Thursday, Aug. 28
Posted 4 p.m. Eastern

What to make of the GDP?

The revised Gross Domestic Product for the second quarter was issued this morning, and the number was surprisingly high. The economy expanded at a 3.3 percent annualized pace during the second quarter, a sharp upward revision from the 1.9 percent pace reported just one month ago. Much of the revision is attributable to exports - in other words, goods purchased not by American consumers, but consumers in other countries.

With other major economies around the globe in even worse shape than the U.S. economy (Japan, Germany and the United Kingdom to name a few), such a boost is unlikely to be sustained.

While the GDP figure shows the economy isn't dead, let's not kid ourselves - it isn't sunshine and daffodils either, regardless of what the GDP suggests. With the economy continuing to shed jobs every month, that alone is a sufficient indicator of recession.

Let me know what you think about the state of the economy. I'll post some of your responses in an upcoming entry.

Thursday, Aug. 21
Posted 4 p.m. Eastern

Finance 101 and lemonade

Here is an e-mail from a very regular reader and participant in the blog with the subject line "Fundamental Problem ... Finance 101 & Lemonade anyone?" Have a read. My comments follow.

"I am trying to teach my oldest daughter fundamental cash flow through utilizing a lemonade stand. I (Dad) play the part of the capital market and the Feds, injecting liquidity into my daughters operation. She borrows capital at a very low rate of interest and purchases her raw materials, the stand, powder, plastic pitcher cups and cookies. Her signage (marketing) and cars driving by provide the consumers. The money lent is a function of both the scale of her operation, location, hours and the anticipation/risk of payback, not consumer demand. I don't lend based upon the assets she now controls, (her stand or raw materials that I lent her the money to buy!) but based upon her ability to pay back based upon profit or loss.

"My point is I see in both bubbles of the last decade, that banks/financial institutions are lending based upon credit and/or asset or commodities or even implied (goodwill) value. Both are highly suspect when balance sheets get skewed by rising/falling asset classes ... too much accounting wizardry, valuation manipulation and potential for fraud. Mark to market is only part of the solution, clearly dividing the two is significant.

What happened to profit and loss based upon cash flow? Assets should always be subordinated to cash profit and loss. Too many shenanigans have been played with both bank and corporate balance sheets, and the individual consumer suffers as a result over the last decade. Simple ... .yes?

"What do you think? Fed rates aren't changing, until the banks get a handle on their debtor's cash flow, customers' cash flow, and their own cash flow. With inflationary concerns/spike being offset by commodities rising and subsequently falling, mortgage rates aren't going to change a whole lot, until the lenders are going to feel confident in getting paid back from everyone else's 'lemonade stand' hence the higher risk premium.

"We now have Treasury's Paulson suffering the opposite of one of Greenspan's favorite quotes about the 'conundrum' of rates lower than they should be earlier this decade. Now Paulson is griping rates are higher than they should be. I disagree, the markets are being both fair and efficient and almost generous right now in valuing risk. Main Street and Wall Street may be missing the boat on this issue. Just because the money is available to lend either through initial lower (Fed) rates, doesn't mean borrowers may be able to pay it back."

Great thoughts. Yes, asset-based mortgage lending is history and we've returned to the real ABC's of sensible lending -- good credit, proof of income and money for a down payment. Some of the lending standards have tightened too far, for example in the jumbo mortgage market where well-qualified borrowers are making outsized down payments, jumping through more hoops than a circus act, and still paying 8 percent.

One area of disagreement, I have. With mortgage-Treasury spreads at a 22-year high, I'm not of the opinion that markets are "almost generous" in valuing risk. Investors, especially those in the mortgage market, are squeamish about risk and when in doubt, the deal doesn't get done.

Monday, Aug. 4
Posted 4 p.m. Eastern

Fed meets Tuesday

The Federal Open Market Committee meets this week, but don't expect any changes to interest rates. With the economy ailing, financial markets still impaired and continued inflation pressures, the Fed is looking at a landscape much the same as what they saw at the June meeting. All this means is that the Fed has little latitude -- either up or down -- on the interest-rate front. Even the post-meeting statement should remain largely unchanged as the Fed doesn't want to paint themselves into a corner.

What we can expect is more tough talk and dissent on inflation. Look for the inflation hawks, Richard Fisher and Charles Plosser, to vote for an interest rate increase. The rhetoric and dissenting voices are about all the Fed has to combat inflation, so expect them to use it.

The recent decline in oil prices is a welcome move, but it is far too little and far too early to be projecting any easing of inflationary pressures or boost to economic growth. Should we see a sustained move to lower oil prices, the Fed's long-held belief that inflation will "moderate" on its own could be proven correct. But only time will tell.

Also, the credit crunch is now one year old and we are no closer to calling an end. What has to happen for the credit crunch to disappear? The best answer is nothing -- as in, if nothing further happens. No more Bear Stearns. No crises of confidence with regard to Fannie Mae, Freddie Mac or large hedge fund blowups. No seizing up of credit. No large bank failures. And no events that none of us can imagine (the "unknown unknowns" as Donald Rumsfeld would say). But the merry-go-round of the past 12 months has brought another crisis just as the credit markets appeared to be on the road to recovery, so suddenly expecting placid waters is a bit far-fetched.

Even with the economy hurting but not falling off a cliff, the Fed seems handcuffed by a lingering credit crunch and the ailing American homeowner, unable to back up their tough talk on inflation with any interest rate moves for months to come.

Fed Outlook archive