Economic Trends

Fed’s Interest Rate Policy Not Helping Small Business

2009-12-15T06:06:00.000-08:00

The Federal Reserve’s interest rate policy is actually making it more difficult for small businesses to obtain bank loans. While the Fed has lowered their funds rate to 0% - 0.25% ostensibly to stimulate loans and kick start the sagging economy, the funds have not found their way to the Mainstreet economy. The reason is quite simple. Banks can borrow from the Fed at these record low rates of interest and then purchase U.S. Treasury bills and bonds which carry no risk of default. At this time, the spread between bank’s borrowing cost and the yield on the 10-year U.S. Treasury bond is roughly 3.4%. With the prime interest rate (the rate charged to most credit worthy customers) now at 3.25%, it makes little sense for banks to lend to businesses incurring greater risk and adding little to their bottom line. Ernie Goss

Federal Spending on Steroids

2009-12-13T14:55:00.000-08:00

Today, the U.S. Senate approved a $1,100 billion (that’s $1.1 trillion) spending bill. The measure, a year-end package that covers about half of all federal programs for the rest of the year, goes to President Barack Obama for his signature. Included in this spending program were 5,244 earmarks for law makers’ pet projects. Relative to the overall economy, this year's spending and debt will be the largest incurred by the nation since 1946. This is after the federal government spending advanced by 8.3 percent in Quarter 3 of 2009 and 11.4 percent in Quarter 2 of 2009. As a result of this out of control spending, federal legislators will raise the debt ceiling from its current level of $12.1 trillion to $14 trillion this next week. As White House Chief of staff Rahm Emanuel recently said, “You never want a serious crisis to go to waste.” Unfortunately, this rapidly increasing federal spending will create its own crisis. Ernie Goss

When Will Job Losses End?

2009-11-30T19:36:00.000-08:00

When will the nation begin to add jobs and is the stock market getting ahead of the economy? Since 1950, the U.S. economy has suffered 10 recessions with a median length of 10 months. On average, the nation did not begin adding jobs until 3 months after the end of the downturns. Normally the longer the length of the recession, the shorter the period before the economy begins adding jobs.

Furthermore, the stock market began rising, on average, approximately 4 months before the end of the recession. Thus if history is a guide, the economy will continue to experience stock market gains and the number of jobs should begin to increase in the first quarter of 2010. Unfortunately, the lack of clarity from policy makers is undermining the willingness of businesses to hire new workers and could delay new hiring and puncture stock market gains. The top need of consumers and businesses---public policy certainty. This will cure what ails the economy. Ernie Goss

Rural Mainstreet Economy Still in Recession: Annualized Job Losses Exceed 5 Percent

2009-11-21T13:42:00.000-08:00

· Job losses for Rural Mainstreet continue at an annualized pace exceeding 5 percent.
· The Rural Mainstreet Economy has yet to rebound.
· Bankers expect 2009 crop income to be down less than livestock income.
· Over 98 percent of bankers think the nation’s 20 largest financial institutions should pay the cleanup costs related to “too-big-to-fail” policies.

For a third straight month the overall index for the Rural Mainstreet economy expanded, but continued to indicate significant economic weakness, according to the November survey of bank CEOs in an 11-state region.

The Rural Mainstreet Index (RMI), which ranges between 0 and 100, advanced to 38.4 from October’s 37.5 and September’s 36.5. A reading of 50.0 is considered growth neutral.

“The RMI has remained below growth neutral for 21 consecutive months. The decline in farm income related to pullbacks in agricultural commodities from last year continues to weigh on the rural, agriculturally dependent economy,” said Creighton University economist Ernie Goss. Goss and Bill McQuillan, CEO of City National Bank in Greeley, Neb., created the monthly economic survey in 2005.

This month, bankers were asked to compare estimated 2009 farm income from crops and livestock to that in 2008. On average, bank CEOs expect crop income to be flat from last year and project livestock income to be down by 5 percent from last year. “This is a much better outlook than the one provided by the U.S. Department of Agriculture that projects 2009 farm income will be down by almost one-third,” reported Goss.

However, many bankers such as Tom Boyer president of Farmers State Bank in Fairmont, Neb., indicate that it is too early to accurately gauge farm income. Scott Tewksbury, CEO of Heartland State Bank in Edgeley, N.D., said, “Crop income levels are a little hard to judge because of the delayed harvest. November weather has been good, and the harvest of row crops is progressing quickly.”

The downturn in farm income has negatively affected both farmland prices and sales of farm equipment. The November farmland-price index rose to a weak 45.6 from 43.0 in October. This was the 13th straight month that the index moved below growth neutral. The farm equipment-sales index advanced to 39.9 from 36.7 in October. “Farmers are a lot more cautious in their purchases of farm equipment than they were in early 2008,” said Goss.

Recent data indicating that the nation’s jobless rate topped 10 percent had a negative impact on the monthly confidence index, which tracks bankers’ economic outlook six months from now. That index fell to 50.1 from October’s 58.7.

Hiring in rural areas remains well below growth neutral. The new-hiring index rose to 36.3 from 35.6 in October and 27.0 in September. This is the 23rd consecutive month that the index has been below growth neutral, due in part to the national and global recessions and weakening farm income from much lower agricultural commodity prices. “Job losses on an annualized basis are more than 5 percent for the Rural Mainstreet economy. Over the past 12 months, the region that we survey has lost almost 265,000 jobs. Recent surveys indicate that these job losses are likely to continue for the near term,” said Goss, the Jack A. MacAllister Chair in Regional Economics at Creighton.

Like much of the nation, retail sales were less than healthy for the month, with an October retail-sales index of 38.5, up modestly from October’s 36.0.

Just like the recently released national housing data, home sales for Rural Mainstreet were not good for November. The November home-sales index slumped to 43.1 from 46.7 in October. But some bankers were more positive. However, according to John Schmaderer, president of Tri-County Bank in Stuart, Neb., “The homebuyer’s tax incentives, combined with low mortgage rates, continue to provide strength to the local housing market.”

This month, bank CEOs were also asked who should pay the added cost of federal financial bailouts related to “too-big-to-fail (TBTF)” policies. Over 98 percent indicated that the cost should be paid by the 20 largest financial institutions in the nation. Less than 2 percent thought the taxpayer, or the overall banking industry, should cover the costs. As expressed by Ken Henstorf, president of First National Bank of Shenandoah, Iowa, “We need to continue differentiating community banks from the TBIF institutions and especially the non-banks in our market.” Henstorf expects TBTF to be a defining issue going forward.

On a related matter, John Nelsen, president of First Tier Bank in Holdrege, Neb., said “We need all banks to participate equally in funding the FDIC assessment, dollar for dollar, with no exceptions. This will prepare us for a failure of one of the TBTF institutions which will surely occur.”

Others such as Larry Winum, president of Glenwood State Bank in Glenwood, Iowa, argue that the TBTF institutions need to be downsized so that they no longer pose a systematic risk to the economy.

Rural Mainstreet bankers say they are getting mixed messages from the federal government regarding lending. The Treasury Department is encouraging increased lending while bank regulatory oversight is negatively affecting lending by the banks. As a result, the November loan-volume index declined to a record low 38.3, down from October’s already weak 42.4.

For November, the checking-deposit index soared to 66.4 from October’s 61.0. The index for certificates of deposit and other savings instruments inched lower to 50.9 from 51.7 in October.

Each month, community bank presidents and CEOs in nonurban, agriculturally and resource-dependent portions of the 11-state area are surveyed regarding current economic conditions in their communities and their projected economic outlooks six months down the road. Bankers from Colorado, Illinois, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota and Wyoming are included.
Ernie Goss

A Weaker Dollar Is Beneficial

2009-11-15T12:55:00.000-08:00

Since March of this year, the value of the dollar, relative to the currencies of the US’s major trading partners, has sunk by almost ten percent. This downward movement has produced the usual hyperbole from chattering political leaders. For example, Timothy Geithner repeats the mantra that a strong dollar is very important to a healthy US economy. http://economix.blogs.nytimes.com/2009/11/12/the-great-shrinking-american-dollar/ However, the benefits of a weaker dollar, within a range, cannot be ignored.

For example, a deteriorating dollar encourages foreign firms to expand or to locate facilities in the US. Recently Christof Romp, head of the turbine division of a German machinery manufacturer, stated that, “If the dollar carries on declining, we might be forced to move more of our production to the US.” http://online.wsj.com/article/SB125809667186946819.html

Furthermore, a weaker dollar makes US goods sold abroad cheaper strengthening US manufacturing and farming. Since the fourth quarter of 2007, the US trade deficit has plunged by more than 50 percent. A large share of this decline was due to a softer Us dollar. It is certainly politically appealing to rail against the dollar decline. Such arguments, however, are not grounded in economic reality.
Ernie Goss

Liberals Economic War on the Productive

2009-11-13T13:48:00.001-08:00

U.S. Senator Majority leader Harry Reid is considering attaching a Medicare tax on workers making more than $200,000 to help fund health care reform. Reid, of course, fails to recognize that these individuals will already be paying confiscatory rates on their income in 2011. In 2011, the Bush tax cuts expire pushing the capital gains rate from 15 to 20 percent and the top marginal rate from 35 percent to 39 percent. Combine that with the 5.4 percent surtax on those making more than $500,000 contained in the House version of the health care reform bill, means that liberals are serious about punishing work and rewarding indolence.

According to the Wall Street Journal, http://online.wsj.com/article/SB10001424052748704402404574527781844595304.html these actions represent a 69 percent hike in taxes for the more productive or high income workers and small business owners. Tacking federal taxes on to state income taxes means that many individuals will be paying between $0.50 and $0.55 in income taxes for each dollar earned. These tax increases threaten the strength of the economic recovery as these higher income workers decide to spend a little more time at the lake and a little less time at the job. Ernie Goss

Did Buffet Get Burned on BNI?

2009-11-09T16:58:00.000-08:00

Last week Warren Buffet announced that his company, Berkshire Hathaway (BRK) would buy the remaining 77 percent of Burlington Northern Santa Fe Corp. (BNI) that he didn’t already own for $100 per share.

Based on the stock prices of two of BNI’s competitors, Union Pacific (UNP) and CSX Railroad, BNI’s stock should be selling for $82 per share. Furthermore, based on Buffet’s bid, UNP should be selling for $76, well up from today’s closing price of $62. So either the analysts following BNI, and UNP are wrong, or Buffet has made a huge mistake. It has been advanced that Buffet is betting on the relative efficiency of railroad to trucking and/or on a U.S. economic expansion. But these explanations do not add up since, in order to consummate the purchase of BNI, Buffet agreed to sell his Union Pacific stock whose earnings are expected to grow at triple the rate of BNI over the next five years.

Given that last year, almost half of BNI’s tonnage was coal and BRK owns coal fired electricity producing Mid-American Energy, Buffet is essentially doubling down his bet that the current anti-coal, growth hostile cap & trade bill before the U.S. Senate will die a deserved death. Ernie Goss.

Cap & Trade: Europe’s Experience Should Be a Warning

2009-11-01T15:52:00.000-08:00

Europe’s recent economic performance shows how “cap and trade” will likely affect the U.S. economy if Congress passes this legislation currently before the body. In 1997, Europe adopted emission reduction goals outlined in the Kyoto carbon targets, termed the Kyoto Protocol. That year, Republican congressional leaders declared the Kyoto Protocol “dead on arrival” in the US Senate. In response, the Clinton administration chose not to defend the Protocol. Instead, the White House announced that, until other key developing countries signed on, the Protocol would not be sent to the Senate. Subsequently, the Bush Administration remained steadfastly opposed to Kyoto for both presidential terms. Now the Obama Administration, in attempt to reduce carbon emissions paralleling that of Kyoto, is backing a cap & trade bill. However, Europe’s economic experience since 1999 provides US Congressional Representatives, Senators and President Obama with real evidence to reject this anti-growth measure.
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From 1999 to 2008, a period marked by Europe’s carbon limitation program, Europe’s inflation adjusted economy grew by 19.0 percent while the US’s GDP expanded by 23.5 percent. In fact if the US grew at the same pace as Europe during this period, US GDP would have been $500 billion less in 2008. In terms of unemployment rates, the comparisons are even more startling. From 1999 to 2008, the average unemployment rates were 8.3 percent in Europe and 5.0 percent in the US. In 2008 if the US jobless rate matched that of Europe, another 4.2 million Americans would be jobless searching for work.

While the gap in US and Europe economic performance since 1999 cannot be pinned solely on carbon emissions programs, Europe’s relative economic lethargy should be a warning to lawmakers considering cap and trade legislation---vote no on this measure. European vacations and wine are just fine, but their carbon emissions sensibilities should not be imported into the US if US economic growth is to be supported.
Ernie Goss.

No Economic Recovery For Rural Mainstreet: Bankers Expect Drop In Holiday Sales

2009-10-15T18:26:00.000-07:00

October Survey Results at a Glance:
· The Rural Mainstreet Index advanced for a second straight month.
· Bank CEOs expect holiday retail sales to shrink by 1.5 percent from last year.
· Farm equipment sales decline again.
· Over three-fourths of bankers support an extension and/or expansion of the tax credit for first-time homebuyers.
· Six of ten bankers report their FDIC premiums are up more than 250 percent from last year.

For a second straight month, the overall index for the Rural Mainstreet economy expanded but continued to indicate significant economic weakness, according to the October survey of bank CEOs in an 11-state region.

The Rural Mainstreet Index (RMI), which ranges between 0 and 100, advanced to 37.5 from 36.5 in September. A reading of 50.0 is considered growth neutral.

“The RMI has remained below growth neutral for 20 consecutive months. The decline in farm income continues to weigh on the rural, agriculturally dependent economy with few signals that the economic downturn is coming to an end,” said Creighton University economist Ernie Goss. Goss and Bill McQuillan, CEO of City National Bank in Greeley, Neb., created the monthly economic survey in 2005.The downturn in farm income has negatively affected both farmland prices and sales of farm equipment. The October farmland price index rose to a weak 43.0 from September’s 41.1. This was the 12th straight month that the index moved below growth neutral. The farm equipment-sales index slipped to 36.7 from September’s 38.6.

However, there are pockets of very strong farmland sales. As reported by Larry Rogers, CEO of the First Bank of Utica in Utica, Neb., farmland in his area recently sold for $6,650 per acre, indicating a very strong market for farmland.

Recent positive national economic news and record low interest rates propelled the confidence index, which tracks bankers’ economic outlook six months from now, to 58.7 from 43.5 in September.

Hiring in rural areas remains frail. The new-hiring index rose to 35.6 from September’s 27.0. This is the 22nd consecutive month that the index has been below growth neutral, due in part to the national and global recessions and weakening farm income from much lower agricultural commodity prices. “Over the past 12 months, rural areas of the region have lost more than 5 percent of their jobs. This compares to a loss of 3.6 percent for urban areas of the region,” said Goss, the Jack A. MacAllister Chair in Regional Economics at Creighton.

Like much of the nation, retail sales were less than healthy for the month, with an October retail-sales index of 36.7 from 32.8 in September. This month bankers shared their expectations for holiday sales. On average, bankers forecast holiday sales to decline by 1.5 percent from last year’s weak sales. Brian Nicklason, president of Woodland Bank in Remer, Minn., said, “I have talked to several local retailers and hospitality businesses, and they are very concerned about business prospects over the upcoming winter months.”

Despite an improving national housing market, the Rural Mainstreet home-sales index stood at a frail 46.7, which was up from 42.7 in September. Bank CEOs were asked about their support for the federal home tax subsidy with 68 percent endorsing a continuation of the $8,000 tax credit for first-time homebuyers and 9 percent backing an increase in the tax credit. Only 23 percent supported an end to the program.

This month bank CEOs were also asked how much their Federal Deposit Insurance Commission (FDIC) fees had increased from last year. Fifty-two percent of bankers reported that FDIC premiums had grown by more than 250 percent. On average, bankers reported an increase of 320 percent from last year. “This increase is undermining the profitability of community banks; the FDIC’s recent proposal for banks to pre-pay their 2010-2012 premiums is especially troubling,” said Goss.

Rural Mainstreet bankers reported mixed banking numbers for the month. The loan-volume index declined to 42.4, its lowest level since November 2006, down from September’s 49.3. According to Frank Sullentrop, president of Legacy Bank in Colwich, Kan., there is a good explanation for this. “Regulatory oversight has had a significant impact on reducing lending activity.

For October, checking-deposit growth dipped to 61.0 from 61.9 in September. The index for certificates of deposit and other savings instruments inched higher to 51.7 from September’s 50.1.

Each month, community bank presidents and CEOs in nonurban, agriculturally and resource-dependent portions of an 11-state area are surveyed regarding current economic conditions in their communities and their projected economic outlooks six months down the road. Bankers from Colorado, Illinois, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota and Wyoming are included.

This survey represents an early snapshot of the economy of rural, agriculturally and energy-dependent portions of the nation. The Rural Mainstreet Index (RMI) is a unique index covering 11 regional states, focusing on approximately 200 rural communities with an average population of 1,300. It gives the most current real-time analysis of the rural economy.

Mortgage Rates Will Top 6 Percent When Job Losses Cease

2009-10-14T13:16:00.000-07:00

For the first week of October, the average rate on a 30-year fixed mortgage was 4.87 percent, down from 4.94 percent last week. Despite this low level, some home buyers are waiting for even lower rates. Forget about it! Even though rates may move a bit lower in the short run, I expect rates to rise very quickly once the economy, as measured by job prospects, improves. That’s right, if you want to see where mortgage rates are going, just watch the job market. At the beginning of the recession in December 2007, annualized job growth was 1.4 percent and the 30-year fixed rate mortgage was 6.1 percent. At the depths of the recession in April of 2009, annualized job growth had plummeted to -5.6 percent and the 30 year mortgage rate had sunk to 4.81 percent. Today job growth is still negative at -2.3 percent and mortgage rates have rebounded slightly to 5.06 percent.

I expect mortgage rates to again top 6.0 percent when the nation begins adding jobs. Thus expect two potentially harsh outcomes when the labor market turns around. First, the monthly payment on a $100,000 home will rise by more than $50. Second, this will signal the end to the high prices and low yields on long term U.S. Treasury bonds that determine mortgage rates. So if you have a large share of your savings in these bonds, either directly or via mutual funds, put your money somewhere else to avoid heavy losses when the labor market improves. Ernie Goss.

Is the market over-valued?

2009-10-09T12:41:00.000-07:00

Many Yo-Yo financial reporters are yelling and screaming about the stock market being over-valued. This may be the case, but many of them are using trailing P/E ratios to justify their hypothesis. This is ridiculous logic, so before you accept their conclusions, let me explain.

For a trailing P/E, they may take the S&P 500’s current price of 1068 and divide by the index’s 2008 as-reported earnings of $14.88. This simple calculation yields a P/E ratio of 72x. The index’s trailing P/E has averaged 16x since 1936, so at 72x, the market is grossly OVERVALUED, right? Don't agree just yet, because this certainly isn't the case if you analyze the P/E from different perspectives.

It may be fine to calculate a P/E ratio in normal times by looking at previous year’s earnings, but last year was in no way normal. Last year’s earnings are a poor proxy for earnings going forward, so for now, please throw your trailing P/E ratio out the window. It is useless.

It is also illogical to use as-reported earnings at this time. In 2008, and continuing on for the next few years, you will see a lot of charges in between the operating and net lines of most companies’ income statements. Financial companies have taken massive losses due to asset write-downs, and other firms have incurred huge restructuring charges to align themselves for a more profitable future. As-reported earnings captures all of these charges, but since they are transitory and astronomically high for now, they shouldn't be included when hypothesizing the over/under valued-ness of the stock market.

Instead I would advise looking at a forward P/E ratio based on operating earnings, which doesn't include those transitory costs. Using 2010 operating earnings expectations should give us a more normalized picture of profitability going forward. Either way, it is certainly a more accurate proxy than 2008 figures.

The forward operating P/E for the S&P 500 has averaged around 19x for the past 20 years. S&P estimates 2010 operating earnings to be $73.47, implying a P/E ratio of 14.5x. From my calculation, the stock market appears CHEAP.

Writers want to sell stories. In deciding that the market is expensive, and since many people follow P/E ratios, they fandoongle the ratio to outrageous numbers to grab your attention and support their conclusion.

When times return to normal, go ahead and bring back your trailing P/E ratio, but for now, don’t be fooled by their calculations.

Aaron Konen

Should You Invest in Gold Now?

2009-09-24T08:11:00.000-07:00

Most investors in the U.S. stock market have seen their “nest eggs” plummet faster than January temperatures in Nebraska. For example, investors who purchased a basket containing one share of each the Dow-Jones Industrial 30 in 1999 lost almost 20% of their investment over the past decade. On the other hand, the investor who invested his/her bundle in gold experienced a gain of 262% during this same time period. What accounts for gold’s superior return? Rising inflation, a cheaper dollar, an expanding economy, and escalating risks account for gold’s fantastic returns. But among these four factors, investor’s risk assessment dwarfs the other three in terms of influence on the price of gold. The best measure of financial risk is the gap between the yield on corporate bonds and U.S. Treasury bonds. As risks rise, investors sell corporate bonds and buy risk free U.S. Treasury bonds. This increases the yield on corporate bonds and decreases the yield on U.S. Treasury bonds widening the gap between the two. If risks rise to levels existing in January of 2009, gold prices are likely to soar by as much as 78% from the current price. However, if risk declines to the level existing in November 2007, one month before the recession began, gold prices will plunge by approximately 11%. Thus, investors’ decision to buy gold should hinge on their assessment of the direction in financial risks. A return to the scary financial environment of early 2009 will reward gold buyers handsomely, while a more soothing economic climate will inflict losses on the gold buyer.

Ernie Goss

Is It Time to Buy Natural Gas?

2009-09-03T11:51:00.000-07:00

Natural gas prices tumbled again Thursday, hitting a new seven-year low of $2.52 per million cubic feet after the government reported an increase in supplies. Meanwhile, benchmark crude for October delivery advanced to $68.17 a barrel on the Nymex. The ratio of the price of a barrel of oil to a million cubic feet of natural gas is now 28.2 compared to the historical average of 10.0. One can interpret this one of three ways; 1) either natural gas prices are artificially low, or 2) oil prices are artificially high, or 3) the fundamental relationship has changed due to supply and demand factors.

If natural gas prices are artificially low due to speculative activity, then this would present an opportunity for the long term investor to buy natural gas. The United States Natural Gas fund (UNG), an exchange-traded fund that tracks natural gas prices, has plunged this year hitting a 52-week low of $8.94 a share on September 3, well down from $62.00 per share in July 2008. So should investors jump in and buy shares of UNG. I say be cautious. The price of natural gas and UNG could go lower.

Even though the ratio of the price of oil to natural gas is at a 25 year high of 28.2, the ratio of oil production to natural gas production is at a very low level (not a record but low nonetheless). What this is telling us is that, natural gas prices are very low due to significant increases in supply or production. Thus, I would not expect any momentous natural gas price rebounds unless and until there is a rapid upturn in natural gas demand due to changing federal energy policy.
Ernie Goss

Regression to the Mean and Investing

2009-08-24T13:00:00.000-07:00

Sir Francis Galton, cousin of Charles Darwin, first identified regression to the mean in his 19th century publication Regression towards mediocrity in hereditary stature. Simply put, it indicates that, left to themselves, things tend to return to normal, whatever that is. Thus when the price of stocks, as represented by the Dow-Jones Industrial 30, declines to a level that is significantly below the long term trend or mean, investors are provided an opportunity to buy low now and sell high later.

Between 1929 and 2007, the Dow 30 grew at a compound annual rate of 5.2%. From December 2007 until August 2009, the Dow 30 plummeted at an annual rate of 14%. In order to return, or regress, to the mean the Dow 30 would have to soar to 14,690. Thus buying the Dow 30 via the Diamonds (DIA) should provide investors with a substantial financial reward, assuming a return to trend.

There is certainly no guarantee when this will happen and there are three reasons that regression to the mean may be a frustrating guide to decision making. 1) It proceeds so slowly that a shock disrupts the process. 2) The regression may be so strong that it “punches through” the trend or mean, 3) The mean may be unstable. Nonetheless, statistically speaking, stocks are currently priced for the buyer, not the seller.
Ernie Goss

Where Is the Next Asset Bubble?

2009-07-30T17:11:00.000-07:00

Over the past decade, U.S. investors have been whipsawed by three major asset bubbles. First buoyed by overly zealous investors in the 1990s, technology stocks rocketed to levels that will not be matched before most baby boomers are either in a nursing home or dead. As a measure of this euphoria, the NASDAQ index rose above 5,000 in March of 2000. Today that same index is less than 2,000 and shows no signs of returning to those go-go days. Second, housing prices relative to income soared to unprecedented levels from 1995 to 2006. However over the past two plus years, residential housing prices have plummeted yearly by more than 15 percent. Third, oil prices increased to almost $150 per barrel in 2008. Today’s price pressures indicate no quick return to that level even after the economy begins to move out of the recession.

What does each of these “bubbles” have in common? All were fueled by investor’s quest to earn economic returns far beyond what would be characterized as normal. So are there asset bubbles in today’s economy, and will the bubble burst? Yes and yes. The largest and most significant bubbles are in U.S. Treasury long bonds and in the value of the dollar. Over the past two plus years, the yield on the 10-year U.S. Treasury has declined from 5.1 percent to its current level of 3.6 percent. To achieve this plunge, prices of the long bond advanced by more than 40 percent during this same period of time. Global economic fear pushed investors from Beijing to Boston to seek a “safe haven” for their investments. These investors judged U.S. Treasuries as the safest of the havens. Thus massive sales of equities and purchases of U.S. Treasury bonds drove demand and prices for the 10-year U.S. Treasury to levels not seen in more than half a century. To purchase these bonds, international investors exchanged their currency for dollars forcing the dollar to speculative highs.

So when investors assess that economic risks have bottomed and equities are the smart play, they will begin selling the 10-year U.S. Treasury bond and buying equities-both U.S. and non-U.S. This will produce colossal losses for investors that have a significant portion of their wealth tied up in U.S. Treasury long bonds. Of course, a decline in the motivation to buy U.S. Treasury bonds will also result in a plunging U.S. dollar. To borrow from Alan Greenspan, we have, at this time, an irrational exuberance for U.S Treasury bonds which has generated a significantly elevated value of the dollar.

Ernie Goss

More Financial Hypocrisy from Warren Buffett

2009-07-25T11:21:00.000-07:00

On April 8, 2009, Moody’s downgraded Berkshire Hathaway stock from AAA to AA2. At that time, Berkshire owned more than 20 percent of Moody’s outstanding stock. On July 23, 2009, Berkshire announced that it had sold more than almost 10 million shares of Moody’s. This appears to be a sign of pure retaliation on the part of Warren Buffett, CEO of Berkshire, and the grand ethicist of Wall Street.

As in the past, Mr. Buffett calls for more objective stock evaluations except when it comes to his company. That is, Mr. Buffett has always been one of the most sanctimonious CEOs in the U.S. For example, he fails to even blush when he calls for higher taxes except when it comes to levies that hit his pocketbook. He has advocated the abolition of the dividend and capital gains tax cuts at the same time he rails against the new cap & trade bill which will cost his Mid-American Energy Company millions in taxes.

Ernie Goss

Cap & Trade: Who Pays the Cost?

2009-07-01T05:42:00.000-07:00

Congress narrowly passed a cap & trade bill that the Congressional Budget Office has estimated to cost more than $600 billion over 10 years. Who will pay the cost of this federal mandate? It depends on the industry.

For products for which the consumer is relatively insensitive to price hikes or there are few competitors, such as electricity, the consumer will pay most of the burden as the producer passes on the increased cost to its customers. For products for which the consumer is much more responsive to price increases or there are many competitors, such as food, the producer will absorb the increase in cost.

Thus it is clear that contrary to the bluster from politicians, Americans, both rich and poor will experience an increase in their costs in the next ten years. Whether one calls that a tax hike is irrelevant.

Ernie Goss

Why Are Oil Prices Higher?

2009-06-22T12:49:00.000-07:00

Despite evidence from Creighton’s three monthly surveys showing no immediate end to the recession (www.outlook-economic.com ), many economists, pundits and analysts contend that the economic downturn is over. What evidence do they have?

It’s hidden in the price of oil, they say. In the past six months, oil prices (in dollars) have soared by more than 80 percent. The bulls contend that this is a signal that the economy is once again on the mend with U.S. economic growth driving prices higher. The bears, on the other hand, argue that this rapid expansion is the result of a weaker dollar and speculator oil buying. So which side has it right?

First, oil prices measured in Euros have risen by 27 percent. Thus, a large share of the increase in oil prices stemmed simply from a weakening U.S. dollar. Next using a simple economic model to explain oil prices since 1999, I conclude that almost none of the run-up in oil prices resulted from improvements in the economy. Instead, I find that of the 27 percent change in oil prices (in Euros), fully 10 percent can be explained by global investors desire to invest in oil rather than U.S. debt. That is, due to looming multi-trillion dollar federal deficits, investors have chosen to sell U.S. Treasury bonds of dubious value and buy oil. Of the remaining 17 percent increase, 4 percent, 7 percent and 6 percent are accounted for by seasonal factors, supply cutbacks and other unidentified factors, respectively.

In conclusion, the largest contributors to soaring oil prices over the past six months have been a weakening U.S. dollar and international investors selling bonds to buy oil.

Ernie Goss

Federal Incentives for Auto Purchases Are Inconsistent

2009-06-18T15:03:00.000-07:00

As part of the 2009 Stimulus Bill, consumers are able to deduct state and local sales and excise taxes paid on the purchase of a new foreign or domestic vehicle costing up to $49,500 that weighs no more than 8,500 pounds.

http://www.driveclassic.com/blog/?p=132

On the other hand, the federal government also allows consumers to deduct up to $25,000 on the purchase of an SUV weighting at least 6,000 lbs. Termed a Section 179 purchase, the bill was intended to assist GM, Ford and Chrysler in the sale of the more profitable large SUVs. Well it failed to prevent the bankruptcy of both GM and Chrysler, but continues to encourage Americans to buy the behemoth SUVs.

http://www.section179.org/section_179_vehicle_deductions.html

If the federal government is serious about cutting gasoline consumption and green house gases, it should first insure that current policies are consistent before embarking on passing new legislation.

Ernie Goss

U.S. Auto Bankruptcy: Good Money Chasing Bad

2009-05-27T13:08:00.000-07:00

On December 4, 2008, my colleague, Ed Morse, and I wrote an essay calling on the U.S. federal government to let the marketplace work in terms of the potential bankruptcy of GM and Chrysler. Since that essay was written, the federal government has funneled good money after bad to the tune of $20 billion to $30 billion.

http://economictrends.blogspot.com/2008/12/reid-pelosi-co-are-not-investment.html

and

http://www.youtube.com/watch?v=RL4MDmaXX7M

As of this writing, Chrysler is in bankruptcy proceedings and there is a 99 percent likeihood that GM will likewise declare bankruptcy. GM's bankruptcy is moving quickly forward due to GM bondholders rejecting the plan to exchange their bonds for GM stock. The GM bondholders have correctly assessed that they will do better under bankruptcy proceedings than under ownership of the "sinking ship." Who could blame them? Well the Obama Administration could and does.

In the Chrysler crisis, the Obama Administration forced secured bondholders to accept a deal that only a Washington Mutual stockholder would agree to. Essentially, the Obama Administration is attempting to abrogate bankruptcy law by strong arming Chrysler bondholders into accepting less than they would have received in statutory bankruptcy proceeding. Well, it is not working with GM as GM bondholders reject the extortion attempts from the Administration.

The Obama Administration must accept the fact that not only does this activist policy approach not work, it produces exorbitant costs for the taxpayer. "Too big to fail" should be replaced by the shorter and more accurate "just too big."

Ernie Goss

Will Obama’s Plan Help Real Estate and Banking?

2009-04-29T06:57:00.000-07:00

The latest incantation of the U.S. Treasury plan announced by Secretary of Treasury Geithner, while addressing the problem, focuses on the symptom, not the problem. The real “banking” problem is that housing prices continue to move lower thus reducing the value of the assets on banks’ balance sheets. The median price of houses sold in the nation declined by approximately 18 percent last year. My own estimates indicate that average home prices across the U.S. need to drop by another 14 percent to get back to the long term sustainable ratio between housing prices and income.

So what needs to be done? In order to underpin the housing market, President Obama’s 2009 Stimulus Package provides an $8,000 tax credit to first- time home buyers. This is inadequate since many of those who qualify do not currently have the resources to make the purchase, nor do they have the tax liability to fully benefit from the credit. Instead, the Obama

Administration’s 2009-10 budget proposal should provide a tax credit of $15,000 for all 2009 home purchases, not just first-time buys. Additionally, President Obama’s 2009-10 budget propsal has proposed a reduction in the mortgage interest rate deduction for families earning more than $250,000. This will have a negative impact on housing sales, prices, and ultimately the health of the banking industry.

The Obama Administration’s plan to cut agricultural support payments will more directly affect RM banks. The plan that has been advanced calls for limiting agriculture support payments for farms with revenues greater than $500,000. This ceiling would snare about half of the farms in Nebraska, for example, and place even more downward pressure on farm land prices, and ultimately the profitability of RM banks. During these fragile economic times, this is no time to be placing additional financial stress on rural communities dependent on farm income.

As an additional step to improve the banking industry, “mark to market” accounting should be abandoned for two years. In 2007, the Securities and Exchange Commission (SEC) implemented what was termed “mark to market” requiring that financial institutions mark or write down assets to market value. This has meant that, due to the inability to price or value packages of mortgages on their balance sheets, these institutions have marked them to practically zero in some cases under the overly restrictive assumption that they will collect nothing from the disposition of these assets. This is clearly draconian and reduces the ability of the financial institutions to make loans thus further weakening the economy.

As indicated by Dale Torpey, president of Federation Bank in Washington, Iowa in our February 2009 survey, “Land prices have leveled off and in some instances have dropped slightly. If some of the farmers can’t renegotiate their rent prices we could be looking at losing some of them in 2010.” Thus, banks, even in those in agriculturally dependent parts of the nation, likely face challenges for 2009 that call for greater attention.

Ernie Goss

Obama and Stock Market Commentary [stop now please]

2009-04-14T10:15:00.001-07:00

Today Obama came out with another downbeat message on the economy. “By no means are we out of the woods,” he said. Yet in the latest 30% run up, he had more of a “glass half full” mentality. And earlier in his presidency, many thought he was far too negative about the economy, adding negative momentum to our already beaten down markets. Does anyone else feel like he isn’t quite sure which side to take? His advisers have yet to find the right balance between being optimistic but not too optimistic to push to markets up 30% in weeks [where we are now] and being pessimistic but not too pessimistic to push the markets down 30% [where we were a few months back]. His comments up to this point have only added momentum (volatility) to market movements in both directions. So until they figure this balance out, how about taking a neutral position and letting the markets work themselves out? The president has many responsibilities, but lets’ leave stock market commentary up to stock market participants.

AIG Execs should keep their bonuses....what?

2009-03-19T14:29:00.001-07:00

I was at a kindergarten class yesterday listening to kids talk about what they wanted to be when they grew up. One child surprised me by saying he wanted to work in Credit Default Swap Risk Management at AIG. I was thoroughly surprised. In the network of people I know, I’m not aware of anyone with even a hint of interest in working at AIG. The little tike surprised me. [JOKE]

Then I started to wonder, why would anyone want to work for AIG? One might expect the reason AIG execs continue to plug away is because they feel personally responsible for losing billions of dollars. Yet in the era of mis-aligned pay structures and leaders refusing to take responsibility for any of our economic problems (i.e. Bush, Greenspan, numerous CEOs), I doubt this is the case.

It certainly isn’t a feel good job either. And your neighbors wouldn’t be impressed. Actually they may downright despise you for working at AIG. Now that we have seemingly donated $200 billion to the company (without that warm-fuzzy feeling you usually get from charity work), every AIG exec’s move is under intense public scrutiny. This certainly doesn’t make the job any easier. In summation, I could only think of 1 reason why I would work for AIG—money. And lots of it.

We shouldn’t force AIG to reduce wages (including bonuses) below market rates. When the ultimate motivating factor [money] is taken away, the talented ones will flee the company. Few people understand the intricacies of AIG’s business, and without high pay, why would anyone who does understand them consider working there, especially when they can find work elsewhere for higher pay and less scrutiny? If all the talented and intelligent people leave for more pay and less scrutiny, I would argue that taxpayers will be on the hook for even more money. Time will tell.

Mexico Strikes Back: Is This the Beginning of the Trade War?

2009-03-17T13:38:00.001-07:00

As part of the 2009 Stimulus Package, Congress inserted ill-advised “Buy America” provisions that require organizations receiving federal funds to purchase from American suppliers. Subsequently, European and Japanese representatives warned that these provisions invite trade retaliation.

Now in response to the U.S. closure of the Mexican border to Mexican trucks traveling to the U.S. with cargo, the Mexican government has slapped tariffs on 90 U.S. industrial and agriculture products. The initial U.S. closure was President Obama’s payback to members of the Teamsters.

President Obama’s wilting under pressure from Congress with the Stimulus Package and unions with the Mexican trucking fiasco is disturbing and foreshadow a potential return to the foolish economic policies of the Hoover Administration with the passage of the Smoot-Hawley Bill in 1930. This is very bad policy and will produce slower growth, higher prices and elevated interest rates.

Ernie Goss

Berkshire anyone?

2009-03-03T15:21:00.000-08:00

Warren Buffet has always paid particular attention to the book value (BV) of his stock -- the value his financial statements say the company is worth. Often times the market assigns a much different value to the stock. Buffet knows that though the market value (MV) of his company will vary, over the course of years and decades, MV and BV will have pretty strong correlation.

2008 was a historically bad year for BRK's BV and an even worse year for its MV. Its BV dropped 10% and its MV dropped nearly 40%. Berkshires ending market to book ratio was 1.37. Over the past 21 years, this ratio has averaged 1.69.Many analysts look at MV/BV ratios to decipher relative value. Similar to a PE ratio, the lower it goes, the cheaper the stock looks.

Berkshire's 5 lowest market to book ratios over the past 21 years averaged 1.4. The year following these low ratios, the stock price increased 36% on average.

Take a look:
2005 MV/BV = 1.46. 2006 return 27%
1999 MV/BV = 1.48. 2000 return 27%
1991 MV/BV = 1.41. 1992 return 30%
1990 MV/BV = 1.45. 1991 return 36%
1987 MV/BV = 1.21. 1988 return 59%

average return = 36%

Keep in mind, BRKs 2008 closing price was $96k. Today it is trading around $74k. Like he said in his latest shareholder letter, "Charlie and I feel like mosquitoes in a nudist camp -- there are opportunities everywhere."

With $27 billion in cash, the old Oracle is in a good position to do what he does best. Speculators/investors will reap significant returns as Berkshire's BV/MV ratio recovers to average levels over the next few years.