PeppercomBlog

Does crying wolf create a wolf?

Posted by Milos Sugovic

Pointing fingers is a fun and popular game during an economic slowdown.  The media has been screaming recession for months now, and they might get it.

The media influences expectations of economic agents, and expectations determine behavior, which paves the course of an economic downturn. With all the slump talk, it’s no surprise nine out of 10 respondents to the Reuters/University of Michigan survey on consumer sentiment say the economy is in a recession. Even less surprising is the stagnating consumer spending and negative growth in industrial production, a proxy variable for investment.

If consumers anticipate a recession, they expect wages to drop in the coming months and will reduce current spending. The drop in consumption means lower markup, lower industrial production, and lower wages. So not only does expecting an outcome create it, there’s negative-feedback and a multiplier effect.

The moral: Expectations determine current and future outcomes, so be careful when tinkering with them.

The independent National Bureau of Economic Research (NBER) is the official referee that identifies the beginning and end of a recession, and a decision could set the buzz and expectations on course. But that decision can take anywhere from six to 18 months and is desired sooner rather than later.

In the meantime, we’ll just have to rely on antsy media speculation.

This Industry is a Teardown Job

Posted by Gene Colter

As any sentient adult knows, real-estate brokers are way down the moral heirarchy ladder, near abusers and certain types of attorneys but maybe just a smidgen above mortgage brokers.

A Justice Department settlement with the National Association of Realtors -- don't call them realtors with a small "r" -- lets this industry off the hook for years of anticompetitve behavior and does nothing to dispel suspicions about the men and women who "help" you to get the best deal for home.

Under terms of the settlement, Realtors cannot discriminate against discount real-estate brokers who might want to put Realtor housing inventory up on their sites. Translation: The Establishment has to let the discounters show everyone's stuff.

But Realtors didn't have to admit any wrongdoing and will not pay a fine.

For years, home buyers/sellers have reported that the big brokers have tried to prevent them from working with discounters. This deal may make things better on the Web (though don't count on full compliance), but bad practices will continue. Some years ago when this blogger opted to list his New York apartment with a discount broker on the belief that the place would sell itself (it was the right time), an establishment broker told me point blank she'd do all that she could to make sure no one came to see the place.

Here is a market where the advent of technology and other competitors has yet to drive down commissons, which have held or even risen a little over the past few years. The Wall Street Journal cites industry executives as saying the Justice settlement won't have much influence overall on commissions.

It's a free market. Just not for the American Dream.

Pawn-Mart Economy

Posted by Milos Sugovic

 A Memorial Day Weekend yard sale was always about spring cleaning and bringing family and friends together. This time it was about making ends meet.

Faced with the toughest times since the early 90s, Americans are unloading precious belongings at upsetting rates to pay for bills as debt and commodity prices rise. Conversely, second-hand good prices dropped 25 percent to 35 percent since last year and part of that is due to an increase in supply.

The trend has been developing for months. Internet sites like Craigslist and AuctionPal.com are seeing higher traffic and sales. Craigslist for-sale listings increased by 70 percent since July, with the fastest-growing for-sale goods tied to gas, while AuctionPal.com sales more than doubled in the last couple of months. On the flip-side, the Salvation Army saw donations drop 20 percent from January to March.

The boom in offline and virtual garage sales suggests the economic downturn is gaining momentum. Evaporating consumer confidence is drying up consumer spending, which drives economic growth. Relying on garage-sale cash is unsustainable, and the desperate consumers know it, while the fortunate ones are waiting for evidence that the economy’s worst troubles are over.

In the meantime, retailers like Wal-Mart will have to adopt the pawn-shop model and turn the U.S. economy into one large garage sale.

Financing With the Stars

Posted by Matt Purdue

Over this weekend, “Star Trek: Deep Space Nine” aficionados and others in the plastic-pocket-protector brigade will be expoxied to their web browsers. They’ll be waiting for news that NASA’s latest baby, the Phoenix Mars Lander, has survived a fiery plunge through the Martian atmosphere and landed safely on the Red Planet’s surface. Phoenix’s mission, in a nutshell, is to spend about three months probing the Martian soil for signs that the planet once held liquid water. The project is running $420 million.

NASA, can I have my money back now? We’re already spending about $10,000 roughly every four seconds on the war in Iraq, and the Congressional Budget Office’s blog projects a 2008 federal deficit of nearly $400 billion. (Let’s not even get started on the money the CBO spends on a blog.)

According to the New York Times, the majority of spacecraft sent to Mars have failed. So there’s a better-than-even chance we’ll never hear from Phoenix again. And if we do, then what? I admit I’m not a geophysicist, but so what if there’s water on Mars? We already know ice exists all over the Red Planet. And NASA has time and again found evidence of water there. Proponents of these expensive, risky projects suggest that where there’s liquid water, there could be life. Again, so what? It’s not going to change our perception much. A large majority of Americans already believes life may exist on other planets. Finding microbes on Mars won’t prompt the Sunnis and Shiites to suddenly throw down their AK-47s and start harmonizing “Kumbaya.”

So how about we stop spending money on harebrained schemes to find water on other planets until we figure out how to find more on ours. I’m constantly amazed at NASA”s seemingly impenetrable public reputation. No matter how many failures they suffer, or how much money they waste on an unfinished space station that they have already made plans to abandon, American taxpayers continue to ignore their profligacy. All PR professionals should have it so easy.

All Clear in Credit Markets?

Posted by Gene Colter

Several recent, successful bond auctions have got pundits and press prognosticating that the credit cycle may be through the bottom and headed for better days. Heck, even a batch of bonds created from subprime auto loans moved into the market successfully Tuesday.

As m’colleague Matt Purdue blogged here last week, journalists sometimes take the latest data bites and run hard, looking for a headline-worthy trend where no pattern may yet exist. (Know who else is guilty of such heedless momentum mongering? Stock investors.)

But is this really the turn? None other than the world’s most important central bank may share the belief that it is: Federal Reserve Vice Chairman Donald Kohn, speaking to a conference in New Orleans, said monetary policy is “appropriately calibrated” to promote employment without sparking inflation. Translation: No more interest-rate cuts to lubricate the credit markets.

It’s also anecdotally obvious that this recession, if we are indeed in the midst of an economic downturn, is shallow, creating an environment where consenting lenders and borrowers can still get together if they choose to do so.

But while the supply of credit may be rising, let’s at least give some consideration to what’s driving demand, and what that means for the overall state of financial markets and the economy.

Large fixed-income investors – funds, companies, pensions and the like – have built up cash. To use the market’s lingo, that cash has to be put to work. In fact, many state and local pensions are required by law to invest the cash on hand rather than sit on it.

OK, so there’s demand from professional investors. What about individuals? Are housing markets soaring again? Are commercial banks inundated with loan requests? Has the U.S. consumer – always a fairly happy-to-spend type - taken it up a notch?

So an admittedly casual observation here might be that any boost in credit markets is due at least in part to demand from big investors who have little choice but t o buy. That’s not a bad thing: Demand from institutions is legitimate and can create a virtuous cycle of demand (and supply) throughout the rest of the economy.

But that demand doesn’t necessarily sound the all-clear. Or at least it doesn’t if it’s comprised of just a few successful bond deals.

Nor does it mean that the infrastructural risks of the credit markets have been properly addressed. One such is securitization, the business of creating bonds from loans and other payments streams. As long as Wall Street banks can hustle loans off their balance sheets into securitization vehicles – and thus sidestep the risk of those loans until they really blow up – it’s entirely possible and even probable that another market event will come along and slam credit markets again.

Here’s hoping the credit markets truly are on the mend. But also let’s insist that bankers, rating agencies, regulators and sophisticated investors work together to ensure better quality control throughout the bond-creation-purchase chain.

Will the U.S. Flow into a Liquidity Trap?

Posted by Milos Sugovic

Repeated gasps of air in the midst of an incoming recession flood come from interest rate cuts by the Fed. But how long before the U.S. economy enters a liquidity trap a la Japan?

Each cut is intended to kick-start growth. With investment and consumption inversely related to interest rates, monetary policy helps jerk output toward the positive direction. So every time we hear of the Fed cutting rates, should we celebrate? Not quite.

Ask the Bank of Japan about its experience during the 1990s. The government and central bank double-teamed deflationary pressure. Nominal interest rates were cut repeatedly and the government resorted to Keynesian spending, widening the budget deficit. But with a whopping deficit, zero real interest rates and imported inflation, Japan became a textbook example of a liquidity trap. Sound familiar?

The U.S. is exhibiting similar early signs: cutting interest rates, importing inflation, and running an elephant budget deficit that's not even news anymore.

So how close is the U.S. to Japan's situation? Paul Krugman says, "Pretty close." 

There is one important caveat, however: Japan and the U.S. are on opposite ends of the spectrum relative to the golden rule savings rate. Encouraging spending in the U.S. is not as challenging, and that might be keeping the economy afloat.

At the end of the day, there's a limit to monetary policy, and the Fed's surely approaching it. The government, on the other hand, is going to need some creative solutions.

Perhaps they should look for ideas in the Clinton-Greenspan bag of policies.

Recession? What recession?

Posted by Matt Purdue

Any day now you’ll begin to hear the talk around the water cooler and see the ticker crawl on CNN asking “What recession?” The zeitgeist is sniffing around the notion that we never slipped into a true recession and aren’t about to. This idea’s not necessarily new. In March, economists at UCLA’s Anderson School were telling us they were “confident that the national economy was not in a recession through January 2008.” They then forecast “weak growth but no official recession in 2008.”

As we all should know, a recession is defined as two consecutive quarters of negative GDP growth. But recently the U.S. economy has been growing, albeit slowly. GDP grew by just 0.6 percent in the fourth quarter of 2007 and the first quarter of 2008. It’s funny to see how journalists reacted to these numbers. When the 1Q2007 statistics were released, reporters said the economy “nearly ground to a halt”  and told us that worries were mounting “that the country is on the verge of a recession.” Then, after the 1Q2008 numbers hit the street, journos described the situation in their lead paragraphs as “better-than-expected.”

Reading the business press today is like watching an Arena Football League game, with all the back-and-forth action and carnival-game scoring. Fact is that these journalists injected a lot of fear into the economy in recent months. Now they’re pointing to good news: increases in government spending, consumer spending, business inventories and residential housing starts. Record tax collections made the news too. But somewhere between us nearly grinding to a halt and better-than-expected growth, well over 300,000 Americans lost their jobs.

You can see what I’m getting at: The media drives the confidence bus. It’s never going to be possible to measure how many executives read dire predictions for the U.S. economy and then decided to cut headcount--even as they were beefing up inventory and building new apartment houses. But this does remind all of us to take even the most trusted news with a grain of salt and continue to educate ourselves so that we can make intelligent decisions.

Make a Wish Upon a Price

Posted by Milos Sugovic

With the last riff the singer screeches, “Grab our new album at the back or make a donation.” Or! Is pay-as-you-wish becoming the new standard?

Radiohead and Jane Siberry turned to the honor system, and others are jumping on the bandwagon with SongSlide, a website that lets musicians sell music to buyers according to their willingness to pay. But other businesses are turning to this model as well.

Kitchener’s City Café Bakery and Kirkland's Terra Bite Lounge have no prices listed on the menu. Customers pay as much as they want, or don’t want. Sounds outrageous, but these businesses are making a profit. How come?

The marginal cost of producing an additional unit is virtually zero. The cost of one additional song downloaded, or an additional cup of tea consumed, is miniscule, and a donation greater than zero equals profit.

More importantly, a pay-as-you-wish system maps price to each consumer’s willingness and ability to pay, which captures, in economic terms, consumer surplus. Virtually all suppliers would love to price discriminate, and many do, ranging from Apple to airlines.

So will a morally based pricing scheme become the new paradigm for giants experiencing economies of scale? We all wish.

Many forces are at play, including free-riding, positive (but diminishing) marginal costs, R&D costs, property rights, sales tax, arbitrage…you name it, it applies. But business models are industry specific, and it isn’t surprising to see pay-as-you-wish flourish in commerce situations where many traditional market forces are bypassed.

Keep that in mind the next time you pay the “suggested admission fee” at a museum.

Train Etiquette in Vain

Posted by Gene Colter

Everything you needed to know about commuting via public transportation you learned in kindergarten. How to assemble in an orderly fashion, for instance. And you’ve been forgetting or ignoring that simple, sage counsel ever since.

I should stop here to note that my boss, corporate co-founder and blogging veteran Steve Cody is the resident expert on All Things Bad about New Jersey Transit. By way of apology for venturing into his patch I will note that I am not about to decry NJT. Instead, I will wail on the only thing more hellish than a Jersey train: a Jersey train passenger.

To explain: Recently I did something so simple and yet so productive: When a fellow passenger approached my row of seating I scooted in to let that person sit down. The whole transaction – “May I sit here?” “Of course. Let me move.” – took just a few seconds. Now let us contrast this with the average seating scenario on a crowded midtown NYC train. 

Passenger A is sitting at the end of the row near the aisle. Passenger B approaches and asks to sit. Passenger A gathers up laptop, papers, personal radio, food, beverage, coat, bag, small arms (OK, maybe not that last one) and stumbles into the aisle. Passenger B falls into the inner part of the row near the window, and passenger A then collapses back into his seat, and both spend the next four minutes trying to get situated. Meanwhile, 40 other passengers have backed up in the aisle and out the door onto the platform waiting for this awkward dance to finish. It gets repeated over a dozen times at busy stops, which is why the midtown NYC train arrives on time about as often as Britney Spears arrives clean and sober for a photo shoot.

At church/synagogue/mosque you scoot in when another worshiper arrives. At the bar you scoot down a seat when a couple comes in and wants to perch and partake together. But on the train you insist on getting up and making the other person move to the inside, as if the aisle seat on an NJT train were somehow the equivalent of a first-class sleeping booth on Singapore Air.

This train, it seems, is making all stops for idiots.

Next Domino in the Subprime Mess

Posted by Matt Purdue

Not that I ever like to see anyone lose a job (schadenfreude is just not my bag), but the resignation of Moody’s president and COO Brian Clarkson last week may sound a tiny ring of truth amid all the clamor over the U.S. mortgage investment collapse.

Clarkson, 52, led Moody’s aggressive move into the business of analyzing and rating the creditworthiness of mortgage-backed securities. Based in large part on the ratings Moody’s and the two other major agencies gave to these complex vehicles, investors and banks around the world poured money into them in recent years. Today, as we all know, many of those investments are near worthless.

To its credit, at least Moody’s was somewhat straightforward about Clarkson’s departure. CEO Ramond McDaniel wrote to employees that the credit-market implosion “created scrutiny and criticism from numerous external sources about various aspects of our business. While much of the criticism…is unfounded, Brian believes that the time is right for new leadership….”

The time is right for new leadership, indeed. We need leaders who will explain to us how the ratings agencies missed the mark on complicated securities, particularly as the other shoe is about the drop in the mortgage mess. Last week, leading mortgage bankers and the Treasury Department met to discuss how to handle the problem of second-lien housing defaults.

Second-lien loans are more commonly known as second mortgages. Homeowners across America borrowed billions of dollars against their (real or imagined) home equity over the past few years. Some paid off high-interest credit cards; others started home improvement projects. Speculators took out second mortgages on their primary homes to buy second and third “investment properties.” Of course, the mortgage lenders and investment banks bundled these second mortgages and sold them as securities, just as they did with home loans.

Now, the powers-that-be realize that borrowers are not only walking away from their home loans, but also from their second mortgages. This shouldn’t surprise anyone, but apparently the feds and the banks now need to figure out how to get everyone out of this mess. Standard & Poor’s recently stopped rating mortgage-backed securities (MBS) propped up by second mortgages, citing “anomalous and unprecedented” behavior by borrowers. Yep, walking away from a home with not one but two unpaid mortgages would seem fairly anomalous, but that doesn’t fix the fact that the horse is already out of the barn. In 2007, as the housing crisis peaked, S&P rated $18 billion worth of these MBSs.

These investments were always a little shaky; many of them were rated Alt-A to begin with, a step above subprime. But get this: Half of the subprime home loans made in 2006 also had a second-lien loan attached to them. Yes, lenders were not only making home loans to millions of Americans with poor credit, but they also were making simultaneous second-mortgage loans to them. And then these loans were being bundled, rated by folks like Moody’s and sold to investors as securities. The ratings agencies have recently been busy downgrading tens of billions of dollars worth of these investments. Now they tell us.