1. Last Week's Employment Report Has Dampened RB's Spirit Some: The raw numbers from last week's unemployment report were bad enough, but started to look even worse to me over the weekend as I drilled down some. My first observations were to focus on the headline numbers including the number of unemployed, underemployed and discouraged workers. Job Losses Worse Than Expected That was bad enough. Some of the other statistics put an even darker glow on those numbers. One number in the report that I will briefly mention is the total hours worked, which fell to 33 hours in June. This is a historically low number, as you would suspect. If demand was picking up, you would naturally expect employers to be increasing the hours worked during a week before hiring new workers. The fact that the hours worked continue to fall in June is just a bad sign. Another statistic, pointed out by Alan Abelson in his column, is that yearly aggregate hours worked has declined to its lowest level since that statistic was added by the Labor Department in 1964.
On the bright side, the decline in non-farm payrolls is following a similar pattern to the early 1980s recession .
There is an uneven historical pattern of restoring positive growth in jobs after a steep decline in employment during a recession. The main point is that the worse is probably over. And the path to a return in job growth will not be a smooth line moving upward, more like two steps up and then one back. The job losses for June were well off the peak in January 2009 of 741 thousand. And, at the end of the process in the early 1980s was the start of a long term secular bull market in stocks.
Another factor to consider is that the BLS data may be way off. Many of the problems with its data collection and assumptions are discussed in this trimtabs report.
Paul Krugman argued in a recent column that this unemployment report proved that another stimulus program is needed on top of the 787 billion "stimulus" bill passed earlier in the year. It is sad to conclude that the Chinese communists can do a far better job with their stimulus plan, which is a real stimulus program, than the Democratic Congress and Obama. China's 600 billion plan was passed after ours, and immediately resulted in spending on infrastructure projects. I heard an analyst yesterday say that about 10% of the 787 billion has been spent by the U.S. whereas the Chinese have already spent two-thirds. The money spent in the U.S. plan has predominantly been transfer payments, such as extending unemployment insurance and other benefits for the poor, rather than anything remotely resembling a job creation project. So, it is hard to see how Congress can get it right by having a second go at a real stimulus plan with even more borrowed money.
And, notwithstanding the waste, the spending that will create some jobs will soon kick into gear, and accelerate into next year. I would be concerned that even more stimulus, on top of what is already in the system, would likely be more dangerous than helpful, adding to the potential inflation fire later next year.
2. Equity Preferred Stocks: A Creation of a Mad Scientist with a Sadistic Streak: I have mentioned on several occasions that I own equity preferred stocks, and treat them as a disfavored asset class. This particular security strips the favorable aspects of bonds and common stock, keeps the unfavorable parts, combines what is left into an unnatural creation and then a PR department is hired to come up with a name, "preferred", that is more of a sales job than anything else. The equity preferred shares are technically equity but they lack the common shares equity interest in the business, which is the main source of the common stock's allure. Yet, the preferred stock keeps the common's perpetual character, along with the liberal rights of the company to eliminate the dividends for both the common and preferred shareholder. The only preference the preferred has is the right to receive a full dividend before the common shareholder receives any dividend. The preferred dividend is all that the preferred shareholder has of value.
So, the equity preferred is about 25% common, with the undesirable parts, and about 75% bond, with few of the benefits of a bond. The equity preferred is more like a bond than a stock. Yet, the equity preferred shares do not have the protections afforded to a bondholder. Other than REITs and a few other equity preferred issues, most of equity preferred securities do not have cumulative dividends and have no time restriction limiting the period of non-payment. A junior bond will allow a deferral, subject to accumulation, for up to five years, usually (not always) with interest payable on the deferred payment. Once a non-cumulative equity preferred dividend is eliminated, it is just gone and can stay gone for as long as the company desires, provided no dividend is paid on a junior security. Even for those equity preferred issues that are cumulative, there is no time period limiting the period of deferral. And unlike a bond, almost all equity preferred issues have no maturity dates. They are perpetual, an always undesirable characteristic.
In short equity preferred stocks are an abomination, a Frankenstein creation. This does not mean that I will avoid them entirely. Since I bought the equity preferred floating rate preferred stocks at prices that provide me with both deflation and inflation protection, I am inclined to give them more leeway by holding them for an extended period of time, simply because they fill an important niche in my asset allocation. I am also inclined to hold most of the cumulative equity preferred stocks bought at such low prices that the yields are anywhere from 25 to 75% annually. My positions in those are however small. The yield at my cost provides a large cushion and incentive to hold some of them over the long term which outweighs the risks and undesirable characteristics associated with these securities. Still, I am in a trading mode for securities for these securities to reduce their inherent risks.
I have also bought small positions in REIT cumulative preferred stocks during this bear market, and traded many of those positions after pops in the share price. From my perspective those stocks were preferable to the common shares, which I normally would own in a bull market for their yields, since the REITs were reducing and/or eliminating their common dividends over the past year, whereas most of them with a few exceptions continued to pay the full cash dividend on their preferred stock, as required when the common shareholders received any dividend payment, no matter how small.
3. How Many Foreclosures Are Due Solely to Borrowers Owing More than the Value of the Home?: After the initial waves of foreclosures connected with subprime and Alt-A mortgages, it would not be surprising to learn that "prime" borrowers are defaulting now in an effort to escape their erroneous decisions to buy at the height of the housing bubble, financing most if not all of their purchase. With the home value plummeting well below the mortgage, they just walk away since there was never any skin in the deal. An opinion piece in the WSJ over the weekend, written by Professor Stan Leibowitz, suggested that a substantial number of the defaults are from prime borrowers, who could pay the mortgage but choose not to do so since they are under water.
While the statistics do show that prime loans account for a bare majority of foreclosures, I do not know if he is interpreting the data correctly. If it is true it could be stopped by the mortgage lenders making it known that they would vigorously pursue deficiency judgments against such borrowers. For some reason, many believe that turning in the keys to the house to the lender ends their problem. The mortgage is just the security for the loan evidenced by a note signed by the borrower(s). After the lender seizes that security and sells it for a loss, there will frequently be a balance due on the loan, and the borrower is still liable for that deficiency. In many cases, it would be more trouble than it is worth to pursue a deficiency judgment against a borrowers who never had assets. That would not be the case for borrowers with a significant net worth. I can only speak on this issue as it pertains to Tennessee. But, while I do not have a mortgage, I know that a lender would pursue me for a deficiency judgment if I defaulted on a note secured by a mortgage. So, I am not sure this kind of default, by a borrower capable of making payments but choosing not to, is as big as Professor Liebowitz makes it out to be. If he is right, it would seem to me that it could be stop by vigorous enforcement of deficiency judgments. Moreover, if he is more correct than not, it is not a government problem by any stretch but a problem in the lenders failing to enforce their legal rights against defaulting borrowers.
While the statistics do show that prime loans account for a bare majority of foreclosures, I do not know if he is interpreting the data correctly. If it is true it could be stopped by the mortgage lenders making it known that they would vigorously pursue deficiency judgments against such borrowers. For some reason, many believe that turning in the keys to the house to the lender ends their problem. The mortgage is just the security for the loan evidenced by a note signed by the borrower(s). After the lender seizes that security and sells it for a loss, there will frequently be a balance due on the loan, and the borrower is still liable for that deficiency. In many cases, it would be more trouble than it is worth to pursue a deficiency judgment against a borrowers who never had assets. That would not be the case for borrowers with a significant net worth. I can only speak on this issue as it pertains to Tennessee. But, while I do not have a mortgage, I know that a lender would pursue me for a deficiency judgment if I defaulted on a note secured by a mortgage. So, I am not sure this kind of default, by a borrower capable of making payments but choosing not to, is as big as Professor Liebowitz makes it out to be. If he is right, it would seem to me that it could be stop by vigorous enforcement of deficiency judgments. Moreover, if he is more correct than not, it is not a government problem by any stretch but a problem in the lenders failing to enforce their legal rights against defaulting borrowers.
About 1 in 5 homeowners owe more on their mortgage than the current value of the home.
One of the well known behavior economist, Richard Thaler, wrote a column in the NYT that modern economic theory assumes that everyone is smart, logical and constantly making rational decisions, a real life version of Mr. Spock, when the reality is closer to Homer Simpson.
Not just one Mr. Spock, but billions of Mr. Spocks. I always thought that basic assumption of modern economic thought was just a hoot. Thaler was arguing that mortgage products need to be made simpler, but there is no need to go back to the plain vanilla 30 year mortgage with 20% down. He says that would hurt innovation. Well, it was "innovation" that got us into this pickle.
4. Skin in the Game and the Entitlement Society: One thing that needs to be learned is the prospective homebuyer has to have skin in the game. If we had had a requirement of twenty per cent down, the current financial meltdown would never have occurred, housing prices would have never gone parabolic in several states where most of the foreclosures are now concentrated. Easy credit would not have distorted price to such an extent that less than 20% of the families in many communities could afford a median price house at the height of the bubble in prices. Sure, those who could not afford a house would still be living in an apartment or with relatives, until they could afford to make the down payment and the monthly mortgage payments without the teaser rate or other financial abominations. So, if what happened in 2002 to 2007 with the mortgage products is called "innovation", then maybe we need less, not more, financial engineering in the future. While 20% might be too steep a requirement for a down payment, I would think that 10%, at a minimum, would make a lot of sense provided there is a real desire to avoid a similar problem in the future.
Maybe our society needs to relearn that you can not have everything that you want when you want it. A move away from the notion of an entitlement society, where everyone is entitled to receive what they want because they want it, may be the most productive suggestion for the future.
I remember stories my mother and father told me. When they were married in 1941, and they are still married today, they had nothing. And I mean nothing, not even $5. My father had to borrow the money to pay the preacher and to buy a two dollar wedding ring. Within a month after their marriage, and a honeymoon trip to the the Nashville airport to drink a coke, WW II started and my father then served during that conflict. After WWII, and a few jobs, there was enough money saved from both my parents working jobs to build a small house in the Sylvan Park neighborhood in Nashville, for around $900. It helped that my dad knew how to use a hammer. In a couple of years, my dad built another nicer home and sold the first for $3200. And so on. Maybe we need to get back to that some. The innovations in mortgage finance during the past decade did not do the recipients of easy credit any good. And it left our financial system in shambles. I am not sure that the powers that be have learned any real lessons from what has just happened.
After listening to the rambling press conference that Sarah gave, I started to wonder whether she was mentally balanced. It was just incoherent gibberish to me. I thought that Maureen Dowd had the same take on it.
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