The stock market, as a leading economic indicator continues to move upwards climbing the proverbial "wall of worry" as professional traders ponder and warn that the market has gotten ahead of itself. Signs of economic stability continue with production, productivity and even consumer sentiment improving. The Fed announced their intention to keep interest rates low and close to zero for the "foreseeable" future, highlighting the market dichotomy between the price of gold (expectation of major inflation) versus the bond market (expectation of growth in a low inflationary environment). We are either in or developing a bubble in the gold market or the bond market – and our memories or still raw from the effects of the most recent housing bubble. The new emphasis on economic analysis that should be made by policy makers and more fully described in our Investor Section may provide some direction into which bubble we may be inflating. Investors should take the potential for a bubble in the gold market, but more importantly in the bond market very seriously.

The pain of the financial crisis has economists striving to understand precisely why it happened and how to prevent a repeat. For that task, John Geanakoplos of Yale University takes inspiration from Shakespeare's "Merchant of Venice."

The play's focus is collateral, with the money lender Shylock demanding a particularly onerous form of recompense if his loan wasn't repaid: a pound of flesh. Mr. Geanakoplos, too, finds danger lurking in the assets that back loans. For him, the risk is that investors who can borrow too freely against those assets drive their prices far too high, setting up a bust that reverberates through the economy.

In a 2000 academic paper, Mr. Geanakoplos offered a theory. He said that when banks set margins very low, lending more against a given amount of collateral, they have a powerful effect on a specific group of investors. These are buyers, whether hedge funds or aspiring homeowners, who for various reasons place a higher value on a given type of collateral. He called them "natural buyers."

Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets. But if a jolt of bad news makes lenders uncertain about the immediate future, they raise margins, forcing the leveraged optimists to sell. That triggers a downward spiral as falling prices and rising margins reinforce one another. Banks can stifle the economy as they become wary of lending under any circumstances.

"It was evident to me that there was a cycle going on, not just in my little market, but all over the world," says Mr. Geanakoplos, who is still a partner at Ellington Capital. The "leverage cycle," he called it.

This idea had big implications for policy makers. For decades, they thought of interest rates as the most important indicator of supply and demand in credit markets, and the only variable they needed to adjust to achieve a desired economic result. Now, Mr. Geanakoplos was saying that something else -- lenders' collateral or margin demands -- could be even more important.

Motivated by a flood of investment from abroad, U.S. bankers created myriad debt securities backed by assets ranging from credit-card receivables to student loans to corporate bonds. To stretch the available collateral even further, they created hundreds of billions of dollars in ethereal investments known as "synthetic collateralized debt obligations," whose value was tied to that of bonds and asset-backed securities.

From 2000 to mid-2006, lenders lowered average down payments on riskier home loans to less than 4% from about 14%. During this time, the average U.S. home price soared about 90%, and total U.S. credit-market debt rose 68%, to $43.3 trillion.

Central bankers expressed concern about the debt-fueled boom. But their main forecasting models sounded no alarms, because the models looked only at interest rates, not at any indicator of how much banks were willing to lend on assets. The models "were not able to draw up the red flags," says Tim Besley, a professor at the London School of Economics who served on the Bank of England's policy-making committee until recently.

In 2007, with mortgage defaults rising, banks pulled back on home lending. The average down payment they required for riskier home loans jumped to more than 10% in mid-2007, by Mr. Geanakoplos's calculation. House prices headed lower.

After Lehman Brothers Holdings failed in September 2008, lenders jacked up the margin investors had to put up to buy mortgage securities to nearly 70% from less than 10%, contributing to a wave of selling and losses. Some bankers became reluctant to lend at all.

Mr. Geanakoplos has yet to develop his theory into a comprehensive model. "His work assumes that the leverage cycle is bad, but gives little guidance [about] to what extent regulators should control it," says Markus Brunnermeier, an economist at Princeton who specializes in financial bubbles.

Coming up with the right model could force economists to move away from the ideas of efficient markets and rational expectations on which much of their current work relies. "If that happens, that will be a change of enormous proportions," says Martin Eichenbaum, a professor of economics at Northwestern.

Mr. Geanakoplos is convinced such a paradigm shift is under way. He hopes it will prove beneficial in protecting people from the excesses of the financial markets. To that end, he believes central bankers should collect and publish data on the amount of leverage in the system, and intervene if it gets out of line.

Right now, that would require the Fed to step in where banks fear to go by lending against risky assets such as mortgage bonds, but it would also mean limiting investors' ability to use leverage in exuberant times.

"Our policy seems geared largely toward rescuing banks and bankers," Mr. Geanakoplos says. "If we could manage these cycles better, I think we'd all be better off."

 

For the entire article in the Wall Street Journal click here:

There’s a prizefight underway in markets, with two heavyweights slugging it out for bragging rights and big winnings. In the yellow trunks: gold, which surged to yet another record price today, hitting over $1,100 per ounce before retreating. For the legions of gold fans, the Federal Reserve’s unprecedented efforts to pump money into the economy will end badly, igniting inflation. In the red, white an blue trunks: Treasurys. Yields on longer-dated government bonds remain relatively subdued, a sign that investors aren’t overly worried about a massive upsurge in prices. Today, investors bought Treasurys, sending yields lower, as they digested a poor unemployment figure that underlined the fragility of the economy. The yield on the 10-year Treasury bond was recently trading at around 3.50%, below its recent peak of 3.95% in June. The discrepancy between these two markets is just one example of how investors radically disagree on a host of questions right now, “perhaps none more violently than the inflation issue,” says Dan Greenhaus, chief economic strategist at Miller Tabak + Co. Gold represents a play on what could happen to prices in the future, says Greenhaus. Bond markets, on the other hand, are focusing on current economic and inflation numbers that show that price pressures remains benign, and could even fall. Eventually, one of these views will be proven correct, winning the bout. Stay tuned for the next round.

For the entire article from THE WALLSTREET JOURNAL click here:

The housing bust left homebuilders with plenty of red ink on their books as they walked away from swaths of land they no longer needed.

But now homebuilders are on the hunt again, vying for choice parcels even in foreclosure-riddled markets like Las Vegas, Southern California and Orlando, Fla., where prices are cheap and there are early signs of a recovery.

While not a full-blown land rush, experts point to a surge in land deals since early summer as home sales and prices began to stabilize. For the better lots, the competition is fueling bids well above the asking price.

Major players such as Ryland Group Inc. and Meritage Homes Corp., are among those that jumped into the fray.

Meritage recently signed contracts to buy 2,500 lots spread out over new communities in several states, including California. The builder plans to open nine new communities this year or early next.

This summer, Ryland bought land or signed option contracts to do so in several markets, including Indianapolis, Atlanta, Houston, Las Vegas and Baltimore.

Of course, not all builders are looking to expand their land stockpile.

Pulte Homes Inc., for example, has been more conservative. The builder added thousands of acres to its land holdings when it acquired rival Centex Corp. in August. And roughly half of those parcels are already primed for construction.

Still, with new home sales up 22 percent this year, builders have grown more confident in their ability to estimate what they should pay for land and expect to profit after construction costs.

Builders are primarily looking for land in areas that are already cleared for home construction. That way, they will be ready to build and sell in just a few months.

For the entire article from MSNBC click here:

In the morning, they were hit with a dreary jobs report. In the afternoon, they learned that consumers had again scaled back on borrowing. But even in the face of grim economic news on Friday, investors seemed content just to shrug it all off.

Stocks traded in a hair-thin range all day, with investors picking up shares of industrial companies and selling off financial stocks. The only real movement was a dip at the market's open as investors tried to draw meaning from a report showing that unemployment in the United States had climbed to a 26-year high.

By the end of the day, the Dow Jones industrial average had risen 17.46 points, or 0.2 percent, to 10,023.42. The Standard and Poor's 500-stock index was up 2.67 points, or 0.3 percent, at 1,069.30, and the technology-heavy Nasdaq composite index rose 7.12 points, or 0.3 percent, to 2,112.44.

The Department of Labor's monthly job market barometer showed that the unemployment rate climbed to 10.2 percent in October, the highest level since 1983. The pace of job-cutting slowed to 190,000 in October, down sharply from the peak of the recession last winter, but there were concerns that the revival of hiring could still be far off.

For the entire article in THE NEW YORK TIMES click here:

Signs of recovery after a torrid year spread around the world yesterday as manufacturers reported rising output and improved employment prospects in the US, Europe and Asia.

From Seoul to San Francisco, manufacturing sentiment has recovered quickly from the shock of the global recession last year, when trade stopped dead and unsold stock piled up.

A year on, manufacturers reported that in October, world output was rising at the fastest rate for five years. The JPMorgan global composite purchasing managers' index rose to 54.4, up from 53 in September, the highest since July 2004.

The biggest surprise came in the US, where the Institute for Supply Management's factory index rose to 55.7 from 52.6 in September. The figure, well above market expectations, sent stocks in the US and Europe surging as it was seen as evidence that the recovery was more durable and entrenched than previously thought.

For the entire article from THE FINANCIAL TIMES click here:

EUROPE'S emergence from its worst post-war downturn seems assured. Figures released on November 13th will confirm that the euro-area economy came out of recession in the third quarter. The fourth quarter also looks promising. Output rose at its fastest rate in almost two years in October, says a survey of purchasing managers. Business and consumer confidence have continued to improve. A jump in foreign orders for German capital goods in September is a sign that export demand is returning.

The latest forecasts from the European Commission reflect this new mood. The commission says euro-area GDP will rise by 0.7% in 2010, a brighter prospect than seemed likely in May, when it forecast a 0.1% drop. The upgrade would be larger if today's growth rate were sustained. But the commission thinks the economy will hit a soft patch early next year, as the temporary effects of fiscal stimulus and of firms' restocking begin to fade.

Other factors will then weigh down recovery. One is jobs, which have not yet fully adjusted to the collapse in GDP during the recession (see article). The commission thinks that euro-area unemployment will continue to rise next year, reaching 10.9% in 2011. That will dampen consumer spending. Another worry is investment, which the commission thinks will fall by 17.9% this year. Businesses are unlikely to waste scarce cash on new equipment and offices when they have spare capacity. Firms confident enough to splash out may find it hard to secure the necessary financing from fragile and risk-averse banks.

Yet the most striking part of the commission's reckoning is the impact of recession on the public finances. Budget deficits are expected to amount to 6.4% of euro-area GDP this year, rising to 6.9% in 2010.

For the entire article from the ECONOMIST click here:

From Dispair Inc.

 

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