David Olson

FOCUS ISSUE FOR THE WEEK: The decline in the rate of unemployment in January may have been illusory since total employment from the survey of payrolls continued to plummet -20,000, even though the household survey, which is used to derive the unemployment rate, showed total employment increased by 541,000 in January. The federal government still appeared to be in gridlock with Obama being unwavering in his desire to pass his comprehensive health care bill without Republican cooperation. Housing is still growing slowly. Most forecasters see slow growth in GDP. Bank profits in 4Q09 were very mixed with high charge-offs on residential and commercial mortgages. We have passed the peak on the residential mortgage write-offs but not yet in the commercial real estate world. We still don’t know how we will deal with the potential 10 million residential mortgages under water but we may muddle through without taking more big banks under. Less certain is how GMAC will survive having lost $10.3 billion in 2009. We don’t know yet what will happen to mortgage rates once the Fed stops supporting the MBS market at the end of March. Mortgage rates should rise 50 to 100 bp this year. We suspect the Administration will continue to support the MBS market since their top goal is to improve the job market and that can’t be done without supporting the housing market. The forecasts for mortgage originations in 2010 range from $1.3 to $1.7 trillion. Much depends on the extent of support the federal government extends to housing.

The DJIA fell 0.5% from 10,067 last week to 10,012 on Feb 5. This week there were 9 positive trends vs.12 negative trends.

Positive Trends

• The unemployment rate fell to 9.7% in January from 10% in December. A survey of households showed an increase in 541,000 jobs during the month. But a separate survey of payrolls showed total nonfarm payrolls continued their decline and fell another 20,000 jobs. This decline in the payroll survey was smaller than the 150,000 jobs lost in December. It isn’t clear yet why there was such a contrasting trend between the household and the payroll survey in January. The household survey is based on a small sample and in December showed a big decrease so the January increase may just be correcting for the excessive decline in December. Most analysts see January as a firming of the employment picture.

• The average workweek rose from 33.2 hours to 33.3 hours.

• Average hourly earnings rose 0.3% in January, up from 0.2% in December.

• According to Wainwright Economics, the Aaa-Baa spread in corporate bonds has now dropped to 93 from a peak of 350 bp at the end of 2008. This normally means rapid growth in GDP (7% or more) for the first several quarters after a recession. This implies the first half of 2010 should be rapid. Most of the impetus of the 5.7% growth in 4Q09 was due to inventory expansion. Business investment spending should be high. As of February 1, Barclay’s Capital reported the Aa-Baa spread as 134 bp, down from the 52 week high of 321 bp.

• The ISM index rose 58.4% in January after a 54.9% increase in January. This was very similar to the Chicago ISM index moves. This index reached the highest point since August 2004.

• Personal income rose 0.4% in December after rising 0.5% in November. Personal spending rose 0.2% in December after rising 0.7% in November. The personal saving rate was 4.8% in December, up from 4.5% in November. The overall trend is toward higher savings. Twenty years ago the rate was over 6%.

• The National Association of Realtors reported that pending home sales rose 1% in December after falling 16.4% in November. They are recovering slowly after the tax incentives for first time homebuyers stopped in November.

• The ISM services index rose to 50.5 in January, up from 49.8 in December.

• Unit labor costs fell 4.4% in 4Q09 after declining 1.5% in 3Q09. Productivity rose 6.2% in 4Q09 after rising 7.2% in 3Q09. This means there is no inflation in wages and should be a sign of rising profits.

Negative Trends

• The two GSEs have jointly $300 billion in loans that are 90 days or more late. They are asking their lenders to buy back some of these loans. During the first three quarters of 2009 Freddie Mac made buy back requests worth $2.7 billion and Fannie Mae requested $4.3 billion. Overall banks repurchased about $14.2 billion in loans from holders of mortgage-back securities during that period. Fannie Mae reported last week that 5.29% of the $2.9 trillion of loans it guarantees are in default. At Freddie Mac the proportion is 3.87%. Both shares are more than double a year earlier. These huge amounts of buy backs will weaken the capital positions of the banks who originated these loans and could potentially force FDIC to close them down.

• The recent meeting of world bankers in Davos, Switzerland show them to be on the defensive for their role in the economic recession. It is widely expected that they will be punished in some way through higher taxes, more regulation, and limits on payment of bonuses to their top employees. Since they are already under much tighter regulation than earlier and under threat from high defaults, it is hard for them to increase their lending to help ease the recession. But Obama and Congress are also on the defensive, so they may not have sufficient power to pass another bill tightening regulation of banks.

• Capital Financial Group predicts the rate on the 30 YFR mortgage will rise from its current yield of 5.1% to 6.1% at the end of 2010. The main reason for this shift is the Fed ceasing to buy MBSs at the end of March. The current yield for jumbo 30 YFR mortgages is 5.9%. That is the rate for mortgages without government support.

• The ISM service employment index was 43.6 in December. If it stays below 50 in January, there will likely be slow growth in employment over the next several months. Nearly 90% of U.S. employment comes from this sector.

• Nurial Roubini of New York U. predicts GDP of 1.5% in 2H10. The average economist surveyed by Bloomberg foresees 2.7% GDP growth in 1Q10.

• The Census Bureau reported that construction spending fell 1.2% in December, after declining 1.2% in November.

• The Census Bureau also reported that the percentage of homes vacant and for sale in 4Q09 rose to 2.7%, up from 2.6% in 3Q09. The 50-year average vacancy rate is 1.6%.

• The proportion of Americans who own their own home was 67.3% in 4Q09, down steadily from a high of 69% in 2004, reported the Commerce Department.

• The Obama Administration proposed a new fee on the liabilities of large banks to raise about $9 billion per year. The new tax would punish large financial institutions for paying out large bonuses to their top employees.

• Initial claims for unemployment rose to 480,000 for the week ending January 30, up from 472,000 the prior week. Continuing claims were little changed. Employers are showing little interest in hiring.

• The 30 YFR mortgage based on the Freddie Mac survey rose from 4.98% a week ago to 5.01% this week. The 10 year Treasury rose from 3.58% to 3.59%.

• Among the 18 top banks in the mortgage market, the worst performance in 2009 was by GMAC. They lost $10.3 billion and had to accept three bailouts from the federal government. Will there be a fourth bailout now? They are owned 56% by the federal government and that share may increase in 70%. Their main goal is provide financing of GM and Chrysler cars and trucks. They have written down much of their investment in residential mortgages.