Bearish News

Arizona is on the brink. Their crisis is arguably the worst in the US. To put things in perspective, Arizona faces a budget shortfall of 30% in 2009. California, the poster-child for pauper states, has a shortfall of only 26%, according to this LA Times piece.

How will Arizona make up a 30% shortfall? They can’t count on the Federal Government to bail them out (yet, anyways). So public services will be slashed, as raising taxes to the extent required seems politically untenable.

If it gets bad enough, the Feds may eventually step in and bail out states as part of a larger decision to print our way out of the problem. But that seems at least a couple years away.

Housing Bubbles and Debt

The aftershocks of a huge housing bubble are still lingering in the Southwest, especially Arizona. According to housingwire.com:

Phoenix’s median paid price per square foot equaled April’s at $64. That number is down 46.3% from last year and has dropped 62.6% from its peak in June 2006 at $171, but according to the DataQuick report, May’s median prices represent a flattening trend.

No, that’s not a typo. Phoenix’s median price per square foot is down 62% from peak. This has had a crushing effect on consumer spending and state tax revenue.

I don’t know how this will all play out, but it’s not going to be pretty. Nevada and Florida are hot on CA and AZ’s tail. These are the first of a wave of state budget crises to come, as people slowly come to the realization that ever-increasing budgets don’t mesh with an economy in depression.

In his latest newsletter, Mr. Mauldin explains how the official unemployment numbers are flawed. The problem lies in adjustments which attempt to correct for jobs that aren’t tracked well by current methods:

Last month saw the number of unemployed rise by 345,000. What was not in the headline data was that 217,000 of those jobs were estimated from the “birth-death” ratio. The US economy creates new businesses that do not get counted in the data, so the BLS estimates what that number is, using previous data patterns. When the economy turns, it overestimates new jobs in recessions and underestimates them in recoveries. No conspiracy, it is just the best methodology we currently have.

But does anyone really think 200,000 jobs were created last month? The real number of lost jobs is worse than the headline. And next month the birth-death number will likely be over 200,000 again. Add another 100,000 or so to the headline number to get closer to reality.

Mauldin ends the newsletter by stomping out some Green Shoots. Yes, I hate this overused term as much as any self-respecting bear. But as long as Kudlow and his ilk keep using it, we bears need to provide counterarguments using the same silly terminology. Goldilocks Economy? Really?

On to Mauldin’s take:

Again, analysts talked about a turnaround because job losses were “just” 345,000. That is a higher number than any month in the 2001-02 recession, and larger than the month after 9/11. That is a green shoot? Yes, we will see the monthly unemployment numbers fall, but they are falling from historic highs.

While the rate of decline is decreasing (oh so slightly), it is only doing so because of drastic government actions. Taxpayers, foreigners, and future generations are footing the bill. Even if citizens realize what’s going on, digital-printing will likely continue. Entrenched powers view inflation as the least-evil outcome, and so do a majority of Americans. Those with lots of leveraged assets are praying for big inflation (REITs, for example).

If you don’t already subscribe to Thoughts from the Frontline, I highly recommend it. It’s free, and is the only way to get his entire post. The site only has excerpts from each letter.

Wall Street is using the May durable goods report as an excuse to rally. A tiny month-over-month increase of 1.8% from April pushed the S&P up as much as 1.6% before drifting lower today.

U.S. agencies like Labor and Commerce arguably have an interest in presenting the best scenario possible. So it’s understandable that they focus on month-over-month data in their press releases. The media follows suit (or is lazy), and highlights only the data they’re hand-fed.

Try to find a mainstream-media piece that mentions the YoY change in durable goods. Every single one I saw only mentioned the slight uptick in month-over-month numbers. So what about year-over-year data? It is available, you just have to dig deep into Commerce’s site to find it.

Once you see the year-over-year data, it’s obvious why they aren’t highlighting it:

May 2008 Shipments – 215,193
May 2009 Shipments – 169,855
Year over year decrease: 19%

May 2008 Orders – 213,150
May 2009 Orders -160,867
Year over year drop: 26.8%

Source – Commerce Dept Report (PDF)

Doesn’t exactly scream “recovery” to me. A temporary slowing in the crash, caused by drastic cash injections, seems the more likely culprit than anything sustainable.

The May report of the Equipment Leasing and Finance Corporation is another fly in the green shoot crowd’s ointment:

The Equipment Leasing and Finance Association’s monthly leasing and finance index fell by 41% compared to May 2008. The group blames tough credit conditions and a tightening of underwriting standards. [from the wsj]

Disclosure: No position in any stock or company mentioned

The Econ world is abuzz with debate over this Krugman piece from 2002. Some argue that he was advocating a housing bubble, and others steadfastly defend his positions (and the pillars of Keynesian Econ). I’ll post excerpts from experts from both sides of the argument. This is shaping up to be a poignant real-world showdown between Keynesian Economists (represented by Nobel-prize winning economist Paul Krugman) and those from the Austrian School (like Mark Thornton from Mises.org). Ding, ding, ding:

Arguing that Krugman Advocated a Bubble:

Mark Thorton over at Mises.org highlights 3 quotes from this time period (2001-02) to demonstrate that Krugman did, in fact, appear to push for re-flating the tech bubble. This is the most damning, to me:

That is, I’ve always believed that a speculative bubble need not lead to a recession, as long as interest rates are cut quickly enough to stimulate alternative investments. But I had to face the fact that speculative bubbles usually are followed by recessions. My excuse has been that this was because the policy makers moved too slowly — that central banks were typically too slow to cut interest rates in the face of a burst bubble, giving the downturn time to build up a lot of momentum. That was why I, like many others, was frustrated at the smallish cut at the last Federal Open Market Committee meeting: I was pretty sure that Alan Greenspan had the tools to prevent a disastrous recession, but worried that he might be getting behind the curve.

However, let’s give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed’s four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect.

Below is another strike against Krugman’s case (to the Austrian Econ crowd, at least). He made this comment in October 2001. There’s more, plus good commentary to be found at the original Mises.org piece:

In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package”

Seems like a pretty good argument that Krugman was pro-bubble back then. He was urging Greenspan to act “even faster”. He is advocating both low interest rates and financial stimus to get us out of the recession. He’s still banging the massive-stimuli war drum today. In the 2002 piece first mentioned, however, Krugman does appear to be hinting that Greenspan played a role in the tech-bubble.  How can he note this as a negative, while simultaneously pushing for interest-rate cuts and stimuli?

After reading the various arguments, it seems that Mr. Krugman was conflicted at the time. But he saw no good alternative to re-flating. Here is the opposing argument preferred by Paul Krugman himself (he linked to it in his rebuttal).

Arguing That Krugman Did Not Advocate a Housing Bubble:

Arnold King, Econ PHD from MIT, defends the 2002 piece saying:

1. Krugman was mainly expressing pessimism. He was not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur.

2. In the event, we had a housing bubble and we got out of the recession. To me, this raises the question of whether a distorted recovery is better than an undistorted recession. That question might be asked in the context of fiscal stimulus as well–at what point do the distortions of the stimulus outweigh getting out of a recession?

3. I personally do not think that Greenspan caused the housing bubble. I do not believe that monetary policy and short-term interest rates are as all-powerful as many economists do. What I was writing in August of 2002 was this.

4. Paul Krugman and Brad DeLong thought that Greenspan kept rates too high in 2002. This makes them poorly positioned to criticize Greenspan now for keeping rates too low. I am pretty sure that Brad is guilty of this hypocrisy. I believe that Paul is not.

Was Krugman just being sarcastic? I guess it’s possible. But it’s important to note that Kling does not believe monetary policy are as powerful as economists like Paul Krugman do, and doesn’t blame Greenspan for the tech-bubble. So counting him as a strong supporter of Krugman’s overall argument is a stretch. But Kling is an MIT guy, with a PHD in Econ. So he’s a lot more book-smart than I will ever be. But the Austrian argument makes more sense to me, in this case.

Krugman also defended himself in this rebuttal, “I was on the Grassy Knoll, Too” today in the NY Times. His explanation is short, and he links to the Kling piece:

Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. Update: A gracious, sensible explication from Arnold Kling.