Tied to the Mast

[EJ]

Tied to the Mast

The world changed in August, but the Fed has so far failed to notice

Top of the news today is not the latest tedious 100 plus point plunge in the DOW, which along with 100 plus point up days over the past month or so have acclimated investors to a steady tossing, like ferry travelers settled in for a two hour ride through stormy seas. (Okay, so it's a corny metaphor. Wait until I get back from Vegas. You'll be praying for corny metaphors.) The news is the growing evidence that the world changed in August, but the Fed has so far failed to notice.

Investors are wondering if the volatility will soon decline toward the mean, or get meaner.

Today we learn that, at least for now, Professor Ben expects the former likely. He read the Beige Book and announced: "Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited."

We believe the latter; our Myth of the Slow Crash theory picked up a few more data points today. Data point number one:

Lay-offs surge 85 pct in Aug vs July: survey
September 5, 2007 (Reuters)

Planned U.S. lay-offs rocketed in August as the housing slowdown and subprime mortgage debacle led to record job cuts in the financial sector, an independent report showed on Wednesday.

Announced lay-offs surged 85 percent to 79,459 in August from 42,897 in July, according to Challenger, Gray & Christmas Inc, an employment consulting firm. August's job cuts were the highest since February, when they totaled 84,014.

"Nearly half of the August cuts came from the financial sector, as dozens of mortgage and subprime lenders caved under the pressure of a sinking housing market," Challenger, Gray & Christmas said in a statement.

As usual, four out of five economists are surprised by the data. These layoffs included an unusually large component of financial services industry personnel, whose employers since mid July took a major hit. Circumstantial and personal data collected by yours truly, visiting friends in NYC during the July turmoil, includes evidence of the nearly instantaneous impact on businesses attached to the finance industry; discretionary spending, such as on third party marketing–advertising and PR–was immediately cut. No need to spend money pitching what everyone believes is unsalable. Reminds us of Wall Street after the tech stock bubble crashed, but not quite the same.

Another predictor predated that July NYC visit, our interview with John Challenger, the founder and CEO of Challenger, Gray & Christmas in early July. No shock that firms associated with the PE bubble were going to lay off a lot of folks. (Listen to the interview if you are curious to know what happens next.)

After the third-party advertising and PR firm cuts come the sales and marketing folks at the financial firms themselves. The crashing tech stock bubble extruded a hoard of tech-centric investment bankers who re-convened the party at the Hedge Fund Bar & Grill. Now that the private equity and hedge fund booze has run out, they stagger off to the golf course, leaving behind only the hard working and experienced hedge fund industry founders to muddle their way through the mess the me-too party-happy followers created, until rumors of the next party start to circulate to get the animal spirits moving again.

Until then, more "surprising" data pour in. Which brings us to data point number two:

Pending Home Sales Sink in July
September 5, 2007 (Alan Zibel, AP Business Writer)

Pending Sales of Existing Homes Fell in July to Lowest Level Since September 2001

A near-record low for an index that forecasts near-term home sales suggests borrowers in expensive areas are struggling to finalize home purchases amid mortgage market troubles.

What happened September 2001 that might have put a crimp on home sales? Oh, yes. Now I remember. The 9/11 terrorist attacks. In July 2007 we have post September 11, 2001 levels home sales activity, except without the confidence sapping impact of the worst terrorist attack on US soil ever. This coincides with our recent observation that we are seeing the worst housing market since The Great Depression, except without a depression. More importantly, we still don't even have post credit crunch housing numbers which will show the initial impact of the lack of availability of credit. Expect them this month. The housing market downturn will rapidly accelerate during an actual recession, with rising unemployment.

We warned October 2006 of a recession starting in Q4 2007 and see no reason to modify our view. The view from the ground is not as antiseptic as the view from the air, which brings us to data point number three:

Metro housing slide keeps repo man busy
September 5, 2007 (TAMMY JOYNER - The Atlanta Journal-Constitution)

'Snowball effect' from mortgage woes, easy credit keeps lot overflowing

Swing by Richard Grosvenor's business for a closeup of how quickly the nation's housing market is unraveling.

In the last six months, Grosvenor and his repo drivers have hauled in hundreds of vehicles in the course of normal business.

Among their more recent hauls: a trailer packed with windows destined for a new home; two backhoes, two Bobcats, two dump trucks, as well as pickup trucks belonging to electricians, landscapers, plumbers and home builders. He's even repoed Realtors' luxury cars.

"The housing market is just taking a toll. It's an instant snowball effect," Grosvenor said strolling through the three-acre gravel lot at Speedy Recovery, a Lithonia business he started 14 years ago. He points to a plumber's black 2007 Corvette. Behind it is a Bobcat. A few yards away under a tree is a white Dodge Ram 3500 pickup voluntarily turned in by the owner of a construction company.

Our iTulip Beige Book, so to speak, comprised of reports from our level headed–according to our surveys–professional community, now 3,500 strong, indicates a rate of change that is typical of secular turning points in credit cycles, changing from gradual to not at all gradual. This includes reports from our iTulip Prosper Lending group of nearly zero defaults up until July and then a huge spike in August.

The "Myth of the Slow Crash" might in the current instance be called the "Silent August 2007 Crash." When rates of change are themselves changing rapidly, the usually innocuous lag time between economic events and the economic data that reflect them become significant.

To wit, the unusual August drop in mortgage applications is still not on the Fed's radar. In fact, mortgage applications were reported as up, bringing us to our fourth and final data point:

Mortgage applications climb
September 5, 2007 (CNNMoney.com)

Mortgage application volume increased 1.3 percent in the past week, according to a report Wednesday.

Not so.

Paul Descloux, creator of the National Mortgage Application Index, reports that for the week ending August 31, 2007: "Mortgage applications continue to plunge. Down another 5.1 percent the last week of August, total activity is now down a staggering twenty percent the past three weeks as the fallout from August’s credit crunch reaches Main Street. Equally dramatic is the slowdown in reported California home sales data, now down 25 percent versus the same four week period last year."

Returning to Professor Ben to conclude, we suspect that he may, like the academic he is, be the kind of guy who waits for clear data. He's waiting for the men in the engine room to report that the first two sections of the ship are full of water before deciding that it's time to start the pumps. The US 1929 and Japan 1990 experience suggest that by then most of the passengers in-the-know who still have their wits about them have already slid off in one of the in-short-supply life boats. And we're not talking about four or five quarter point rate cuts, already priced in. We're talking about the kind of drastic response the Japanese failed to see was needed, and that perhaps Ben doesn't see is needed either. Not because he isn't smart, but because other factors–a weak currency and huge deficits– have already tied his hands, so he doesn't want to see the August 2007 rate of change and impossible choices facing him.

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