on.
There was nothing in the Richmond survey to provide any hope over the short term. As most of you know, we focus on the sub-indices within these surveys to offer some insight on how the sector will behave over the next six months. In the case of Richmond, the shipments, new orders and back log indices all posted ugly readings. Even the prices paid index, which has declined a bit among the other factory surveys, remained elevated – actually increased a bit from the August reading.
The charts below show how depressed manufacturing activity is in the Richmond Federal Reserve district compared to the national view. (Remember though, zero marks the line of demarcation between expansion/contraction for the Richmond survey and 50 is the line of demarcation for ISM).
Correction:
Yesterday I stated the following when touching on monetary policy mistakes:
Why did they leave fed funds so low for so long? Simply because the unemployment rate remained below where Greenspan and Co. wanted it. That’s the reason. They ignored that this Phillips Curve mentality has proven feckless, and at times harmful, for 30 years now and continued instead to grasp it no matter how precarious the hold.
I meant to say because the unemployment rate remained above where Greenspan & Co wanted it.
The overall point was that the Fed ignored the reality the economy was booming and inflation was running at a rate that vastly exceeded their fed funds target – real fed funds was negative. This subsidizing of debt encouraged the financial sector to increase leverage and a large percentage of home buyers to move to adjustable rate mortgages – two factors that have caused the current situation to become quite unpleasant.
Have a great day!
Brent Vondera, Senior Analyst
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