This is very, very bad! Maybe Ron Paul is right about having a gold based currency. Interest rate changes are warranted to smooth the edges of the business cycle, not to bail out a bunch of transparently poor financial decisions made by borrowers and lenders! This is the most socialist, politically motivated, special interest serving thing that I have ever seen the fed do!

In the free market, those that made bad credit decisions must be allowed to pay the price, and only by paying dearly can lessons truly be learned. Borrowers who were unwitting and took on too much debt must learn that there are consequences for their actions. Homebuilders that built too many homes or overpaid for land need to face the consequences. Wall Street firms that provided credit to all of these activities with too much laxity must also pay a price. This is all part of a healthy correction.

Fed Rate Cut!

I've spoken to a number of people over the past few years who've convinced themselves that the housing bubble is really only something that is going on in California and the increase in their home price is real permanent wealth. Such a fallacy is perfectly understandable emotionally, but its bad business. Here are some graphs of the regions of the country that are most impacted by the "sub prime" forclosure problem. Do you live in one of the darkly colored areas? If so, lots of people in your area can't afford to pay their mortgages. That means housing prices in your area are going to go down. Most of the Americans on MemeStreams that I know live in such an area.

The Big Picture | Brief Foreclosure History & Mortgage Delinquency Maps

House prices in the U.S. from 1890 until 2005, plotted as a roller coaster that you ride from a first person perspective. Here is the datasource. Hold on to your hats.

Real Estate Roller Coaster - Google Video

There are several disturbing similarities between the U.S. economy's recent behavior and its behavior in 2000–01, but also some reassuring differences.

I don't feel reassured. You can actually SEE the bubble popping in this chart.

National Economic Update, March 2007 - Economic Research Publications - FRB Dallas

Restaurant chains that want to reduce portion sizes also face considerable skepticism from Wall Street. Investors want to see steady growth in sales from what are called comparable stores, those restaurants that have been open for at least a year. To get that growth, a company has to increase the number of people coming through the door or what they spend.

“If you shrink portion sizes, you kind of have to reduce prices,” said John Glass, an analyst at CIBC World Markets. “A lower check drags down comp-store sales. What you hope is, you offset the check with higher traffic.”

Mr. Glass added: “It’s been a difficult sell on Wall Street. It does work but it takes time, and we all know that investors are focused on the short term.”

I thought I'd highlight this article from PNW's Sunday NYT roundup that offers a sober look at America's obesity problem. It interacts in interesting ways with liberatrian idealism about market economics. Ideally, you'd like restaurants to increase same store sales by increasing the variety and quality of the food they offer, but its much easier to simply increase the sizes. In fact, many retaurants define themselves as fitting a particular quality and genre niche, and can't easily tweak that variable. Consumers are, however, willing to buy more food than they need, mostly because an evolutionary deficiency in our nervous systems fails to rapidly communicate fullness to our brain. Essentially, consumers are irrational with regard to food qualities, and the market has met this irrationality, and the result is a national health problem. Now this article seems to indicate that consumers, after 20 years, are starting to become more rational in this regard, and the market is attempting to respond, but it is finding it difficult, as the maximally efficient solution is not in the interest of shareholders. Is this a market failure that requires government intervention? I'm not convinced that it rises to that level, but at the same time, I think its an interesting illustration for those who think that market failures do not exist.

Will Diners Still Swallow This? - New York Times

1. Chinese regulators caused the meltdown

2. It was Greenspan's fault.

3. Blame China's market crash.

4. A Dow Jones Glitch caused the plunge

5. Prices Fluctuate
(And we got fluctuated pretty good)!

6. Stock prices will be higher six months from now.

7. Selloffs such as this are healthy.

8. The Fed stands by ready to cut if this gets much worse.

9. The market is not forecasting a weakening economy.

10. This had nothing to do with anything fundamental!

What makes this situation potentially dangerous is that this was the first day of the selloff, not the last.

The enormous distributive volume and the horrific market internals were anything but healthy. It suggests a major change in underlying metrics and psychology.

This view is far more pessimistic than mine. Its also far better informed.

Top 10 Myths of Tuesday's Correction

"When you get this far away from a recession invariably forces build up for the next recession, and indeed we are beginning to see that sign," Greenspan said via satellite link to a business conference in Hong Kong. "For example in the U.S., profit margins ... have begun to stabilize, which is an early sign we are in the later stages of a cycle."

It seems like the boats have been rising a bit too fast in recent months. I don't know what has been driving it (I really haven't been paying all that much attention), but it felt too good to be true. No one likes a market crash but I can't say yesterday's events were totally suprising. I think people just got ahead of themselves. Greenspan seems to think they may have gotten further ahead than usual.

Greenspan Warns of Likely U.S. Recession: Financial News - Yahoo!Finance

This year, I expect the Holiday Retail season could very well end up being the “canary in the coal mine” -- for the economy, as well as the stock market.

A weak consumer spending season bodes poorly for the start of 2007.

Hrm...

The Big Picture | Canary in the Coal Mine

1) The current rather mild U.S. recovery has been driven by asset appreciation/consumption and not employment or capex growth.
2) Future growth is dependent on additional asset appreciation in real estate and stocks if Asia continues to absorb much of our investment and many of our jobs.
3) Recent asset appreciation has been set ablaze by several fiscal/monetary pumps displayed on page 2 with 5-year real rates being the central driver/gasoline can.
4) Tax cuts are a thing of the past and 5-year TIPS yields can theoretically decline only 60 basis points or so more.
5) The reason why intermediate/long TIPS have an interest rate floor is that if we approach potential deflation, investors risk losing money on a government guaranteed investment. The same concept applies to homes, stocks, and other inflation-adjusting assets without government guarantees.
6) The Fed may soon be out of fuel, despite hints of Bernanke-style helicopter money. Stocks and houses are already at low yields and high prices reflective of European economies nearing Japan-style liquidity traps.

PIMCO Bonds - IO July 2005 - Fire!

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