MarketVVizard's Market Thoughts

Top 710. Dec 18, 2003 11:33 AM

» pbradford6 - Re: Foreclosure flood

In response to message posted by Austrian:

Thanks for the foreclosure article. Here is another similar article:

By Dean Baker, Dean Baker is an economist and co-director of the Center for Economic & Policy Research in Washington.

Any assessment of Alan Greenspan's long tenure at the Federal Reserve has to present the stock bubble as his biggest failure. If Greenspan had effectively and consistently warned investors of the irrationality of stock prices in the late 1990s, the bubble never would have reached such dangerous proportions. His "irrational exuberance" comment just wasn't enough.

The collapse of the bubble, which destroyed more than $8 trillion in paper wealth, was the immediate cause of the 2001 recession and the economy's subsequent period of weak growth and failure to create jobs. The collapse also left pension funds unbalanced and forced millions of workers to delay retirement. After his failure regarding the largest financial bubble in the history of the world, it looks like Greenspan is now actively promoting the world's second-biggest bubble: the housing market.

The basic story is simple: Over the last eight years housing prices have outpaced the overall rate of inflation by more than 35 percentage points. There is no precedent for this sort of rise in home prices. In the past, home prices largely kept even with the general rate of inflation.

The housing bulls have a number of explanations for this increase in home prices: a growing population, a limited supply of urban land, environmental restrictions on development. But these stories are no better than the "new economy" yarns of those who defended the stock market bubble. We have always had a growing population and limited supplies of urban land, and environmental restrictions predated the mid-1990s. These factors never led to elevated home prices in prior decades, which is why experts are warning about a housing bubble.

Fortunately, it is not necessary to get into these details to prove that there is a housing bubble. If underlying factors, rather than irrational exuberance, are the basis for the increase in home prices, then these factors should be having the same effect on rental prices. Studies have shown that, historically, rents and home prices have appreciated together. In other words, underlying factors will drive up home sale prices and rental prices by roughly the same amount. The rental markets tell a different story.

From 1998 to 2001, rental prices rose more rapidly than the overall rate of inflation, but not nearly as fast as home prices. If higher home prices are the result of a real shortage of housing, then rental prices should continue to rise to catch up with homes prices. That isn't happening. Rental prices are barely moving as record vacancy rates nationwide force landlords to hold the line on rents. In bubble areas, such as Seattle and San Francisco, rents are falling.

Where does Greenspan fit in?

He has promoted the housing bubble by reassuring people in public statements that there is no bubble. He also helped drive mortgage interest rates to 40-year lows earlier this year — allowing people to spend more money on houses, which adds to price inflation and to the bubble.

The health of the economy will be the key to George W. Bush's reelection. Over the last three years, the housing market has been the driving force in the economy. Greenspan appears determined to have it keep playing that role as long as possible. But the bubble will eventually burst, leading to another recession and destroying the main source of savings for tens of millions of families. Could a responsible public official possibly pursue such a policy?

When President Bush's first tax cut was being debated before Congress in January 2001, the public anxiously awaited Greenspan's views. He told Congress that the tax cuts were a good idea and that he was worried that without them the budget surpluses would be too large and that the government would pay off the national debt too quickly.

Three years later, we face huge budget deficits. There is no reason to ask whether Greenspan — who doesn't have to answer to anyone — would pursue a destructive economic policy for political reasons because he has already done so.

-- posted by pbradford6

Top 711. Dec 18, 2003 2:58 PM

» MarketVVizard - CPI Analysis [The Boskin Fix]

OK -- I said I would post about CPI today. This story is much like the story on the SAT (yes, the scholastic aptitude test that high school students take so colleges can compare students from around the country). What am I talking about, you may be wondering??? Well, like the SAT, the CPI has been "tweaked" somewhat quietly, without much attention, for political reasons. In the case of the SAT, it was the decades long string of ever declining national average scores, making politicians and school boards everywhere look bad. In the case of the CPI, it was of course, all about money.

In both cases, again, due to political motivation, NEITHER MEASUREMENT was given a new name (suggestions might include "dumbed down SAT" and "worthless CPI"). The fact that they are still using the old names is the most irritating (not to mention downright deceptive) part of the political game. In the case of the SAT, after 1995 it is IMPOSSIBLE to compare scores to pre-1995 scores. Similarly, changes to the CPI started in 1998 and were phased in though 2000. It is now much harder to compare CPI post '98 to CPI pre-98 (although we will do it!).

HOW did this happen?? In both cases, the public didn't really know about or understand what was going on. Simply put, there weren't very many voices of opposition, so the changes slipped though, and the politicians benefited as truth and usefulness took a back seat.

The CPI corruption ultimately can trace its roots to a 1997 commission (known as the Boskin commission, named after its leader, Michael Boskin) appointed by the Senate Finance Committee. The credentials and integrity of the commission were so vigorously defended that no one dare question the findings or the resulting changes to the CPI calculation.

First you need to understand what the political motivation is for corrupting the CPI such that it show a lower rate of inflation than what actually exists. Its quite simple: the payments for many federal programs, the largest of which is Social Security, are linked to CPI. It would cost the government an unnecessary $1 trillion in additional spending between now and 2008 if the CPI were indeed "overstated" by the 1.1 percent the Boskin committee suggested. Under the corrupt CPI, the federal government can justify reducing social security benefits. But this goes much further than social security, many wage contracts, government (and private) pension plans, as well as federal income-tax brackets are all linked to CPI.

Furthermore, if Boskin was right, the economy and productivity were growing faster than reported. Their conclusions were embraced with great fanfare, fueling the "new economy" mantra of the late nineties. Even Alan Greenspan jumped on board, embracing the Boskin conclusions and bowing to the "productivity miracle".

Very breifly, the Boskin logic is that IF you are paying the same $1 for a razor that you now get twice as many shaves from, you are actually only paying 50 cents for that razor. If your car lasts twice as long and has automatic windows and an airbag, you are getting MUCH more bang for your buck. All of this sounds wonderful AND it's totally true (quality of products must be considered when accounting for price changes). The problem is that this is NOT a "new" revelation, it is something that has always been known, and the Bureau of Labor statistics had already been making such adjustments. That didn't bother the powers that be though, because now they seemed to have an excuse to apply "fuzzy logic" to subjective estimates that can easily be exaggerated.

A post-Boskin study undertaken by a penal of 13 economists from a wide range of institutions led by Schultze of the Brookings Institute pointed out the many holes in the Boskin analysis. In fact, they concluded that in many cases the Bureau of Labor Statistics actually OVER-adjusts for quality, meaning reported inflation is TOO LOW! For example, just because the computer I bought this year is twice as fast as the computer I bought two years ago, does that mean I am twice as productive? Of course not. How about 50% more productive? 10%? Eh, I'm really not more productive at all! smile

Furthermore, Boskin paid NO attention to product quality deterioration (for example airline service or education -- there's that SAT thing again!). In the years following the Boskin conclusions, surveys have consistently found declining satisfaction for both goods and services. The CPI has been reduced to an impossible attempt to measure "quality of living". But how can you measure "quality of living" when you only consider improvements and not deterioration? For example is a car worth less if traffic congestion rises? And if the crime rate goes up, people must spend more on security devices, doesn't that impact living standards? The Shultze panel actually noted that consumers need constant improvements just to remain as satisfied as they were.

And here's a gem -- the Boskin commission even believed we should calculate the benefit of new products to consumer well-being. For the purposes of this calculation you can assume any given product already exists, but it is so expensive that no one can afford it. The difference between the imagined price and the actual price once the product hits the market should be used to show a reduction in CPI!

So this is where we are. Instead of doing something useful like calculating the price of a fixed basket of goods or services, we are attempting to calculate an arbitrary "standard of living" that is subject to the whims of political influence, fickle economists, and perma-optimists who ignore deterioration in "quality".

Simply put, the CPI has become just one more "managed" number like everything else on wall street.

A guy I know has done much more analysis into what he calls "the Boskin Fix" than I have. The following is from Bill:

From all of the data that I use in evaluating inflation, it appears that most (not all, most) of the "Boskin Fix" changes have taken place. The changes seem to have started in 1998 and ended some time in 2000. There's still an issue about a delay that showed up recently, but I'm going to ignore that for now.

Assuming the changes ended in 2000, we now have 30 data points (monthly values) since January 2001. Enough to get an idea of how the structure of the inflation calculation changed due to the "Boskin Fix".

As per previous whinings, I disagree with the "Boskin Fix", however I wouldn't whine as much if they were to make it a new series and not corrupt the original CPI-U. However, as whined before, my guess is that the reason they don't do that is because the average guy will realize how goofball the "Boskin Fix" really is. In other words, the CPI-U values before 1998 were calculated one way, the "Fix" was phased-in over two years, and now the CPI-U values are calculated a different way. That means that if you compare today's inflation rate to the inflation rate before 1998, you just fooled yourself into believing that inflation has recently dropped.

<img src="http://www.creationfaq.net/VViz/boskinbacktest.gif" alt="Click to Enlarge" width=520>
[VViz: Note that the blue line is the output of Bill's proprietary inflation model, which is calibrated and consistent over the entire timeframe. His model is probably more reliable than anything else out there]

The red line is the "Official" CPI-U rate as published monthly by the BLS. The blue line is the CPI-U "Without the Boskin Fix". Now that we have enough data, I've added the green line. The green line is the inflation rate if the "Boskin Fix" had been consistently applied all along. What? You don't remember the deflation of 1986/1987?

You can draw your own conclusions, but notice that in general, inflation now is NOT that much different than it was before 1998. It is only different if you are not CONSISTENT in how it is calculated (possibly why they corrupted the "Official" series and didn't publish two series originally).

The best part is the new structure of Boskin's Inflation. If you model inflation with the following equation:

Inflation = Constant + (c1*PriceChange1 + c2*PriceChange2 + ... + cn*PriceChangen)

The first issue is the "Constant". The Constant that is calculated "Without the Boskin Fix" is essentially 0.0%. That means that if the price changes ("c1*PriceChange1 + ...") were zero, the inflation rate would be zero. That's exactly what you would expect. The second issue is the coefficients (c1, c2, ... cn) for all the price changes in the second part. They are all positive for inflation "Without the Boskin Fix". Again, as you would expect.

When you do the same calculation using the "Boskin Fix", the Constant is 1.7%. That means that if the second part ("c1*PriceChange1 + ...") was zero, the inflation rate would be 1.7%. You might say, Bill, that means that the "Boskin Fix" ADDS 1.7% to the "Official" inflation rate. Well, it does, however, and this is the best part, one of the coefficients on a key price in the second term is now NEGATIVE. In other words, as that price change goes up, its contribution to "Boskin Fix" inflation goes down. And, its negative contribution is more than enough to offset the 1.7% Constant. This is hilarious.

Bosky, you got some 'splainin to do.

Anyway, there are other issues that are just as funny, however I think I'll save that stuff for later. The bottom line is, one of these days we're going to wake up to a world that realizes just how goofball the current CPI-U really is. America, keep buyin' them bonds.

Probably sometime around January/February 2004 you'll begin to hear more and more about the "Coming Inflation" problem (or should I say "panic"). As prices rise, and long term bond rates move up, it will be harder and harder to hold onto those bonds. The new push will be toward short term notes (and probably stocks).

The funny thing is, I don't think CPI-U based inflation will respond much this time around. The "fixes" to the CPI-U have made it less and less responsive to real world prices. In fact, CPI-U inflation now moves in the OPPOSITE direction to some prices. So, as prices move up, causing brokerage firms to push harder on the "Coming Inflation" theme, they're not going to get much help from the CPI-U. If this discrepancy becomes obvious enough, some group like the AARP will finally figure out how they have been screwed. This could be real entertaining.

In case you're trying to estimate the "true" inflation rate (the way it was estimated before the "Fix"), add 1.5% to 2.5% to the published rate (the "add" used to be 1.5% to 2.0%, but from the data, it looks like they're continuing to deaden the index).

Excerpts from a Recent Investor Survey Survey Date: June 2003

"....Although most U.S. investors (57%) believe interest rates will rise in the next two years, only 6% believe rates will go down. Nearly two-thirds (65%) are unaware that rising rates generally have a negative impact on the value of bond investments...."

"....Investors have been retreating to bond funds throughout the bear market in equities, but this survey indicates that most are unaware of the risks posed to bonds by a possible rise in rates. The strong returns from bond-related investments in recent years have drawn investors seeking a safe haven...."

"....However, only 35% said they believe the value of bond investments decreases when rates rise. 27% said they believe the value of bond investments increases when rates rise, and the remaining 37% either said they didn't know the impact or that they believe the value of bond investments stays about the same if rates increase...."

"....The survey shows investor awareness of interest rate risk little changed since April 2002 (30%), when the poll was first conducted...."

"....Just as the strong equity returns of the late 90s may have led individuals to a higher concentration in equities than was prudent, the environment of recent years may have led some individuals to overweight bonds without consideration of interest rate risk. Investors who have not taken interest rate risk into account in structuring their portfolios may want to consult with a financial advisor to discuss appropriate protection of their investments from risks of a rate increase...."

There's more, but it's all pretty much the same. Just like Vegas, it stops when the mullets run out of money. ____________________________________________________________

Well, a lot more can (and will) be said about this. But that's all for now.

-- posted by MarketVVizard

Top 712. Dec 18, 2003 4:20 PM

» pbradford6 - Re: CPI Analysis [The Boskin Fix]

In response to message posted by MarketVVizard:

I have suspected that the CPI was being understated. Your explanation was the first I have read explaining a possible explanation.

I do extensive financial reading and have never seen this explanation that I recall. If true why wouldn't this be picked up by the unions, social security retirees, AARP who have a vested interest in making sure the CPI is correct?

Would most consider your explanation radical or out of the main stream?

Thank you.

-- posted by pbradford6

Top 713. Dec 18, 2003 4:53 PM

» Normxxx - Re: CPI Analysis [The Boskin Fix]

In response to message posted by MarketVVizard:

Inquiring Minds Want To Know: How Can Euro-zone Consumer Inflation Be Higher Than That Of The U.S.? full text

by Paul Kasriel and Asha Bangalore

The Northern Trust Company
Economic Research Department
Daily Economic Comment

Yesterday, the BLS reported that the year-over-year change in the U.S. CPI was 1.8% in November – the smallest year-over-year change since September 2002 (see Chart 1). So, the trend rate of U.S. inflation is falling (just as the FOMC used to fear it would). In contrast, the consumer inflation rate in the euro-zone is not falling, but holding relatively constant at about 2.1%. I find it curious that not only is euro-zone consumer inflation not trending lower if U.S. consumer inflation is, but also that euro-zone consumer inflation is running 30 basis points higher than that of the U.S.

-- posted by Normxxx

Top 714. Dec 18, 2003 5:38 PM

» Jas_Jain - CORRECTION -- Re: Re: Oh, Baby!

In response to message posted by MarketVVizard:

--
Hello VVVVViz,

I can understand your reaction in the light of an error on my part. I meant to say 2 years of pain and FOUR years of gain. I am already in the mode of 2004 and made a subtraction error.

Anyway, I went short DELL in Apr'98 (I was also short G and KO at the time) and had pain for 1.75 years (until Jan'00). It has been a smooth sailing, more or less, since then.

I will respond to your total lack of understanding of how to select stocks for shorting, and how to short, soon. Got to go.

Jas

-- posted by Jas_Jain

Top 715. Dec 19, 2003 12:04 PM

» Austrian - Re: CPI Analysis [The Boskin Fix]

In response to message posted by MarketVVizard:

Great Post adds a whole new perspective to hedonic pricing and Richebacher's long standing contentions.

Regards,

--Austrian

-- posted by Austrian

Top 716. Dec 19, 2003 12:53 PM

» Kirk - Re: CPI Analysis [The Boskin Fix]

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In response to message posted by MarketVVizard:

Furthermore, Boskin paid NO attention to product quality deterioration

Good God this is a HUGE decline for many areas where prices are falling.

Quality has gone up in autos, but the cost has gone up faster due to mandated quality (consumer safety) features.

PCs used to come with a good warranty and customer service with a native English speaker from Texas or California.... now it is often India.

but has quality overall improved for most goods and services? At first glance, you could say there are no more smart folks at Sears or Wards (Bankrupt) to help you buy tools, paint or air compressors. But, the smart ones left Sears for HomeDepot and Loews or run small, more expensive hardware stores. I can find good advice on what to buy, but I have to go to a more expensive retailer to get the advice. This gives them the opportunity to make the sale on "more than price" but I still have the ability to walk out and purchase on the internet or super discount store if they don't offer good value.

-- posted by Kirk

http://www.epinet.org/content.cfm/press_...

Top 717. Dec 19, 2003 1:34 PM

» MarketVVizard - Re: Re: CPI Analysis [The Boskin Fix]

In response to message posted by pbradford6:

pBrad -- its usually safe to assume that if I take the time to post just about anything, its "out of the mainstream" smile

The reason you haven't seen outrage about the CPI yet is because its all very much under the radar still, and its a topic that is complex enough that people just don't understand it (refer to the prior quotes on bonds).

I DO believe the spit will hit the fan. The reason is because the CPI corruption is CUMULATIVE. This means that as time goes on, the difference between reported inflation and reality should get out of hand. The AARP and everyone else is going to figure it out, and the game will be over for the politicians. However this game could go on for years, and they may make further adjustments in an attempt to save face. Without further adjustment, the next recession could make things very "awkward" for the BLS -- CPI will most definitely go negative (visualize Jas jumping up and down patting himself on the back). At that point they will probably manage it back into the positive again.

Here are some references for you:
http://www.findarticles.com/cf_dls/m1093...

http://www.mises.org/freemarket_detail.a...

http://mwhodges.home.att.net/inflation.h...

A book has also been written on the subject:
Getting Prices Right: The Debate over the Consumer Price Index edited by Dean Baker of the Economic Policy Institute

Amazon REVIEW: "The first half of the book presents the Boskin Commission's findings verbatim, and supporters of overstatement are able to speak for themselves. The second half presents Dr. Baker's deconstruction of the Commission's findings. One part of his criticism involves the presentation of technical arguments and instances of CPI understatement. However, the most compelling part is Dr. Baker's reconstruction of recent U.S. economic history using Boskin's implied measure of prices. He shows that 50% of families were apparently living below the 1994 poverty level in 1960. This is implausible. Protagonists of the debate will no doubt continue slinging instances of over- and understatement of prices at each other. However, until supporters of CPI overstatement can explain away Dr. Baker's findings about implied poverty levels, their arguments will ring hollow. "

p.s. Jas -- please don't post your stock picking system, I'd just as soon keep the image I already have of it in my head. It makes me smile.

-- posted by MarketVVizard

Top 718. Dec 19, 2003 2:51 PM

» pbradford6 - Re: Re: Re: CPI Analysis [The Boskin Fix]

In response to message posted by MarketVVizard:

My appreciation for a very informative/interesting post that was very will written.

-- posted by pbradford6