Economists React: ‘Bitter-Sweet’ Report on Housing

Economists and others weigh in on the month-to-month increase in June housing starts.

  • This report could be interpreted in two ways. On the optimistic side, it appears that residential construction activity may have stabilized, following three consecutive years of deep correction, and that housing activity could perhaps contribute favorably to U.S. economic activity in the second quarter. On the other hand, with sales continuing to lag behind the level of building activity by a factor of 200,000, this uptick in construction will likely mean that the inventory of unsold homes (which remains at historically high level) could continue to rise. As such, one could interpret this report as somewhat bitter-sweet. –Millan L. B. Mulraine, TD Securities
  • While starts have moved off of their cyclical bottom, we see limited upside potential over the months ahead. In the single family segment, continued weakness in the labor market and what will remain a steady stream of foreclosures will keep downward pressure on house prices and ensure that builders – in an increasingly broad geographic range of markets – see steady competition from low-priced foreclosures. –Richard F. Moody, Forward Capital
  • With the number of unsold homes for sales already extraordinarily high and set to ramp up further in coming months as foreclosures accelerate and the recent backup in mortgage rates potentially puts some pressure on sales, this recent spike in single-family housing starts certainly seems ill-advised and likely to worsen still massive imbalances in the housing market. Meanwhile, rising apartment vacancy rates, an even worse inventory situation in the condo market than for single-family homes, and the collapse of the commercial real estate financing market are likely to continue to keep multi-family construction badly depressed. –Ted Wieseman, Morgan Stanley
  • This is a pleasant surprise; we expected a period of consolidation after the unexpected leap in May — which was revised up. Even better, all the gain in starts was in the single-family sect or, up a massive 14.4%. This was the fourth straight gain, though note that single-family starts need to rise another 20% or so just to return to the trend prevailing before Lehman. We are inclined to reserve judgment on whether this is the start of a re al rebound or just a return to the pre-Lehman trend. –Ian Shepherdson, High Frequency Economics
  • Multi-family construction is being restrained by the glut of condominium and apartment projects completed over the past couple of years. Apartment vacancy rates have soared in recent years. Rising vacancy rates are pulling down rents and reducing the incentive to build new properties. –Mark Vitner, Wells Fargo
  • The improvement, on the surface, did not appear to be spread evenly across the nation. There were about 30% gains in both the Northeast and the Midwest, a small drop in the South but a large decline in the West. But even in those areas where starts were off, single-family activity still improved. That is a sign that conditions are changing in most of the nation. –Naroff Economic Advisors
  • What can we tell from this data? Nothing about monthly change in Starts (data points less than the margin of error are statistically insignificant); We can say that permits were up month to month, although how much of that is seasonal is hard to decipher… Plus 3.6% with a margin of error of 11.3% = YOU DON”T KNOW. –Barry Ritholtz, Fusion IQ
  • The evidence is growing that housing construction has bottomed out and that single-family housing construction is beginning to recover—although, given the volatility from month-to-month in housing starts and building permits, we would like to see the July data before talking too much about recovery versus stabilization. Moreover, stabilization and modest recovery in housing construction and home sales does not imply stabilization in home prices given the inventory of homes for sales and elevated levels of foreclosures. –RDQ Economics
  • Single-family starts have risen at an accelerating rate in every month since March and are up in each of the four census regions. Because starts remain at an extraordinarily low level – below to trough of every other post-war recession – further increases from here look likely. However, the excess inventory of existing homes should slow new investment as starts recover from today’s depressed levels. –Nomura Global Economics
  • There is no doubt that today’s report, particularly concerning the single family sector, was considerably better than expected. However, before getting too carried away by the news, bear in mind that the National Association of Homebuilders’ Housing Market Index for July, released yesterday, is still languishing at a very low level of 17, and it has managed to improve by just three points in the most recent three months after bouncing in April from record lows set over the winter. Therefore, while this index (and single family starts) are well off the massively depressed lows set late last year and early this year, this has in all likelihood been a rebound from unsustainably weak results rather than the start of anything resembling a sustained “v-shaped” recovery. –Joshua Shapiro, MFR Inc.

Compiled by Phil Izzo

Offer your reactions in the comments section.

Dig into an interactive summary of economists’ forecasts for the coming year from the latest survey.

Location, Location, Location

New construction of single family homes increased a seasonally adjusted 14.4% in June, rising for the fourth month straight and reaching the highest level since October. But to many economists the rise seems likely to peter out. After all, there’s a massive inventory overhang of unsold homes which will only be added to by continued foreclosures. Surely that has to be cleared away before there can be a real pickup in construction.

But there may be a catch. The housing glut is uneven, with areas that had big housing manias and lots of available land to build on — think Las Vegas — saddled with a huge number of unsold homes. But towns where the housing froth wasn’t as bad don’t have that sort of inventory problem, and they may have better economies, too. So it makes sense that, with the worst of the downturn over, builders in those communities are breaking ground.

Is GE Capital Another CIT Waiting To Happen?

General Electric is no CIT Group. But how much different from CIT would GE be if the federal government hadn’t backed it up in the bond market this past year?

“This is the biggest issue right now and the biggest difference,” said Steve Winoker, an analyst at Bernstein Research in New York. “[GE] has liquidity, CIT doesn’t. The biggest reason they have liquidity is the government support.”

Would GE be in the same position as CIT were it not for government assistance in the bond market in the past year? “Not quite but pretty close,” Winoker said in an interview Thursday.

GE Capital, the finance division of the Fairfield, Conn., conglomerate, has been mentioned often this week in connection with the struggling CIT, as both companies are big, specialty lenders that focus on midsize commercial lending. Some have wondered if woes at CIT will scare GE investors and counterparties, since the two companies lend to similar customers such as airlines, restaurant franchises and construction firms buying heavy equipment.

“While there are similarities, the differences due to size, government support and historic risk appetites are very different,” wrote Steven Winoker at Bernstein Research in New York. He sought to explain the differences and similarities between the two in a report on Thursday. Here’s a summary of the analysis from him and his colleagues:

1) Size and Scope
GE Capital has $636 billion in total assets versus $76 billion for CIT. Both companies have been trying to shrink their balance sheets, with GE’s down 7% and CIT’s down 21% from a year ago. GE Capital has $361 billion in gross receivables, compared to $51 billion for CIT. Winoker points out that GE is more international than CIT, with 52% of its assets abroad, as compared with 28% for CIT. Perhaps most importantly, GE is a $100 billion industrial conglomerate standing behind GE Capital. The parent gets billions of dollars of dividends in good times but has been sending billions of dollars back to its capital division now that it is on hard times.

2) Government Support
While huge exposure isn’t necessarily a positive for GE, Winoker notes that it partly explains why the government has been more willing to support GE Capital, the fifth largest U.S. financial institution in risk-weighted assets behind Bank of America, J.P. Morgan Chase, Wells Fargo and Citibank.

CIT became a bank-holding company last year and received $2.3 billion in Trouble Asset Relief Program funds; GE didn’t participate in TARP, because it remained a unitary thrift-holding company rather than a bank holding company. Meanwhile, GE has full access to the FDIC’s Temporary Liquidity Guarantee Program and the Federal Reserve’s Commercial Paper Funding Facility. GE has issued about $41 billion in long-term debt since December, fully funding its debt needs for 2009 and into 2010 with $6 billion raised outside the federal program. CIT application for TLGP hasn’t been approved, and it hasn’t been able to raise cash to pay $1 billion of debt that matures in August.

GE Capital’s credit rating is AA+; CIT’s is at junk levels, seven notches below investment grade. And while Bernstein analysts think GE’s rating is too high, they still view it investment grade.

GE would face higher costs of debt without the TLGP program, but CIT’s exclusion from TLGP “has meant that CIT has effectively lost access to the capital markets in 2009,” Bernstein analysts say.

3) Asset Quality and Credit Buffers
In terms of reserve coverage for nonproducing assets, CIT is in a superior position relative to GE Capital. However, GE Capital tends to have higher recovery rates and collateral values relative to most lenders, so a lower percentage of nonproducing assets are likely to be charged-off compared with other lenders, including CIT. The federal government’s stress test of the health of large U.S. financial institutions this year indicated CIT needed another $4 billion of capital. A stress test Bernstein ran on GE Capital showed them it passing the fed stress test without requiring additional capital, though it said a cushion of another $5 billion would add safety.

Winoker and colleagues say CIT’s possible exit “is not helpful to a struggling U.S. economy. But they believe the government will continue helping lenders like GE and CIT’s “dire situation and potential exit from the market could actually be a positive for GE Capital” in two ways. 1) Losing a major competitor could mean GE gains pricing power in lending. 2) GE could gain market share, although GE will be cautious of risks and of lending at a lower tier in the lending market.

Bernstein analysts note that, with a departure of CIT, GE could grow larger in aircraft leasing as well as in trade and vendor finance.

Secondary Sources: Government Intervention, Fed Forecasts, Central Banking

A roundup of economic news from around the Web.

  • Government Intervention: On the Baseline Scenario, Simon Johnson looks at what we’ve learned about government intervention. “Who won this argument in the US and on what basis? And have the winners perhaps done a bit too well – thinking just about their own political futures? On who must be saved, we see the new dividing line. If you have more than $500bn in total assets, post-Lehman, you make the first cut. If you’re below $100bn (e.g., CIT), you can go bankrupt. On remaining private, the outcome is more complicated. Citigroup had the best political connections in the business, but turned out to be so poorly managed that the state essentially had to take over – in a complicated and ultimately unsatisfactory way. Bank of America’s relatively weak political connections meant that the impulse purchase of Merrill Lynch could go very badly – and also led to a bizarre form of government takeover. The prevailing idea and organizing principle for this new sorting is not Lloyd Blankfein’s “we’re the catalyst of risk” – investment banks are peripheral, rather than central, to nonfinancial risk taking and investment in this country. It’s Jamie Dimon’s idea: just don’t demonize the competent bankers, let us take things over and we’ll smooth it all out. “
  • FOMC Forecasts: Tim Duy thinks the Fed’s newly released forecasts are overly optimistic. “Clear signs of a bottom are an obvious reason to stabilize and boost near term forecasts. Still, the Fed staff’s projections appear overly optimistic, seeming to imply that future dynamics will be very similar to the past. I am skeptical. Remember to take forecasts relative of potential GDP in context of diminished expectations. The wide range of projections speaks to an interesting spectrum of Fedspeak in upcoming months. The game will be to track the data, being wary not to read to much into a short-lived bounce off the bottom. I side with the low end of the FOMC forecasts; call me a pessimist. Place your own bets, being prepared to adjust with the data.”
  • FOMC Forecasts: At voxeu Stefan Gerlach, Alberto Giovannini, Cédric Tille ask whether the golden years of central banking are over. “While the financial crisis has unleashed strong disinflationary forces, we believe that re-affirming the commitment to price stability must remain a central focus of monetary policy. The exit strategy from the unconventional measures adopted by central banks during the crisis is likely to prove delicate and will be even more so should the public question their commitment to price stability. Moreover, at the present time, governments are engaging in substantial fiscal stimulus programs and financial rescue packages that will add to their indebtedness. Indeed, this has led observers to discuss the risk that governments could eventually find financing their debt burdens through inflation too tempting to resist. While this is a minority view, central banks should be careful to ensure that this risk does not materialize.”

Compiled by Phil Izzo

Live Blogging BofA’s Earnings Conference Call

Bank of America reported a higher than expected profit in the second quarter, but there was also a big dose of bad news in the quarter. The first problem area: Bofa reported losses across nearly all of its consumer loans portfolios and its commerical loans are souring. Another challenge: the merger with Merrill Lynch. BofA said this morning that the merger is on track. If that’s true, investors will likely want to know why so many Merrill bankers are jumping ship. “Difficult Challenges Lie Ahead,” Ken Lewis said in a statment this morning.

9:35: Ken Lewis starts on a positive note. He says Bofa is feeling a little less “constrained” by economic events than it has in the past few quarters. (That means a lot coming from a bank that is under secret supervision of the federal government and was forced to replace 7 members of its board)

9:40: And now, for the bad news. “Profitability will be much tougher in the second half of the year than it was in the first half.” One time gains, like the sale of Bofa shares in China Construction Bank, will be gone and credit losses are likely to increase. Loans loss reserves are likely to increase through the end of 2009 and charges off are like to peak at the end of the year, but continue to increase into 2010.

9:45: CFO Joe Price is running through the numbers. Bofa is adding 611,000 new credit card customers, even amid the recession. Another bright sign: 29% of its mortgage business was for home sales (as opposed to refinancing)

9:50: Price says legacy trading exposure — CDS and leverage loan — offset its recent gains in trading in the quarter, mostly by tapping the rich vein of fixed income trading where spreads are near record high. (Goldman and JPM had also benefited from the trading boom, but reported no such “legacy” problem)

9:55: More commerical real estate pain. Half of BofA’s $1.3 billion in commercial loan loss reserves are for commercial real estate loans, particularly in the office and retail sectors.

10:00: Credit card losses increased to $5 billion from $3.8 billion in the first quarter.

10:03: Price says charges off decreased in auto loans, probably due to seaonality but a positive sign.

10:04: More on Commerical real estate loans: Losses on retail and office real estate loans grew faster than losses on home builder loans, which make up 60% of the portofolio. They said its home builder losses are stabalizing.

10:10: Joe Price: we’ve been fighting the downturn for two years, but its difficult to call when credit costs will peak. Merrill Lynch integration “is on track” and they are expecting to achieve 40% of cost savings this year. (”on track” was also the way the merger was described in the comapny’s written statement. But not much more details on what that really means)

10:20: Analyst Meredith Whitney asks has the California housing market bottomed?

Lewis: Hard to generalize about the whole state, but some markets are showing signs of improving. (But Bofa isn’t yet jumping for joy about a bottom. That could be because the bank still has its hands full from California mortgage losses, after it thought it saw a housing bottom and bought Countrywide in 2007)

10:25: Deutsche Bank asks will credit losses in commerical lending lag the losses in consumer lending which appears to be bottoming.

Lewis: There is a bit of a lag.

10:29: FBR says everyone is trying to find a bottom in credit losses. How should investosr interpret signs of stabalization in consumer delinquencies.

Price: There are so many factors at play — unemployment and bankruptcy — that’s its almost impossible to make that call.

10:32: Analyst Mike Mayo: What happens if unemployment goes to 11.5% instead of the more common 10% estimates.

Price: It would signal broader weakness in consumer spending. It would be additional costs BofA would have to absorb on the consumer side and it would roll through commercial loan portfolio also.

10:35 Lewis says he expects a loss in 2010 of about $500 to $700 million from the credit card bill of rights being proposed in Washington. “We are obviously working on that issue and see if there are ways to mitgate that number.”

10:40: Lewis: The bank would like is to pay the back TARP (Bofa owes $45 billion) sooner rather than later but it won’t be able to do it all at once. The discussion of when it can begin the payback has begun with the government.

10:40: Price: Our direct exposure to California (government) is “managable.” But overall, we still have issues generally in the state with credit losses because the economy and housing remains weak.

10:41: Morgan Stanley asks: what are you going to do with all of the liquidity building on your balance sheet.

Price says we are going to hold on to it. (JP Morgan said yesterday that it may be geting ready to buy back stock, but Bofa says its hoarding its capital, just as the Feds want it to)

Lewis adds that reserve building will continue to slow in the next few quarters, but “I am not a psychic. I can’t say whent it’s going to end.”

10:50: The conference call ends with Bofa shedding little light on the Merrill Lynch merger. Also, despite analysts prodding, Lewis and Price were careful not to go too far out on a limb to predict when credit losses will end. Next up: Citigroup at 11 am.

The Morning Leverage: Fat Cats And Phat Cribs

In this morning’s media roundup:

News: A bevy of banks and bank-like entities reported earnings this morning, including Citigroup Inc., Bank of America Corp. and GE Capital. The results have generally been quite strong, but The Economist cautions that the banking systems is by no stretch of the imagination out of the woods just yet. As for the private equity angle, FT Alphaville presents a table detailing Citi’s private equity results, and here’s our take on J.P. Morgan’s results yesterday.

Struggling Kellwood Co., backed by Sun Capital Partners, has extended a debt swap deadline and negotiated a forbearance agreement with its bank group as it tries to figure out how to deal with its debt load. Elsewhere in troubled LBO-backed land, auto parts maker Cooper-Standard Holdings Inc., backed by Cypress Group and Goldman Sachs Capital Partners, secured a waiver from its lenders to give it a little more breathing room. Read the LBO Wire stories here and here.

Another auto parts maker, Delphi Corp., continues to try and figure out how it’s going to emerge from bankruptcy. In the latest twist on this long-running saga, Delphis’s lenders say they’ll bid for the company against Platinum Equity LLC’s rival offer, our colleagues at the Wall Street Journal report. The auction starts today.

Another much-watched auction, for bankrupt retailer Eddie Bauer Holdings, apparently had bidders at CCMP Capital Advisors and elsewhere burning the midnight oil. The Seattle Times reported the auction was expected to go through the night, and Women’s Wear Daily said this morning that it’s continuing today. And here’s an intriguing fact: CIT Group is among Eddie Bauer’s DIP lenders. UPDATE: We have a winner. It’s Golden Gate Capital.

Speaking of CIT, its clients are scrambling to figure out their cash needs in the event of a bankruptcy, the WSJ reports. Some of its clients, including companies owned by Thoma Bravo LLC, are attempting to draw down their revolvers, the Chicago Tribune reports.

Itty-bitty sign number 889 that the PE apocalypse may yet pass: Silver Lake is considering making another run at Norwegian videoconferencing company Tandberg, a deal that it previously abandoned in the depths of the credit crisis. The WSJ’s coverage is here.

The Financial Times interviews Pete Peterson of the Blackstone Group. Among the paper’s questions, after Peterson says “fat cats” should have to pay higher taxes: How much should you, as a fat cat, have to pay?

Just for fun: Buyout firm Flexpoint Ford inherited Steven Begleiter from Bear Stearns Cos., and his poker habit too. Begleiter is one of nine to make it to the main event of the World Series of Poker in November, according to the Associated Press. As long as it’s not a bridge habit.

PeHub questions why ex-car czar Steven Rattner bought a house in D.C. if he didn’t plan to be there long. Our colleagues over at Deal Journal have the details on the house, described as “one phat crib.”

Deals of the Day: Where CIT’s CEO Went Wrong

Deals of the Day gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. Deal Journal’s homepage is You can see real-time updates of our posts and our favorite deal-related articles on other Web sites through our Twitter feed at

Wall Street Roundup:

Thank you traders. Bank of America reports $3.2 billion profit, higher than analysts expected, while Citigroup reports $4.3 billion profit helped by a one time gain on its sale of its Smith Barney stake. Many analysts had forecast a loss. Read about Bofa’s decent quarter here, and Citigroup’s quarter here.

CIT Watch:

CIT executives are trying to line up private-sector financing of $2 billion to $3 billion, while CIT bondholders were discussing a plan to swap $5 billion in debt for equity. The company could file for bankruptcy protection as early as Friday if it can’t raise emergency funds. [WSJ]

CIT’s CEO Jeffrey Peek miscalculated by expanding the company’s lending business as he aspired to compete with the likes of Merrill Lynch, a firm he once hoped to lead. [NYT]

The FT looks at why Peek was never a good fit for CIT. “Here was a white-collar guy trying to run a blue-collar, rough and tumble kind of business.” [FT]

Mergers & Acquisitions:

Warren Buffett’s Berkshire Hathaway Inc. offered $1.7 billion in cash to buy Bermuda-based reinsurer IPC Holdings Ltd. It appears tjhat Buffett was reportedly the mysterious “Party M” bidding on the company. [Bloomberg]

Auto parts supplier Delphi Corp has had talks with bankruptcy lenders that are preparing a bid for its assets that could challenge a proposed sale to private equity firm Platinum Equity [Reuters]

Deal Makers:

A group of Saudi businessmen are locked in a rare public dust-up. One of Saudi Arabia’s most powerful family-owned companies has filed a lawsuit in which it accuses Maan Al-Sanea, the Saudi billionaire, of “massive fraud” [FT]

Steve Rattner’s Washington Digs: A House Fit for a Car Czar

During a six-year stint in the Clinton White House, Robert Rubin lived in a suite in the Jefferson Hotel. When Congress is in session, Sen. Chuck Schumer rents a small house with three fellow pols.


Steven Rattner, another New Yorker who embarked on his own D.C. tour of duty this year, took a different approach. On May 15, he purchased a home for $4.35 million in the city’s posh Kalorama neighborhood, according to a person familiar with the matter.

Fifty-nine days later, Rattner stepped down from his job as President Obama’s top auto adviser. Treasury Secretary Tim Geithner said that with General Motors’s restructuring complete, Rattner had “decided to transition back to private life and his family in New York City.”

He leaves behind one phat crib. With five bedrooms and an “expansive master suite with two full baths and dressing room,” the stately Georgian mansion (left) is a “grand residence” that “exudes the essence of Kalorama sophistication,” according to the Web site of Jim Bell, the listing agent. The home was purchased from Hani Masri, a Palestinian-American businessman and a major supporter of Hillary Clinton’s presidential campaign, and his wife Cheryl, according to a person familiar with the deal. The Kalorama neighborhood is home to such D.C. big wigs as Massachusetts Sen. Ted Kennedy and former Defense Secretary Don Rumsfeld.

A spokesman for Rattner and his former private-equity firm, Quadrangle Group, declined to comment. Tom Anderson, President of Washington Fine Properties, which represented both the buyer and seller, declined to comment.

Rattner, a former investment banker who reached No. 2 at Lazard, was one of the administration’s wealthiest officials. His financial disclosure put his net worth at between $188 million and $620 million. In addition to his new Washington manse, Rattner owns an apartment on Fifth Avenue across from the Metropolitan Museum of Art, a horse farm in North Salem, N.Y., and a summer home in Martha’s Vineyard, Mass. (More Rattner real-estate trivia: Before his move on up to the Upper East Side, he and his family lived crosstown in The Dakota, the landmark Upper West Side building knownmade famous by John Lennon’s assassination.)

The official owner of Rattner’s new house in D.C. is David A. Deckelbaum as Trustee, according to real-estate records. Deckelbaum, a Washington, D.C., lawyer, frequently serves as trustee for multimillion-dollar home purchases in the area by owners who wish to remain anonymous, according to Washington residential real-estate brokers familiar with his work. The trustee’s address is listed as 375 Park Ave. in New York City, the same address as Quadrangle, the firm Rattner co-founded and left earlier this year after accepting the government post.

Deckelbaum declined to comment. The news of Rattner’s home purchase was reported Thursday by the PE Hub blog.

In recent weeks the New York Attorney General’s office has intensified scrutiny of Rattner and Quadrangle Group in connection with “pay to play” scandals involving private-equity firms and pension funds. There is no indication of a connection between the stepped-up scrutiny by the Attorney General and Rattner’s decision to leave his White House post.

It is possible Rattner will be back to D.C. in the near future. Earlier in the week, Geithner said he hoped Rattner “takes another opportunity to bring his unique skills to government service in the future.”

Using Garbage to Measure Consumption

To solve the so-called equity premium puzzle, one researcher has gone digging through the garbage.

A better way to measure consumption? (Getty Images)

In a forthcoming paper in the Journal of Finance titled “Asset Pricing with GarbageUniversity of Chicago graduate student Alexi Savov makes the case that the amount of rubbish we produce is a better (i.e. more volatile) measure of consumption than traditional tools, and that helps explain why investors demand such a high premium for stocks over bonds. (That’s government bonds, not “junk” bonds, of course.)

The equity premium puzzle has been festering unsolved in economic circles since the 1980s. The puzzle is this: economists can’t adequately explain why investors demand such high-risk premiums to own volatile stocks over relatively steady bonds. The risk premium for stocks over bonds in the long term is about 6%. But 6% seems like too big a premium to economists.

In theory, one way to explain the premium would be to look at consumption, a broad measure of wealth. People should demand a premium from an investment that goes down when consumption goes down. That’s because the alternative — bonds — hold on to their value when consumption declines. Another way to put it: When you are making lots of garbage, you are rich. When you stop making garbage, you are poor. Unlike bonds, which continue to pay out whether you produce lots of garbage (and are rich) or not, stocks are likely to lose their value during bad times. Therefore, investors should want a large reward for putting their money in something whose value decreases at the same time as their overall wealth decreases.

The problem among economists has been that the accepted measure of consumption doesn’t show enough of a correlation to stocks to explain the premium. In theory, consumption and stock prices should move up and down in tandem. But consumption as measured by the government (personal expenditure on nondurable goods and services category of the National Income and Product Account), just doesn’t fluctuate very much. “Consumption changes were so minor it didn’t explain why they were demanding such a high premium from stocks,” Mr. Savov says. The relatively low volatility of consumption implies that people are as frightened of stocks as someone who refuses to leave home for fear of being hit by a brick falling from the sky.

But using garbage as a proxy for consumption works better. Garbage production is more volatile – like the stock market — and goes a long way to show why the premium investors demand is rational. If consumption goes up and down a lot, then people want to be compensated a lot for buying assets that go up and down in tandem with that consumption. The garbage data in the U.S., for instance, tracks stock performance twice as well as the government’s consumption data. (The U.S. data has a correlation of 60%, while the government consumption data tracks at 30%.)

Mr. Savov, 26, moved to the U.S. from Bulgaria as a teen, and is now in his final year as an economics Ph.d candidate at the University of Chicago. He verified his idea with garbage statistics from 19 European countries and Japan. Japan had the highest correlation of garbage output to stock market performance of around 90%. “They have very strict laws on disposal and have good data on it because of the strict regulation,” he says.

In case any one gets the idea to start a garbage-related hedge fund, Mr. Savov says don’t bother. “By nature, you see garbage after the consumption, so it’s not really a predictor of anything,” he says.

The source data in the U.S. for Mr. Savov’s work is Environmental Protection Agency records going back to 1960. They include all types of garbage, including the recently trendy recycling categories of paper, plastics and cans. There’s also food and yard waste.

A Look Inside Fed’s Balance Sheet — 7/16/09 Update

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The Fed’s balance sheet expanded for the first time in three weeks, rising back over $2 trillion. Direct-bank lending rose after posting declines in the four previous weeks, though the increase was relatively small. A bigger contribution came from a more than $5 billion boost in the Term Asset Backed Securities Loan Facility, which is aimed at spurring consumer lending but hasn’t been used nearly as much as originally envisioned. The largest expansion in the balance sheet came through purchases of Treasurys, agency debt and mortgage-backed securities. The Fed started a program in March to ramp up such acquisitions in order to push down long-term interest rates low. Since that time the makeup of the balance sheet has shifted substantially, with less direct emergency lending to banks and more holdings of debt. Central bank liquidity swaps increased for the first time in 14 weeks, but still remain lower than crisis levels reached soon after the collapse of Lehman Brothers.

In an effort to track the Fed’s actions, Real Time Economics has created an interactive graphic that will mark the expansion of the central bank’s balance sheet. Every Thursday afternoon, the chart will be updated with the latest data released by the Fed.

In an effort to simplify the composition of the balance sheet, some elements have been consolidated. Portfolios holding assets from the Bear Stearns and AIG rescues have been put into one category, as have facilities aimed at supporting commercial paper and money markets. The direct bank lending group includes term auction credit, as well as loans extended through the discount window and similar programs.

Central bank liquidity swaps refer to Fed programs with foreign central banks that allow the institutions to lend out foreign currency to their local banks. Repurchase agreements are short-term temporary purchases of securities from banks, which are looking for liquidity and agree to repurchase them on a specified date at a specified price.

Click and drag your mouse to zoom in on the chart. Clicking the check mark on categories can add or remove elements from the balance sheet.

Bank Investing: The Law Of Unintended Consequences

It’s not just private equity firms that are new to bank investing that are displeased with proposed Federal Deposit Insurance Corp. guidelines governing how they can do deals. Long-time, proven investors in financial institutions are also upset.

fdic_E_20090716164328.jpgBloomberg News

In a comment letter regarding the proposed rules, veteran bank investor Banc Funds Co. says the proposal might well inadvertently affect its deals.

Charles Moore, president of the Chicago-based firm, says in the letter that Banc Funds has been investing primarily in community banks since 1986 and has traditionally capped its ownership interests at 9.9%.

“We have exercised no control over any of those companies,” Moore writes. “We have neither sought nor accepted board seats, management roles, special voting covenants, veto control over management actions, solicited proxies, or joined a voting group.” Additionally, he writes, the firm invests directly from its funds, and not via more controversial silo structures.

The approach is different from that of many other private equity firms, which typically seek control so that they can effect operational changes – a distinction Moore acknowledges in his letter. “The pool of bank investors in the United States is not homogeneous, and the pool of private equity investors is not homogeneous,” he writes. He wasn’t available for comment.

Moore suggests the FDIC should differentiate between firms like his and others that take bigger stakes in banks. “We would request that you include a brightline test delineating which investors will be subject to the qualifications and associated responsibilities,” he writes, suggesting that investors with a less than 9.9% interest should be exempt from the requirements.

Without the exemption, minority investors would find their ability to invest “eliminated,” the letter says. “The proposed qualifications would be very onerous for us.”

You can see all comment letters on the proposal here. The comment period ends Aug. 10.

Paulson’s Version of Financial Armageddon: ‘People in the Streets’

It is amazing how leaving government can loosen the tongue.

“Cats and dogs, living together….”

Former Treasurer Secretary Henry Paulson was on Capitol Hill today for the first time since leaving office in January. He was there to defend the Bush administration’s response to the financial crisis generally and, more specifically, his role in ensuring that Bank of America closed its $50 billion acquisition of Merrill Lynch.

Amid his testimony, Paulson admitted that as the global financial crisis unfolded he had been apprehensive about telling people what he really thought would happen if the federal government didn’t prop up the financial system because he didn’t want to frighten the public further and exacerbate the crisis.

“Well, now take the opportunity to scare people,” Rep. Paul Kanjorski implored Paulson. “Tell them the truth. I mean, we’ve got to deal with the American people now and some of our fellow members who think that this was a facade of some sort, that it didn’t really happen.”

OK, Congressman, you asked for it. What follows is the former Treasury secretary’s somewhat stream-of-consciousness take on just how close he felt the U.S. came to the economic precipice back in the summer of 2008:

“If you have a situation where a banking system is frozen and money can’t move between financial institutions, what ultimately happens is that every business, even businesses that seem to be solvent and small businesses across America, will not be able to fund their inventory. They won’t be able to meet their payroll. You will have a–when a financial system breaks down, the kinds of numbers that we were looking at in terms of unemployment was much greater than the numbers we’re looking at now. People in the streets and, of course, around the world–it is very significant because I remember talking about, for instance, German leaders who were explaining to me that people in the old east were unhappy with the big discrepancies in wealth, but they at least believed in the system and believed in some form of market-driven capitalism, but that if we had a meltdown of the system, this could even lead to chaos or people even questioning the basic system…

I had some people say, well, listen, look at everything that’s been in place since the Great Depression; we can’t have that, you know, we certainly couldn’t go through that again. I looked at it the opposite. What I looked at in a world where information can flow, money can move with the speed of light electronically. I looked how fast this liquidity went. I looked at the ripple effect. I looked at how, when a financial system fails, a whole country’s economic system can fail.

I believe we could have been–gone back to the sorts of situations we saw in the Depression. I remember asking [Federal Reserve Chairman] Ben Bernanke what he thought the world would look like, and he said, well, just take a look at what happened in the Depression. But I didn’t spend a whole lot of time thinking about that because I knew it was going to be very bad, and I never wanted to experience very bad.”

Plans to Postpone Retirement Often Fail to Pan Out

Even though Americans may want to postpone retirement as they face decimated portfolios, circumstances often force them out earlier.

Research from the Employee Benefit Research Institute finds that while 26% of people expect to retire before the age of 65, 72% actually leave the work force before reaching 65.

A loss of savings caused by the financial crisis has led more and more people to say they will delay retirement. About a quarter of respondents to an EBRI survey said they expect to postpone retirement. The data show that even though Americans are retiring earlier than they expect, more are leaving the work force later in life — with a median age of 62 in 2003 compared to 59 in 1991.

The phenomenon could have wide implications for the economy. More people staying in the work force could further delay recovery in the struggling labor markets. The move doesn’t have to be a net negative, though. Most of the money earned from working later in life is likely to go to savings, but delaying the move to a fixed income also could allow Baby Boomers to consume more while they remain employed.

The EBRI data, though, reminds us of the important lesson about the best laid plans of mice and men. The survey indicates that circumstances often force workers into retirement. Health problems or disability caused 42% of respondents to leave the work force early, while 18% had to care for a spouse or another family member.

Another problem of the current recession is that while many may want to work longer, their employers have other plans. More than 30% cited changes at their company, such as downsizing or closure, as the reason for retiring early.

Regulatory Viewpoints: Private Equity Vs. Venture Capital

The private equity and venture capital industries may be as different as night and day, but on one thing they’re basically agreed: Neither poses a systemic risk to the financial system.

That’s why it’s so curious that private equity firms are supporting - sort of - Obama Administration legislation that would require all private funds with assets of more than $30 million to register with the Securities and Exchange Commission, while the venture capital industry continues to vigorously oppose it.

tresnowski_A_20090716124607.jpgBloomberg News
Mark Tresnowski
loy_A_20090716125710.jpgBloomberg News
Trevor Loy

Compare and contrast the following language from Mark Tresnowski, managing director at buyout firm Madison Dearborn Partners, and Trevor Loy, general partner with venture investor Flywheel Ventures, who were representing their industries at Senate hearings yesterday to discuss the proposed legislation. Their comments are remarkable for their similarity, and leave me wondering whether the two industries might have more weight if they were to combine their legislative efforts to push for the same ends, rather than working at cross-purposes.

On leverage:

MT: PE firms have limited or no leverage at the fund level. PE funds do not rely on short-term funding.
TL: Venture capital firms do not use long-term leverage or rely on short-term funding.

On interconnectedness and risk:

MT: PE firms are not deeply interconnected with other financial market participants through derivatives positions.
TL: Venture capital firms are not interdependent with the world financial system.

On whether or not their industries pose systemic risk:

MT: PE does not have the potential to create the kind of systemic shocks that contributed to the financial crisis. Therefore we do not believe this form of investment poses significant concerns in the context of the financial regulation debate.
TL: In light of the financial meltdowns of the past year, we believe that Congress has a right and duty to examine regulatory policy to protect investors from systemic risk…We agree that those entities and industries which could cause financial system failure should be better monitored so that the events of 2008 are never repeated. However, venture capital is not one of those industries.

Given all that, it’s weird that they diverge on the next, key point, which is whether or not registration makes sense. The private equity industry generally supports requiring firms to register even as it denies that it’s necessary, but wants concessions made within that framework, depending on the size of the firm and the burden posed by registration. The venture industry, meanwhile, argues that any registration is too much, and wants to be excluded from that requirement entirely:

MT: We generally support the registration requirements contemplated by the Administration and S. 1276…Given the fact that PE firms are not a cause of systemic risk, these additional regulatory requirements are arguably unnecessary. That said, we are mindful of the fact that excluding any asset class from the new regulatory regime could contribute in some way to diminishing confidence in the effectiveness of the new regulatory regime and therefore we support the casting of a wide net…we do believe Congress should direct regulators to be precise in how new regulatory requirements are calibrated so the burdens are tailored to the nature and size of the individual firm…We believe the Administration’s financial reform plan strikes a good balance between regulating PE while still allowing it to play its historically valuable role in making American companies stronger and more competitive.
TL: We do recognize the need for transparency into our activities and, in that spirit, venture firms have provided information to the SEC for decades [via Form D filings]. We believe this information remains sufficient to meet the need for transparency without burdening our firms with additional regulations that do not further the understanding of systemic risk…Using the Advisers Act brings layers of additional regulatory requirements that can prevent us from focusing our time and financial resources on helping to start and grow new companies.

One More Cost of the First Data Buyout: 500 Citigroup Jobs

Ah, how the chickens of the leveraged buyout bust are coming home to roost for Citigroup.


Consider Citigroup’s history with First Data, the data processor that was bought out by private-equity giant Kohlberg Kravis Roberts at the height of the LBO bubble.

Citigroup underwrote much of the debt financing for KKR’s $28 billion buyout of First Data, then was stuck with some of the souring loans on its balance sheet when it couldn’t syndicate them. It is unclear exactly what Citigroup’s losses were on the loans. Some estimates shortly after the deal was completed in September 2007 said Citigroup and other lenders took a $2 billion hit, at least.

Here is the latest twist: In an effort to save money, the struggling Citigroup said Wednesday it is outsourcing about 500 data-processing jobs to none other than First Data. The affected jobs are in Citigroup’s U.S. receivables-management business. First Data said it would hire the displaced Citigroup employees.

Meantime, investors are left to ponder whether Citigroup would still need to outsource these jobs if the bank had steered clear of risky buyout deals, like First Data.

A Readers’ Guide to the Econ Blogosphere

Americans trying to understand the financial crisis are flocking to a surprisingly lively source of enlightenment: blogs written by economists. The Wall Street Journal’s economics bureau chose the top 25 economics blogs and include five honorable mentions. We confined ourselves to blogs that are free and focused on straight economics commentary.

We haven’t included any of the many excellent market-focused blogs, including Felix Salmon of Reuters and Barry Ritholtz’s Big Picture, or blogs that tend to look more closely at politics and policy, such as Ezra Klein at the Washington Post as well as Noam Scheiber and Zubin Jelveh at The New Republic’s the Stash. We also left off some fun blogs, like Ecocomics or Parentonomics that are specialized and primarily focused on entertainment.

The econ blogosphere is growing every day, with a plethora of interesting and informative content. This isn’t meant to be the definitive list, but should represent a good starting point. We encourage you to get out there and explore. You’ll be glad that you did.

Secondary Sources: Fed Minutes, Recession Not Over Yet?

A roundup of economic news from around the Web.

  • Meeting Minutes: On the Atlanta Fed’s macroblog, David Altig pulls the important news from the Fed’s minutes. “The Fed’s balance sheet is likely to get bigger before it gets smaller, but it will get smaller. The planning for managing to a smaller balance sheet is under way. Whatever the future brings for the balance sheet, the time has not yet come to remove policy accommodation—either by adjusting the federal funds rate target, by removing the backstop of most liquidity programs, or by making adjustments in the FOMC’s asset purchase programs (described here, here, and here). With respect to those asset purchase programs, the point is to improve “market functioning,” not target long-term market interest rates.”
  • Recession Not Over: Writing for BusinessWeek’s Economics Unbound, Peter Coy offers five reasons the recession isn’t over. “UNEMPLOYMENT: Consumers won’t start shopping again in earnest as long as the unemployment rate is at 9.5% and threatening to break into double digits. People who are out of work can’t spend, and people who fear being out of work won’t spend. SPARE CAPACITY: Companies won’t hire or buy equipment as long as they have lots of slack. Today’s industrial production report revealed that the U.S. industrial capacity utilization rate fell in June to 68%, the lowest since recordkeeping began in 1967. World Bank Chief Economist Justin Lin said today in South Africa that unless global overcapacity is reduced, “we will face a deflationary spiral and the crisis will become protracted,” according to Bloomberg. DEBT: As I’ve written, household debt soared from two-thirds of GDP in the early 1990s to 100% at the end of 2008. Simply getting debt back to three-quarters of GDP, the level of 2001, would require paying off 25% of all outstanding household debt, $3.5 trillion worth. Paying down debt gets even harder when GDP is falling—that’s Keynes’s paradox of thrift. BOND VIGILANTES: If fixed-income investors get nervous that the government’s massive deficit spending will push up inflation, they will sell bonds and drive up interest rates. That would be a huge setback for homebuying, car sales, and other rate-sensitive sectors. DOUBLE DIP: Even if the gross domestic product rises in the current July-September quarter—and it might—output could very well fall again in the fourth as the effects of the stimulus tax cuts begin to fade.”

Compiled by Phil Izzo

The Morning Leverage: Testing The Financial System

In this morning’s media roundup:

News: CIT Group said yesterday “there is no appreciable likelihood” of fresh government support for it. As our colleagues at the Wall Street Journal write, “What happens next will be a major test of whether the financial system and economy are sufficiently healed to absorb CIT’s problems.” Click here for an analysis of just how bad CIT’s loan portfolio really is and here for our look at the problems a CIT bankruptcy could pose to the mid-market private equity world.

Is Brynwood Partners’ decision to shut Stella D’Oro’s Bronx plant half-baked? The Huffington Post reports on various attempts by the company’s union to fight the move.

Jim Spanfeller, chief of Elevation Partners-backed, is stepping down in the latest shakeup in the financial publishing world. Our colleagues at All Things Digital have the memo.

Huntsman Gay Global Capital joins the exclusive club of debut funds that have been able to raise capital in this environment, closing its new fund at $1.1 billion. Like another debut fund we recently reported on, Huntsman Gay attributed part of its success to the rather large $100 million commitment to the fund by its own partners. Read the LBO Wire story.

Blackstone Group is facing some community protest over three coal-fired power plants its Sithe Global Power portfolio company is building. Protesters say the plants don’t make environmental or economical sense. Here’s the LBO Wire story.

Opinion: Olivier Sarkozy and Randall Quarles of the Carlyle Group have taken the private equity industry’s quarrel with proposed new FDIC rules governing private investment in banks to the op-ed pages of the Wall Street Journal. Taking issue with the “super-capital” rule, the “source of strength” rule and the “cross-guarantee” rule, they write that “any one of these requirements would pose a substantial deterrent to private investors. Together, the three would dramatically reduce the amount of capital that the FDIC could attract to its auctions of failed banks.”

Analysis: BusinessWeek takes a look at the time bomb lurking in corporate debt - an issue that makes the PE industry especially queasy. It says economists are worried by the thought that the corporate default rate could remain high for an extended period of time - a change from previous recessionary patterns.

Just for fun: Guess the financial bust, over at FT Alphaville.

CIT Group may not be too big too fail, but this sheep is.

Zannino on CCMP: We’re Both Hard-Driving But Not Loud About It

CCMP Capital Advisors LLC today announced that Richard Zannino has joined the firm as a managing director and co-head of consumer, retail and media. Zannino is the former chief executive of Dow Jones & Co., the publisher of this blog, and also has worked in senior positions at Liz Claiborne Inc. and Saks Fifth Avenue. Since leaving Dow Jones after the company’s sale to News Corp., he has worked on a few real estate and private equity projects, spent time on some charities, and enjoyed some quality family time. We spoke to him and to Jonathan Lynch, managing director and head of investor relations, about the new position and what the future holds for CCMP.

Why are you getting into private equity, and why CCMP?
[After leaving Dow Jones], I had a number of offers to go back to work but I was really waiting for the right thing. When I was thinking about what I wanted to do next and inventorying my career, which includes broad industry and job experience, private equity felt like a very natural next step to me. [As for CCMP,] it’s an opportunity to work with great world-class people with a very disciplined approach to investing which mirrors my own. The firm has been a net seller over the last couple of years, liquidating $6 billion worth of capital and only putting $1 billion to work in that time period of frothy multiples and high prices. CCMP’s approach of operating improvements was very appealing to me as an operating person, and culturally I found the firm very compatible in terms of value, work ethics and style - we’re both ‘hard-driving but not loud about it.’ I met Chairman Greg Brenneman and Chief Executive Stephen Murray through a mutual friend at a gathering in early May and we took it from there.

Your new post is co-head of consumer, retail and media. What’s your outlook for these sectors?
I think change and disruption always creates opportunity, right? Given where the economy is, there’s an opportunity for us to invest in companies with cyclically low earnings and relatively low purchase price multiples, in a market where we see more and more companies with a reason to sell - financial distress, liquidity needs, a wish to take money off the table. All that combines to make it a pretty good market to be a buyer in.

What’s the split between focusing on the operations of existing portfolio companies and looking for new ones?
My mix of responsibilities here will be 50% working with existing portfolio companies and 50% helping source, evaluate and execute transactions. Fortunately CCMP has a very solid portfolio, unlike some others in the private equity business, so there aren’t a lot of problems to work on. The idea is to invest in businesses where we can help drive improved operating performance. We’re in the bidding process on Eddie Bauer, and I hope to contribute there.

It’s been a case of all quiet on the private equity front when it comes to M&A for some months. What’s the firm’s take on when things will pick up?
Jonathan Lynch: It’s primarily a function of trends in the economy generally. People don’t want to make decisions until there’s visibility, and uncertainty still reigns in the market, which puts a pretty big damper on deal-making. Companies that don’t have to sell, that have time to evaluate when they want to come to the market - their plans won’t change in the near future. But there are significantly over-levered companies that need to have a capital solution. Those companies will continue to come to market. That said, I don’t think the deal market’s going to become meaningfully more active in the near future. You’re going to have to go out and hunt for those companies that you want to own. We like that - it fits our strategy.

Tips For Raising A Debut Fund: Big GP Commitment Helps


As reported in LBO Wire this morning, oil and gas-focused private equity firm White Deer Management LLC has defied the tough odds facing debut managers in the current economic climate.

It has held a $301.5 million first closing of its debut fund, taking the fund nearly halfway to a $750 million target, according to a Securities and Exchange Commission filing.

Debut fund managers face a tough road in a fund-raising environment in which even established firms are having trouble securing capital from cash-strapped investors. But White Deer has several things going for it.

For one, co-founders Ben Guill and Tom Edelman have long track records in their chosen industry. Guill hails from First Reserve Corp., a well-respected energy-focused private equity firm, while Edelman held senior executive positions at large energy companies including Biofuel Energy Corp. and Patina Oil & Gas Corp., both of Denver.

Perhaps more importantly in the current environment, the firm’s own managers proved willing to put their money where their mouths are. White Deer’s general partners chipped in some $100 million of their own money to the fund, representing a hefty 13% of its target, according to prospective investors.

The firm plans to invest the new fund in mid-size oil and gas exploration and production companies, as well as in energy infrastructure and companies that service the oil and gas industry. Its investment strategy is akin to funds that First Reserve raised back in 2000 and 2001, when that firm had a heavier emphasis on oil and gas and before it pushed deeper into renewables and other subsectors of the energy industry.

For more, read the LBO Wire story.