Sunday, November 25, 2007

JAPAN | Surprise, the Nikkei Opens and Stays Strong

Nov. 5, 2007–For the last five trading days (Friday was a holiday), the Nikkei 225 headed downhill in the early hours. In broad-brush terms, the Nikkei 225 went above 18,000 in July, fell to 15,000 in August, recovered to 17,500 in October and has fallen below 15,000 in November.

Three of the last five trading days, Japan's Nikkei 225 has declined in the morning and then recovered in the afternoon. We saw this big-time on Tuesday, Nov. 20, but you can see it on Friday, Nov. 16 and Thursday, Nov. 22. Were Tokyo's traders seeing an infusion of central bank liquidity or did the afternoon upticks come from lunchtime liquidity? Unfortunately for Tokyo traders, the London Stock Exchange is not open yet when they finish their day.

So it's a change in pace today, and good news, that the Nikkei headed straight up from the opening.

Saturday, November 24, 2007

IRAQ WAR | What Has It Cost?

Nov. 25, 2007–I received an email from a fan of Rep. Ron Paul who said that Paul estimated the cost of the war in Iraq at $3.5 trillion.

That number originated two weeks ago from the Joint Economic Committee Democratic majority.  Two cost-of-war spending clocks (today they read $442 billion and $472 billion) are much lower because they represent only spending to date, whereas the JEC spending includes in addition ten more years of the war.

Looking back on the history of the cost estimates, they keep rising because:
  • The Administration wanted to keep the initial estimates as low as possible to ensure support for an invasion.
  • When the first estimates wereprepared, the war was projected to last ten years at most. Now, five years later, the war is still being projected to last 10 more years, i.e., 15 years altogether.
  • The JEC number includes a factor for payment of interest on the borrowed money.
  • Some estimates include the war in Afghanistan; some don't.
A time line of estimates is documented here and summarized below.

Baseline: $50 billion. The Pentagon originally estimated the cost of a war in Iraq at about $50 billion. Michael O'Hanlon of the Brookings Institution said this was fine as an invasion cost, but added that a U.S. occupation could cost $5-$20 billion more per year.

September 15, 2002: $200 billion. Lawrence B. Lindsey, Assistant to the President on Economic Policy, estimates the cost of a war in Iraq would be $100-$200 billion. During the next two weeks, the Democratic Caucus of the House Budget Committee concurs, with a 10-year end date (2012) and the Congressional Budget Office provides an estimate consistent with the other two

October 29, 2002: $1.6 trillion. Yale University Professor William D. Nordhaus argues existing estimates don't include enough to pay for a long occupation. He estimates the cost of a war in Iraq could be $120-$1,600 billion through 2012. Lindsey leaves the White House. On December 31, 2002, the Budget Director puts the cost of the war at $50-$60 billion. On March 20, 2003, the United States invades Iraq. On April 9, Baghdad is occupied. On May 1, President Bush, on the deck of the USS Abraham Lincoln, announces the end of combat operations in Iraq. On June 27, 2003, the various estimates converge slightly. The Department of Defense raises its estimate to $60-$95 billion. In the same month, Professor Nordhaus scales back his upper estimate and raises his lower estimate, for a range of $500-$600 billion over 10 years. On February 27, 2003, George Soros estimates the cost of the war in 2003-2004 at $160 billion. On May 19, 2005, the Congressional Budget Office estimates the cost of the war at $600 billion through 2010, i.e., at the upper limit of the revised Nordhaus range.

January 8, 2006: $2+ trillion. The Boston Globe announces a study by Professors Linda Bilmes and Joseph Stiglitz showing the Iraq war could cost the economy more than $2 trillion through 2010. The authors’ data are published a month later as a National Bureau of Economic Research working paper. The Congressional Research Service estimates the Iraq war is costing nearly $2 billion a week and then later at $12 billion per month. In December 2006, Bilmes and Stiglitz, in a Milken Institute article, specify a range of $2-$2.267 trillion as the cost of the Iraq war through 2016. On October 24, 2007, the Congressional Budget Office estimates the cost of the war at $1.2-$1.7 trillion through 2017. The report covers both the Iraq and Afghanistan wars and other activities related to fighting terrorism.

November 13, 2007: $3.5 trillion. The Joint Economic Committee, which in 2007-2009 was chaired by Sen. Chuck Schumer (D-NY) with Rep. Carolyn Maloney (D-NY) as Vice Chair, announce a new estimate of $1.6-$3.5 trillion, i.e., the economic cost of the Iraq and Afghanistan wars so far (2002-2008) is $1.6 trillion and projected through 2017 is $3.5 trillion. Minority Republican members of the committee dispute individual numbers but do not provide an alternative estimate.

If you think you can come up with a better estimate, here is an Iraq War cost calculator that allows you to estimate the cost of the war based on your own assumptions about, for example, how long U.S. troops will be required in Iraq.

More tragic than the spending is loss of life in the Iraq war with 3,874 Americans dead so far, and 28,451 U.S. wounded. A new report suggests that the wounded figure leaves out 20,000 unrecorded brain injuries suffered by U.S. soldiers. Monthly losses have, blessedly, been declining recently.
Perhaps the best take on all of this is a November 18 article in the Washington Post that lists some of the things we could have done with the money and of other priorities that might have had a better chance. These costs are much greater than the spending itself. Click here for a continuous update of tradeoffs.

Tuesday, November 20, 2007

U.S. DEBT | Foreign Holdings

Nov. 20, 2007–Watch what they do, not what they say. Based on the latest available data issued November 16, amid the posturing at the recent OPEC meetings, oil exporters have been adding to their holdings of U.S. securities over the past year, from $114 billion to $126 billion.

Japan has pared $36 billion, but is by far the largest foreign holder of U.S. dollars ($582 billion). The People's Republic of China has added $7 billion (to $397 billion). The biggest friends of the United States have been the UK, which added $204 billion (to $266 billion), and Brazil, which added $64 billion (to $109 billion). These two buyers more than account for the growth in foreign holdings of U.S. securities of $222 billion (to $2,247 billion). The top five holders of U.S. securities (counting oil exporters as one holder) account for 66 percent of all foreign holdings.

The year-over-year increase in holdings uses the dollar measuring stick. It looks differently to someone translating the dollars to yen or renminbi or the euro. The euro rose from $1.27 in September 2006 to $1.39 in September 2007, so from the perspective of someone buying most of their goods from Europe, the value of the U.S. securities fell 9 percent, canceling out what Uncle Sam is paying by way of interest.

Two caveats: (1) The numbers for November and December may have a different look–we will know in January and February 2008. (2) The U.S. Treasury International Capital reports are "estimated" based "on annual surveys ... and monthly data".

Monday, November 19, 2007

LVT | Scott Stringer on Vacant Lots in Manhattan (Updated Sept. 25, 2016)

At a Manhattan breakfast meeting this morning sponsored by the Drum Major Institute. Boston Mayor Thomas Menino spoke about his survey of abandoned buildings in Boston. Based on this survey,  through a variety of creative initiatives (not without opposition), he reduced the number of abandoned units by 77 percent.

In 2006 the U.S. Conference of Mayors recognized the Mayor's strategy as "best practice." The event was recorded in a liveblog by Corinne Ramey. I posted a comment on the following two paragraphs of her report:
  • Brad Lander, Director of the Pratt Center for Community Development, returns to the idea of approaching vacant buildings in different markets. We've only in the past few days fixed certain tax laws, he says. He says that the J51 tax abatement rules need to be fixed here, but might be slightly different in different cities.
  • Scott Stringer, Manhattan Borough President, jumps in. "Or we could sit down and figure out a different tax structure for abandoned buildings," he says. "Right now we tax buildings -- imagine if we created a system of incremental land value taxation. I don't know what the result would be, but we need to figure out the next bold move as it relates to tax policy. Let's research what's going on in other cities and other states. Land is our asset and commodity."
Clearly, the reason that Manhattan Borough President Stringer has been able to find so many vacant properties in Manhattan is that property-owners suffer no penalty for warehousing empty lots or buildings. The owners are waiting for prices to rise. Unimproved land is taxed at a much lower rate than improved land.

Some cities have attempted to solve this problem–the low taxation rate of unimproved land, encouraging speculative warehousing of land–by taxing vacant land at a multiple of the rate for improved land. Others have taxed improvements at a fraction (e.g., half) the rate of taxes on land value.

The ultimate fix is to tax just the underlying land (hence "land value taxation" or LVT) and not the improvements, so that property-owners pay the same tax regardless of improvements. The LVT concept isn't far from NYC's actual practice of encouraging developers/builders to put up new buildings with tax abatements or, more recently, fixed Payments in Lieu of Taxes (PILOTs).

But there is a problem with tax abatements and PILOTS. The bigger, and therefore the more effective/attractive, they are, the more they undermine the City's ability to pay for the service needs created by the development. These service needs include education, sanitation, police, and the annual debt service for the bond issues to pay for local infrastructure improvements.

Comment (September 25, 2016)

The use of PILOTs grew significantly during Mayor Bloomberg's administration. The impact of these PILOTs grows every year as new services are required for developments approved a few years ago.

Friday, November 16, 2007

U.S. MISERY INDEX | 8.3 Percent

Fed Chairman Ben Benanke has warned Congress both about the possibility of higher inflation and a recession in the near future. Higher inflation would arise in part from costlier commodities imports (reflecting the declining value of the dollar and the higher cost of oil). A recession could be induced by falling housing prices and the impact of foreclosures and writeoffs on credit markets.

The danger of a combined higher inflation and unemployment is stagflation, measured by the so-called "misery index", which was at its highest in June 1980 at 22 percent and at its lowest in July 1953 at 3 percent. In October, U.S. inflation was 3.6 percent at a seasonally adjusted annual rate (SAAR). The unemployment rate was unchanged at 4.7 percent. The misery index was therefore 8.3 percent.

In New York City, the unemployment rate rose in October to 5.3 percent, seasonally adjusted, an increase from 5.1 percent in September 2007. With NYC inflation at 3.1 percent year-over- year, its misery index is a relatively low 8.4 percent, just 0.1 of a percentage point higher than the nation's.

NYC is still in the early stages of a housing downturn and financial sector mass layoffs. BLS reports that third-quarter "layoffs in the finance sector were primarily in the credit intermediation and related activities industry, which reported its highest number of events and separations in program history.”

Monday, November 12, 2007

Overseas Subprime Loan Losses Large but Unclear

The status of overseas subprime loan losses is unclear, but it will be large. Several banks have declared multi-billion-dollar writeoffs. The stock prices of Barclays and the Royal Bank of Scotland, which had fallen sharply on rumors that they will have to take large subprime losses (Sanford Bernstein projected last week that the two banks would have to write off $4.4 billion of such losses), recovered somewhat today as Barclays denied that it subprime loan losses were so serious. But investor confidence in both Barclays and the RBS, which earlier were fighting over control over ABN Amro Holding NV (RBS's team won), remains weak, with their price-earnings multiples in the range of 6 to 7 whereas the average for European banking institutions is 10.

Sunday, November 11, 2007

SUBPRIME LOANS | U.S. Problems Exported

Nov. 11, 2007–Foreigners holding U.S. securities are losing money because of the decline in the value of the dollar. Now, it seems, many of them may find they are also losing money on the securities themselves.

Barclays and the Royal Bank of Scotland appear to be caught in the web of Collateralized Debt Obligations. It was an RBS analyst, previously cited, who put the magnitude of the loss from subprime debt at $250-$500 billion. A Deutschebank analyst's forecast is more precise at $300-$400 billion. These estimates are larger than the S&L losses in the 1980s. This time round, the rest of the world will be sharing the pain.

I am using several public sources to generate a side-by-side comparison of the Savings and Loans and subprime crises. It may be found here. This is a work in progress and will be updated.

Thursday, November 8, 2007

BUBBLE | Cognitive Dissonance - Equity- vs. Fixed-Income Markets

My point on October 19 about the relevance of cognitive dissonance – which John Tierney has since written about in the NY Times in a non-Wall Street context – continues to apply through two more seriously down Dows, the second of which was the 361-point decline yesterday.

The cognitive dissonance is between signals that securitized subprime losses and other bad news are fully written off/discounted and other signals suggesting that they are not. Or, as a Wall Street trader put it to me at noontime yesterday as we were listening to Fed Governor Kevin Warsh: "The equity markets have been saying one thing and the fixed-income markets another. They can't both be right." Traders make their living by surgically eliminating their preconceptions based on new truth and making swift moves in advance of other investors.

The fixed-income markets were at their most bearish yesterday since August, while equity investors have mostly been hanging on in the hope that the latest Dow drop is the last. Professionals are more wary of "catching a falling knife" by believing that what looks like the end of the bad news really is. I remember that in the summer of 2000, after the disastrous March downfall of the dotcoms, someone was attempting to sell shares in a bottom-fishing hedge fund that would pick up dotcom bargains. Well, the dotcom basement had a sub-basement and even a level B and C below that, as we found out in November 2000 if not before.

The fast-growing Royal Bank of Scotland, fifth-largest bank in the world, takes a surprisingly dim view of how much more in the way of losses remains to be declared. Its chief credit analyst, Bob Janjuah, estimates subprime losses and new accounting requirements (FASB 157, effective Nov. 15, which make it hard to mark Level 3 assets to "make-believe") will bring cumulative writedowns in the $250-$500 billion range. Up till now we have seen at most $50 billion acknowledged. So either RBS exaggerates, or the capital markets have further significant adjustments to make.