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May 8, 2009
First, the miracle of loaves and fishes: economic optimism and immense deficits combined to blow up the Treasury market, but mortgage rates have held in the fours.
The 10-year T-note had traded deeply in the twos since Thanksgiving, never above 3.02%, and yesterday spiked to 3.36%. With mortgages in the high fours, the spread to the 10-year is as narrow as ever, half last summer’s, held only by the Fed’s promise to buy another trillion-worth of MBS in the remainder of this year.
If the economy really has entered a “vee” bottom to recovery, not even the Fed can hold mortgages here. However, that “vee” resides in the minds of a small but very loud minority; ask passersby on a sidewalk, and you’ll not find anybody in that group.
On the positive side, the sensible center has correctly concluded that the risk of a second Depression has faded, hence the withdrawal of panic bids from Treasurys.
The new data do show a moderation in economic contraction. Net of revisions, April payrolls shrank by 539,000 versus the 699,000 lost in March, and new claims for unemployment insurance slid 34,000 last week to 601,000, the lowest since January. However, this gentling is not bottom: the unemployment rose another .4% to 8.9%.
There is a great deal of stimulus in action. The Fed’s rate will stay at zero, which will tend to anchor long-term interest rates despite the Treasury deficit. Some energy-price decline will soon reverse (oil is pushing $60), but the overall decline is still in place. Tax credits and rebates began to arrive in envelopes two months ago, and federal money has offset lost revenue at states and cities, preventing deep cuts in spending. The Fed’s “quantitative easing” -- printing money to buy $1.55 trillion in MBS and government securities -- is providing credit that the financial markets cannot.
Negative forces are at least as great. The wealth effect running in reverse has demoralized to every diligent household. Honest economic estimates overseas give the lie to help from a global rebound: Germany now estimates a 6% GDP decline this year (twice that in the US in the last six months), and Eurozone officials expect no recovery until the second half of 2010.
Troubled housing markets here are not stabilizing -- although not sinking as Case-Shiller and brainless Zillow have it. Three housing roadblocks: strong households now knocked over by job loss; the millions of households trapped by big negative equity, who will gradually lose faith and discipline and walk; and mortgage credit so restrictive that it has completely offset the drop in rates. Purchase applications for loans still have not increased, and there will be no bottom until they do. Credit, credit, credit....
The stress tests deserve some congratulation. Getting inside the bankers’ kimonos to conduct a future cash-flow valuation of toxic assets -- good work. The dinky $75 billion in new capital required (versus $5 trillion in banking assets at the Big 19) is legitimate good news, although much compressed by banks’ ability to earn new capital with widest-ever spreads between cost of money and interest charged to borrowers.
However, the object of the exercise is credit. Perfesser Bernanke warned that recovery would abort if the “financial system relapsed.” Question, sir: how could anyone tell? The Fed’s own survey of bank credit terms in April showed “only” 40% of banks tightened terms -- and not one single bank eased. Oh-for-eight-thousand.
Consumer credit outstanding in March contracted by $11 billion, the sharpest pace since 1943 (not a big domestic-consumption year). Certainly, some of that paydown is voluntary and healthy, but more is circular: fear of an inability to borrow pushes households into no-consumption bunkers.
The principal clarity from the stress tests: hopes for restoration of banks as public utilities... shouldn’t have bothered. Business as usual. BoA’s Ken Lewis yesterday: “Our game plan is to get the government out of our bank as soon as possible.” I’m sure he didn’t mean the FDIC guarantee of deposits; he thinks that’s his, not ours.
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