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Wrought Asunder

"What can be avoided / whose end is purposed by the mighty gods?" asked Julius Caesar, before he was stabbed dead on the Ides of March.

Among other things, the gods are currently grinding down the boom in real estate, support for the Iraq war, consumer incomes and spending power, the U.S. balance sheet...and the empire itself.

The Mortgage Bankers Association expects mortgage originations to drop off by 20% this year; it says refinancing should fall by 40%. Without easy finance, consumers have less to spend. Yesterday brought news that retail sales had fallen in February, for the first time in six months.


"Too many consumers have been attracted to products by the seductive prospect of low minimum payments that delay the day of reckoning, but often make ultimate repayment of growing principal far more difficult."

Speaking was U.S. Comptroller of the Currency John C. Dugan, and what he was speaking of, specifically, was the way in which consumers took out interest-only or negative amortization mortgages.

"In the last two years, however," Dugan continued, "we have seen a spike in the volume of payment-option ARMs which are no longer confined to well-heeled borrowers who can clearly afford them. Increasingly, they are being marketed as 'affordability products' to borrowers who appear to be counting on the fixed period of exceptionally low minimum payments -typically lasting the first five years of the loan - as the primary way to afford the large mortgages necessary to buy homes in many housing markets across the country."

We already know what will happen. We see the signs before us. Foreclosures are rising. Households which bought more house than they could really afford are going broke. Consumer spending has become a little wobbly.

The expected effects on the housing market itself are starting to show up. Sales are down. Inventories are rising.

In California, the housing boom has raised prices to the point where the median wage earner in L.A. County can only afford one out of every 35 properties on the market. We wonder who, then, will buy the other 34? Other people are beginning to wonder, too. Transactions in January fell
24% from the year before.

Speaking of prices, "I would expect a general decline of 5% to 10% throughout the country, some areas 20%...and in areas where you have had heavy speculation, you could have 30%," says Angelo R. Mozilo - a man who ought to know. Mr. Mozilo is the CEO of the nation's largest mortgage lender, Countrywide. While we have no reason to doubt Mozilo's words on the subject, it is his actions we'd bet on. According to Grant's Interest Rate Observer, Mozillo "has been a steady and heavy seller of Countrywide common for two years."

We recall an estimate reported in these epistles a few months ago. Fully 40% of the job growth since 2001 is said to be the fruit of the housing boom. If that is so - and if despite these new jobs, real wages have gone down during this period - we can't help but wonder what will happen to
wages when the boom ends. It seems likely that they will go down further. And, it seems likely that consumer spending will fall, too. Is that when history starts up again?
From The Daily Reckoning...www.dailyreckoning.com
by John Mauldin

Long-time readers know that I do not think the world is going to devolve into a soft depression because of the imbalances in our trade deficit and our large and growing debt. Those will have to be dealt with, of course, but I think it will happen in the normal context of the business cycle. A recession here, a falling dollar there, and slower than trend average U.S. growth over the next five years or so and we get to where the re-set button has been hit. It will not be fun, but it will not be the end of the world. It is what I call the Muddle Through Economy. I am actually quite optimistic about the investment opportunities once we get through that period, with the usual caveats and asterisks.

But I have maintained for many years that the one thing that could change my basic optimism is a new wave of protectionism. Senator Smoot and Representative Hawley infamously sponsored a bill in 1930 that raised tariffs on a variety of products in order to "protect" American jobs. Of course, the rest of the world retaliated and soon we went from a recession into a global Depression. Unemployment soared and all those jobs we "saved" went away.

Recessions are part of the business cycle. The Fed cannot stop one, try though it might, nor can Congress write legislation outlawing recessions. And in the main, and with a few exceptions, they have not on balance been all that bad. One can make the argument that they are needed to correct imbalances and "irrational exuberance" here and there. Typically, unemployment rises a few percent but comes back in a few years, the stock market falls but comes back and profits fall but go on to make new highs after the "reset" button is hit.

I am not trying to be cavalier. If it is your job or investment or profits that get hit, it can mean some very long and sleepless nights. Been there. Done that. But for the vast majority of U.S. citizens, the last recession had little effect. Unemployment never rose above 7%, and corporate profits came back quite strong. The next recession may be worse, but it will end soon enough. That is the way of the business cycle.

But while recessions are part and parcel of the economic cycle, it takes a government to really mess things up and create a depression. Show me a depression (not a shorter term recession!) in a free society that was not the result of government incompetence or some form of direct government involvement. You can't. Usually they are the result of multiple and coordinated government groups all working together to make things better and having the opposite effect.

Yes, I suppose you could say that Smoot and Hawley were just responding to the Zeitgeist of the times, that the voters were demanding their jobs be protected, so that the American people got what they deserved, but Congress and the Fed aided and abetted. President Hoover should have
used a veto. For that alone, he deserved to be defeated two years later.

Last week, an updated version of Smoot and Hawley's Congress put together a veto proof gaggle to stop the United Arab Emirates from buying a British port management company that ran six of our nation's ports. Security was the ostensible reason, but anyone who did their homework knows that national security on any level was never at risk. This congressional tantrum bothers me on several levels.

Our ports are run by a number of companies that are not U.S. based companies. Five ports have Danish firms running them, for instance. Two are run by the Chinese. Basically these companies move freight. Pick it up here and put it there. They have nothing to do with port security. Port security is the province of U.S. Customs and the Coast Guard. And they hire American union workers.

The U.A.E may be the largest non-U.S. port service for the U.S. Navy in the world, based in Dubai. They are a solid ally and a voice of moderation and stability in an area of the world where such is needed.

There is a process where foreign investments in the United States that have security implications are brought before the Committee on Foreign Investment in the United States (CFIUS). This governmental inter-agency group looks at foreign investments, and if one of them sees a red flag, they run it further up the command chain. This was an investment that, after being thoroughly investigated, caused no concern and was approved. And then some politicians saw an opportunity for political gain.

Now, someone in the administration at the middle levels should have seen the political implications of this deal. Sadly, the Bush administration does not do a good job of explaining their policies. This should have privately been run up to Congress and vetted there before the approval went through. So, a lot of the blame should be laid onto the administration for having a "tin ear."

The next thing we know, talk radio is going over the edge, calls into Republican congressmen are running 9-1 against the deal in an election year that looks tough for them to begin with, Democratic Congressmen see a chance to appear concerned about national security and really tweak the President and before you know it, there is a move to stop the deal.

There is a reason for the CFIUS process. It works, and it keeps politics more or less out of business deals. But now, Congress has learned it can basically look at any deal and say that it's against the national interest for some foreign company to buy a U.S. company. And every tin pot congressman who wants to posture in front of a camera and who has a company in his district that becomes a target will now want to get involved. Companies that lose a bidding war or that have an axe to grind will complain to Congress: "I don't want that foreign company competing on my turf and taking U.S. jobs from my employees!" Shades of Smoot-Hawley!

We have spend decades persuading nations around the world to open up their countries to investment. And they have. We have over $10 trillion invested outside of the United States, which made American firms $500 billion last year, a little under 5% of our GDP! That is about $1,600 for every man, woman and child in the United States. That money gets paid out as dividends, gets invested in our economy, and goes to pay our workers.

Last year, foreigners increased their investments in the United States by $1.4 trillion, in a wide variety of investments. Without those dollars, the U.S. currency would have collapsed, interest rates would be through the roof and we would be facing (or in!) a REAL recession, not the garden variety ones we have had since 1990.

"A study by the Organization for International Investments finds that about 5.3 million Americans are directly employed by foreign owned firms with wages averaging $63,000, or about 50% more than the average U.S. wage. Foreigners are not buying up America's wealth; they are investing in ways that add to it," reports the Wall Street Journal.

That means that about 8% of American workers are employed by foreign-owned companies. You can bet they are happy they have the higher paying jobs. If not, they would simply leave. But the line for those high paying jobs is long.

But now, there are those in Congress who would like to stop that wealth and job creating foreign investment.

"In recent weeks Members of Congress have suggested that the foreign-ownership ban should apply to roads, telecommunications, airlines, broadcasting, shipping, technology firms, water facilities, buildings, real estate and even U.S. Treasury securities." (The Wall Street Journal editorial, March 10, 2006)

How does this sound to those nations that we are trying to get to open up to U.S. investments? Why should they cooperate id we re not going to practice what we preach, when it is in our clear interest to do so?

If this was just the U.A.E. deal, I could rest easier. But last year it was the dust-up over China buying a mid-size U.S. oil company that had relatively little U.S. production. We have Senators Charles (Smoot) Schumer and Lindsey (Hawley) Graham cooperating in a bit of bi-partisan idiocy to try and put a 27% tariff on Chinese goods.

And let's be blunt. To suggest such a thing demonstrates either astounding economic ignorance or simple political pandering of the worst kind. Probably both. Do we really want to raise the price of everything from China by 27%? On items that we no longer make here? Do we want to risk the start another trade war? Or have the Chinese stop buying U.S. Treasuries? Can you say recession, boys and girls?


John Mauldin
for The Daily Reckoning

Editor's Note: John Mauldin is the creative force behind the Millennium Wave investment theory, author of the weekly economic e-mail Thoughts from the Frontline, JohnMauldin.com, and a private letter for accredited investors. As well as being a frequent contributor to Capital & Crisis and Strategic Investment, Mr. Mauldin is a New York Times best-selling author with a unique ability to present complex financial topics and make them understandable to the lay reader with insights into the current economy and hedge fund industry. His latest book, Just One Thing, was released in December of 2005. You can purchase your copy here:

Just One Thing

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  Articles: (3)
Wrought Asunder
A Congressional Tantrum
The End of History