One More Turn Before The Home Stretch

By: Michael Ashton | Fri, Oct 22, 2010
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On a Friday with no economic data, and with one more turn to go before the home stretch to Election 2010 and QE 2010, the markets were predictably quiet. That quiescence survived the revelation - which by now is hardly revelatory - that Fannie Mae and Freddie Mac are bottomless pits sucking up taxpayer money. The FHFA estimated (see the Bloomberg story here) that the two GSEs could require as much as $363bln through 2013 if the housing market worsens, although the cost to taxpayers would "only" be a cool quarter-trillion dollars.

But we're used to seeing ugly worst-case scenarios. What was a little more of concern to me, at least, is that under the best case scenario the total cost would be $221bln (a mere $142bln after dividend payments), or in other words another 50% or so more than has already been spent. That bears repeating. The best case scenario is that the GSEs will need another $73bln.

The other thing we know is that worst-case scenarios from government entities have had a nasty way of being exceeded by actual events (remember the "worst case" unemployment rate from the stimulus bill? The original Romer chart is below. For the record, we are around 3% above Romer's projections for late 2010, and around 1% above her worst-case analysis).

Thank goodness we didn't get the worst-case scenario!

It bears noting that these FHFA projections do not contemplate the complete unwind of the GSEs. That is to say that even if these are accurate estimates for the cost of the current crisis, they do not include any costs of protecting us against the next crisis. These aren't the numbers to get FNM and FRE to conservative leverage ratios and profitable, higher-quality lower-volume business. These are the numbers to get them off life support.

However, since the future of the GSEs, the economy, and the government may all see an inflection in the next two weeks, perhaps it's reasonable to look away from these numbers. At the very least, it is advisable to do so if you are prone to nausea.

Monday's data consists of another rotten Existing Home Sales number (Consensus: 4.30mm from 4.13mm) and activity indices from the Chicago Fed (no forecasts) and the Dallas Fed (Consensus: -8.0 from -17.7). Before July, the lowest ever Existing Home Sales number had been 4.53mm in November 2008, so keep any bounce in context! More important than the sales numbers, I think, are the inventory numbers, which have recently leveled off at the awful level of 4mm units. To get home prices to stabilize for the year ahead, that inventory needs to get back to 3.5mm units or below (see last month's commentary here. The chart is reproduced below.

Home Sales / Price Chart
More supply? Lower prices.

I don't, however, expect that the market will react very sharply to Existing Home Sales. More provocative next week are Consumer Confidence and the Home Price Index on Tuesday, Durable Goods on Wednesday, and the advance look at Q3 GDP on Friday. I expect sluggish trading otherwise, although we may start to see a little downward pressure on stocks later in the week as investors cut positions before the election and Fed meeting.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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