Economic Commentary

As a bond trader for a major insurance company, I receive tons of economic commentaries from banks on the street on daily basis. I'd like to share some informative stuff you guys might find interesting going forward.



David Rosenberg

Merrill Lynch Chief North American Economist



In need of a new bank - a jobs bank



"Internals of the report were as weak as the headline

The internals of the report, like its recent predecessors, were at least at weak as

the headline. The benchmark revisions were mixed but December was taken

down to -577,000 from -524,000 respectively. With all the revisions and the

current estimate for January, the economy has now shed 2.5 million jobs in just

the past four months. Compare that to the 1.8 million average decline we

typically see through the entire 10-month recessions of the past. We exceeded

that in just the past four months alone!

Job losses very broad based

The diffusion index is down to an all-time low of 25.3%, which means that for

every company adding to their payrolls, three are in cutback mode. The

comparable figure for manufacturing, by the way, is down to an all-time low of

7%, which means that businesses in the sector that are cutting jobs are

outnumbering the ones adding to payrolls by a 14-to-1 ratio. In the last recession,

the low in this factory diffusion index was 10 and in the early 1990s the trough

was 17 ? just to put the current 7 figure into perspective.

Household survey showed a record 1.24 million job plunge

The companion Household survey was even worse than the payroll report, if that

is possible ? showing a record 1.24 million job plunge. The data go back to 1950,

and we have never seen something like that before; even in per cent terms

(-0.9%), there has not been a decline of this magnitude in over 40 years. And

almost all of the January plunge was in full-time employment ? down an eyepopping

1.1 million, taking the cumulative loss since the recession began in late

2007 to 6.1 million, which is unprecedented. In a ?normal? recession, we lose a

little more than 2-1/2 million full-time positions. We have already lost nearly three

times that amount and counting.

Unemployment rate for full-time workers spiked to 8%

And, it is full-time employment that ultimately drives income, confidence and

spending. While the unemployment rate jumped 0.4 percentage points for the

second month in a row to 7.6%, the highest since September 1992, the rate for

full-time workers spiked from 7.5% to 8%, which was the highest since January

1984."

<strong>Home prices still far from stabilizing</strong>

It stands to reason before we can expect to see the chain events reverse course,

we first must see house prices begin to stabilize. Unfortunately, at a record 12.9

months supply of unsold new housing inventory, we are nowhere near the eightmonth

level we would like to see before calling an end to the residential real

estate deflation cycle. Between now and the time that we attain that eight-month

supply threshold, there is at least a 15% downside potential to nationwide home

prices, with a adverse implications for bank capital not to mention the

government?s best efforts to modify delinquent mortgage loans.



<strong>Unprecedented loss in household wealth</strong>

As it now stands, the bear market in residential real estate and equities has

resulted in the household sector losing $13 trillion of net worth, which is a 20%

plunge and ongoing. Not since the 1930s has there been such a gaping hole

created in the household balance sheet. And insofar as households realize that

unlike prior recessions, this loss is going to be permanent and not temporary, the

impact is going to be at least a 3% decline in consumer spending annually in

each of the next three years as households are forced to put more of their

paycheck into the coffee can in order to make up for this monumental loss of

wealth.

<em>"A society that promotes lies (make believe computer based asset valuation by fiduciaries) as truth (real value) for the profit of the few is NOT a society, but rather a group of animals destined for their own immediate destruction."</em>



- James Sinclair on the proposed change in mark to market accounting rules to mark to ...

<span style="font-size: 13px;">Deflation in home prices to

linger longer</span>





<strong>Housing starts will make even lower lows</strong>

The good news is that the homebuilders are finally getting serious about cutting

supply and over the past two months they have sliced the level of single-family

starts below the level of underlying demand. The bad news is that it is looking

increasingly as if housing starts, which are already at post-WWII lows, are going

to have to make even lower lows because trying to grow our way out of the

excess housing inventory looks more remote than ever because affordability has

already improved to its best level in history. Yet, new home sales in the fourth

quarter collapsed at a 57% annual rate and fell by 23% in the existing home

market. In January, we see that mortgage applications slid at a 20% annual rate

and the NAHB sales index fell to a new all-time low of 6; it was 78 at the 2005

peak, and it?s down to 6 despite the lowest mortgage rates in over a generation.



<strong>Attitudes towards debt have shifted substantially</strong>

The bottom line and this came though loud and clear in the Fed Senior Loan

Officer survey that just came out for the first quarter, is that less than 10% of

households increased their demand for credit while nearly 60% reduced their

demand for consumer credit and for the 14th quarter in a row, households cut

their net demand for mortgages. So again, a key reason for the weakness in

housing sales isn?t even so much the tightness in the supply of credit but attitudes

in general towards debt from the demand side have been altered substantially

and housing by definition is a leveraged asset.



<strong>Would take years to mop up surplus inventory?</strong>

This, in turn, means that to eliminate the inventory through the builders

maintaining discipline on the production front, and assuming that we get no

pickup in demand, it would take more than eight years to soak up the excess

supply. Alternatively, if the builders just issued a complete moratorium on new

housing starts, then it would take two years to mop up the surplus inventory.



<strong>And years to get some resolution to housing deflation</strong>

For anyone out there who does believe that a revival in the demand for homes is

just around the corner, consider that the inventory problem is so acute that sales

would have to soar 350%, and that still assumes that the builders leave their

starts at their current record-low level. That just shows you how arduous an

exercise this is going to be. Our assumption in our macro forecast is that home

prices begin to stabilize by early 2010, but that is just an assumption. Looking

through the lingering excess inventory, and what it could take to get to a renewed

balance between supply and demand, it could easily take years before we get

some resolution to the housing deflation cycle.

Just to run through the math quickly, we have net household formation now all the

way down to 770,000 units, and when you apply a 68% homeownership rate to

that, we get underlying demographic demand somewhere around a 520,000 unit

annual rate. Single-family starts are all the way down to a 400,000 annual rate.

So, you can see that if things just stay the way they are, it takes eight years to

absorb the 1 million units in excess single-family inventory.



<strong>We still have another 15% downside to home prices</strong>

In any event, if there is one part of the forecast we are extremely confident in at

this point, it is that we still have at least 15% more downside to average home

prices nationwide. This comes on top of the record 25% decline so far in this

down-cycle. That additional 15% decline, as an aside, would be enough to wipe

out the remaining capital at the large banks and would double the number of

people who are upside-down on their mortgage from 13 million to 25 million. This

means that half of the 51 million households with a mortgage would then be in a

negative net equity position, so the process of fiscal stimulus, government

incursion into the banking sector and loan modifications doesn?t end this week.

You guys are funny,





<strong> The states are in a state of disarray</strong>

We still think that whatever analysis on the fiscal stimulus is done must take into

account the escalating restraint at the state and local government level. The

states are in disarray. Seven of them have now totally emptied out their

unemployment insurance trust funds. Fiscal gaps have opened up in 42 states,

and, when added to the shortfalls at the start of the year, they cumulate to a

whopping $80bn. California, the world?s ninth largest economy, is in crisis mode,

slashing pay for 200,000 civil servants by an average of 9.2% as the state opts

for a two-day? per month furlough. But all that does is save the state $1.3bn (it

has a $42bn fiscal gap to close).

Have a look at page 19 of the Sunday, 8 February New York Times article

?California Work Program For Young Is Threatened?. It is unfortunate that the

California Conservation Corps, modeled on the depression-era Civilian

Conservation Corps which put unemployed younger men to work in enhancing

the country?s landscape (from fences, to bridges, to soil improvement to park

construction) is about to face the governor?s budget knife.



<strong>State & local governments: the largest employer in the US</strong>

If the government can move to insure bank bonds in an effort to bolster confidence

in the banking system, or the Fed can move to backstop the asset-backed market

for consumer loans, why would the federal government not look at providing

support for such a critical part of the economic and social fabric of the country as

the state and local government sector? This is a sector that represents our

teachers, law enforcement, fire prevention, and health and social assistance? The

state and local government sector spends $1.8tn per year, an amount equivalent to

nearly 13% of GDP. That is more than what businesses spend on new plant and

equipment annually.

The state and local government sector employs 20 million, or 15% of the total,

compared with 13 million in manufacturing, 8 million in financial services, less

than 7 million in construction and fewer than 3 million at the federal level. At some

point, Washington will figure out that the biggest bang for the buck will come from

supporting this fledgling segment of the economy, as opposed to tax gimmicks

aimed at boosting auto spending at a time when the average American household

owns 2.2 vehicles, or boosting housing demand in what is still a near-record 68%

homeownership rate.



<strong>State and local government GDP collapsed in 4Q</strong>

As Chart 1 vividly illustrates, the state and local government segment of GDP

literally collapsed at a record 7.8% annual rate in 4Q. One would think that it

would be a given for any effective fiscal stimulus plan to prevent this huge share

of GDP, employment and social services from contracting any further.
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<strong>Look for yet another 500k+ job slide</strong>

Look for yet another 500k+ job slide when the February payroll data roll out too:

It?s not just because the jobless claims are north of 600k or the 45% surge in

Challenger layoffs in January, but yesterday we also were on the receiving end of

the Conference Board?s employment trends index, which faltered to 96.6 from

97.5 in December, 100 in November and 118.7 a year ago.



<strong>Gas prices are now on the rise</strong>

In addition to the steep job losses, accelerating deflation in home prices, and the

backup in mortgage rates, gasoline prices are now on the rise. In fact, prices at

the pump now average 1.92 bucks a gallon ? up 30 cents since the start of the

year for a $40 bln annualized cash flow drain. Whatever is in this coming fiscal

package, all we can say is ... it better work.



<strong>The next crisis ? university endowments</strong>

Speaking of university endowments, we caught this headline off our Bloomberg,

?Dartmouth to Cut 60 Jobs After 18% Endowment Decline.? The college will fire

60 employees after the value of its endowment sank $700 million. An additional

70 employees have accepted buyouts while 28 others will have their hours cut.

(deleted)

I'm enjoying your tidbits of news BondTrader. Keep em coming.

.

<span style="font-size: 14px;"></span><u>A Plan for a Plan</u>



<span style="font-size: 13px;"></span>

<strong>Short on details, long on promises</strong>

The Treasury?s new Financial Stability Plan (FSP) was released with a reasonable

structure yet little in the way of detail. The general themes had been anticipated

for some time: another round of capital injections, a plan to allow for the purchase

of distressed assets, an expansion of the Term Asset-backed Liquidity Facility

(TALF) and a housing program aimed at reducing foreclosures. Media reports of

the four program sizes suggest the FSP will be financed using the remaining

TARP funds.



<strong>Partners</strong>

This public-private fund to purchase distressed assets is potentially the keystone

to the entire plan. Yet, the amount of information provided regarding the plan was

minimal and therefore we cannot evaluate the possible efficacy of this aspect of

the SFP. The Treasury Secretary noted that the program could be $1 trillion in

size. However, the purchase method, the interest of private participants and the

methodology for valuing assets is all uncertain. Linking this program more tightly

to the capital injection program would have eliminated the need for the ?stress

test? and rationalized the size of any capital injection.



<strong>Bottom line</strong>

The market seemed to react negatively to a lack of details after a build up of

market anticipation. It appears to have been disappointed by what is perceived as

a continued ?ready, shoot, aim? approach. While the Treasury likely weighed the

cost and benefit of holding off on the announcement in order to iron out details,

the market seemed to be hoping for more clarity than was provided today.

For whoever is interested in knowing more about the bank rescue plan. The system will ask you for your name and company, just make up something, like "Michael Jordan, Lehman Brothers",







Credit Suisse Conference Call: Preliminary Thoughts on the Treasury Plan

Date: Tuesday, February 10, 2009

Time: 4:15 - 5:15pm EST



Replay:

*Dom: (800) 642-1687

*Int'l: (706) 645-9291

Pass code: 85452778

Available through: February 20, 2009

<strong>Latest on the stimulus bill</strong>

With a version of the stimulus package having passed the Senate, the bill now

moves into conference where the House and Senate will come together and

hammer out some sort of compromise. The only reason the bill was able to pass

the Senate with more than 60 votes (60 votes is critical because it?s the breaking

point for a filibuster) was because three moderate Republicans signed on after

cutting roughly a $100 billion of social spending from the package. And, we see

on page A4 of today?s Wall Street Journal (?Obama Seeks to Restore Some

Stimulus Spending?), that the President wants some of that spending back in and

the final bill to look more like the version passed by the House. However, we see

the following on the front page of today?s Investor?s Business Daily: ?Centrist

Senators Warn House Over Stimulus.? These moderate senators are warning

House Democrats not to tinker too much with the version of the bill passed in the

Senate.



<strong>US consumer confidence remains weak</strong>

A couple of consumer confidence reports were released yesterday and they both

dropped. The IBD/TIPP Economic Optimism Index dropped to 44.6 in February

from 45.4 in January. Remember that on this index, anything below 50 indicates

negative sentiment and it has been flashing negative since April 2007. We also

received the weekly ABC News/Washington Post consumer comfort poll, which

dropped to -53 for the week ending February 7 from -52 the week before. The key

takeaway from this report was the fact that the state of the economy component

collapsed to -92 from -90, a new record low.



<strong>Another sign of the new frugality</strong>

Take a look at the front page of today?s Financial Times, ?Discount Coupons

Open New Format in Battle of the American Brands.? Here is what the FT had to

say, ?The humble money-off coupon rather than the high-profile advertising

campaign is emerging as a new battleground for some of America?s biggest

packaged goods brands as U.S. consumer demand falters.? And, in a sign that

the luxury goods market is not about to recover any time soon, take a look at

page 20 of today?s Financial Times, ?De Beers Sees No Diamond Recovery in

Sight.?



<strong>State governments shedding jobs too</strong>

And, it?s not just private employers shedding staff. California, the world?s ninthlargest

economy, is on the verge of cutting 20,000 employees as it faces a $42

billion deficit through June 2010. Governor Schwarzenegger warned that workers

will have to be sent layoff notices if a budget deal is not reached by Friday. The

savings would be about $150 million through the end of the 2009-10 fiscal year.

Also take a look at page A3 of today?s Wall Street Journal, which points

deleted

BondTrader,



Thank you for your executive summary of our economy. I enjoy reading it every morning like a morning paper.

<strong>Adjusted misery index is on the rise</strong>



<em>Misery Index - Unemployment Rate + Headline Inflation</em>



We decided to reconstruct the misery index to accommodate for the changing

environment. We amended the index in two ways: First, we set 2% on headline

inflation as a target rate for price stability. Deviations further away (both up and

down) from 2% would add to the misery index. Secondly, we counted the

difference between the unemployment rate above the natural rate of

unemployment as increasing misery. We did this to remove the impact of

structural changes in the labor market over time. After all, once you drop below

the natural rate, it is not clear there is any decline in misery associated with a

further drop in unemployment. The chart below reconstructs the misery index

using these changes with our latest 2009 forecasts. The chart clearly illustrates

that misery is on the rise, not in retreat.



<strong>Deflation also creates economic instability</strong>

The underlying assumption in the traditional misery index is that a rising rate of

inflation creates social and economic costs, which is true. A higher rate of inflation

means that the purchasing power of currency declines. It also increases the cost

of holding cash and, more generally, creates uncertainty.

However, what that is missing is the fact that deflation, which is the dominant

macroeconomic risk over the near- and intermediate-term, is also a source of

uncertainty. As deflation expectations set in, consumers delay purchases on the

notion that prices will continue falling and that this reduces economic activity.

Deflation also hurts borrowers. Since deflation increases the purchasing power of

currency, borrowers would be paying off debt with dollars that are increasing in

value while the value of the asset being paid off is falling. In other words, the real

cost of debt is going up. The original misery index was telling a meaningful story

when inflation was running in the double-digits and the national savings rate was

north of 8%. That is not the case today.



<strong>Price stability cuts both ways</strong>

Price stability cuts both ways. Deflation can create as much misery for the

consumer as inflation. That?s why central banks adopt target rates of inflation or,

in the Fed?s case, comfort zones ranging between 1.5-2%.
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<strong>I hope I'd be able to find some good news for you guys in the near future... </strong>

[quote author="BondTrader" date=1234417813]<strong>I hope I'd be able to find some good news for you guys in the near future... </strong></blockquote>


Please don't. Keep the bad news coming.

If spending the taxpayer's future is not effective, just steal some pension funds and that will work?



<a href="http://www.nytimes.com/2009/02/10/business/economy/10pension.html?_r=4">Ackerman</a>

<strong>China a buyer of US Treasuries</strong>

Finally, an answer comes out over whether or not China would begin a buyer?s

strike against the US Treasury market,the answer is that it ain?t going to happen (China

selling our bonds) and don?t take our word for it ? just heed the words from Lui

Ping, director-general at the China Banking Regulatory Commission in a speech

in New York yesterday (and excerpts available on page 13 of the FT ? ?China To

Stick With US Bonds?). We love this one ? ?Except for US Treasuries, what can

you hold? Gold? You don?t hold Japanese government bonds or UK bonds. US

Treasuries are the safe haven. For everyone, including China, it is the

only option?. Liquidity. Transparency. Optionality. Safety. Yes indeed, for the

?bubble-ites? out there ? there are reasons beyond the coupon to own Treasuries,

and the Chinese understand that.

And, it even looks as though the typical retail investor saw what we saw as the yield

on the 10-year note jumped 100 bps in short order ? a buying opportunity, because

investors plowed $5.14 billion into bond funds last week (ICI data) while equity

funds suffered a net outflow of $739 million. See page C13 of the WSJ for more.



<strong>Ports in a storm</strong>

According to the WSJ, container activity at the Port of L.A. slid 15.8% YoY in

December. This was the steepest decline in 13 years. Volumes finished the year

down an average of 6%, the second straight year of decline, which has never

happened before (at least back to 1980).



<strong>How ironic is that?</strong>

A year ago, the consensus forecast was that 4Q08 GDP growth was going to be

the best for the year at nearly +3% at an annual rate and it now looks like it will be

worse than a -5% annual rate. And the reason was because the economy is

almost always reaccelerating in the fifth quarter following the first Fed rate cut. In

fact, on average, real GDP growth is north of 3% in that particular ? the fifth

quarter after the first easing. Never before has it been this negative this far into a

rate-cutting cycle. Just another way of saying that this is not really a recession at

all but something entirely different altogether (if you catch our drift).

<strong>Congress reaches an agreement on stimulus bill</strong>



Yesterday afternoon, we learned that the House and Senate have reached an

agreement on the economy recovery package. The final price tag on the package

came in at $789 billion, below the price tag of both the House and Senate

version. This figure is close enough to our original estimate that it will not require

us to adjust our deficit outlook for the year. We continue to expect a budget deficit

of $1.45 trillion. Here are the key details of the package:



???? 35% of the bill would be tax cuts, 65% would be spending



???? Tax breaks: $800 for family, $400 for individuals



???? $44 billion in aid to the states, including money for education



???? At least $6 billion to modernize schools.