Value Investing using Economic Value Added (EVA)

Asset Deflation Bad: Consumer Price Deflation Good - Best Stimulative Package Yet

Lower consumer prices are like tax cuts.  Deflation on everyday items like food and gasoline and discretionary items like diamond rings increases real-income - the same dollar buys more today than it did last year.  Consumers that use most of their income for essentials benefit the most from this. 

Often we ignore the stimulative results of declining consumer prices.  This result is the flip side of China's currency peg and our outsourcing of low skilled jobs overseas.  With an artificially high US dollar that comes with the peg against China's yuan, consumer prices in the US are held down.  The currency peg has been a tax on inefficient US businesses forcing them to retool or go outside, but the peg has been a subsidy to the US consumer. 

Funny, but since the Olympics last year China has stopped allowing its currency to appreciate.  The peg is back and the US consumer benefits. (see how the dollar declined vs the Chinese currency from around 8.3 to 6.9 but is flat since the Summer of 2008)

You think Chinese currency appreciation had anything to do with the recession? How about the Chinese deliberately throwing a bone to the US Senate so as to not ruffle their Olympic show - that's another post where we explore how the US benefits from the peg.

WalMart's slogan says it best - Save money. Live better.  Here's what ABC News had to say on the subject.

(ABC News) There has never been a better time to be a consumer. America is on sale. The Great Recession has caused massive job losses and hardship for millions, but it has also fostered a shoppers' paradise. Anyone who still has the means to spend can find unheard of deals.

Prices on everything from clothes to coffee to cat food are dropping, some faster than they have in half a century. Items rarely discounted — like Tiffany engagements rings — are now. The two biggest purchases most people make — homes and new cars — are selling at steep price reductions.
 
What's happening now has been building for years. Wal-Mart Stores Inc. introduced "every-day low prices" many years ago. Amazon.com redefined the idea of bargain prices during the late 1990s when it helped introduce online shopping. After the 2001 recession, automakers introduced zero-percent financing to boost sales. McDonald's "Dollar Meals" made fast food even cheaper. But until the Great Recession came along, consumers hadn't seen anything yet.

Hotel rooms cost travelers nearly 20% less, on average, than last year, the biggest decline since Smith Travel Research began collecting data in 1987. Home prices have dropped 30%, on average, from the peak in 2006. In some markets, they're down more than 50%. Homes in parts of Detroit are cheaper than a new car.

Overall, prices are tumbling at the fastest rate in decades. The government's Consumer Price Index, which measures the average price of goods and services purchased by households, has fallen 1.5% over the last 12 months. The reading for July showed a 2.1% annual decline, the biggest since 1950 (see chart above).

BERK

HT: CARPE DIEM: America On Sale: Great Time To Be A Consumer Shared via AddThis

Risks to the Expansion - A Poisonous Cocktail

Insanity: doing the same thing over and over again and expecting different results. - Albert Einstein

Why does this Congress think that they should expand a law that has led to an enormous amount of bad mortgages? They must be insane!

Peter Schweizer, a research fellow at the Hoover Institution and author of Architects of Ruin: How Big Government Liberals Wrecked the Global Economy---And How They Will Do It Again If No One Stops Them (Harper, 2009),  wrote this article in Forbes which was eye popping due to the hockey stick graph of bank commitments under the Community Reinvestment Act (see below). 

The financial market meltdown was not caused by any one thing - but the critical state that the markets were in just before September of last year - was the result of a few really bad government policies.  Not too many people would debate that the insane lending practices whereby banks would make zero down-payment, no documentation and low teaser rate loans was a main driver that brought the financial system to its critical state just before the government seized Fannie Mae and Freddie Mac, let Lehman go bankrupt and bailed out AIG the next day.

So far regulators looking to "fix" something and the press looking to report something have focused on minor causes whose remedies will not do much to ensure that the system never gets to that same critical state again.  We have heard that financial industry compensation levels and structure were one of those main drivers.  The convenient consensus of political leaders is that "compensation caused all the problems", as my friend Marc Hodak recently wrote here and here.  Of course, if compensation caused the crisis, then they do not have to deal with the possibility that government manipulation of interest rates and mandates to the banks to lend more and more to the disadvantaged actually caused the crisis - those would be facts that do not support the case that government can work smart and deliver economic justice.  Better to ignore the facts I guess.

Regardless of my belief that government meddling and subsidization through Fannie Mae and Freddie Mac of the mortgage market was a main culprit leading to the critical state before the crash, it seems we would be insane to double down on those same policies.

But that is what is going to happen if ACORN - yes that same group that was caught on tape giving advice to a pimp and a hooker - and the Services International Employees Union (SEIU) - yes the same SEIU that wants to eliminate "secret ballots" in union elections and let the government decide whether employees of say WalMart should be forced to join their union - get their way.  They seem to get their way if the White House gets to say anything about it. So watch out.

As we try to shake off the financial crisis, here's a bright idea. Take a law that has led to the writing of an enormous amount of bad mortgages and expand it. Then take enforcement away from bank examiners and give it to housing activists.

Sound like a poisonous cocktail? Well, it is what the Obama administration and Democrats are currently stirring up on Capitol Hill.

The White House and Congress want to expand a 30-year-old law--the Community Reinvestment Act--that helped to fuel the mortgage meltdown. What the CRA does, in effect, is compel banks to seek the permission of community activists to get regulatory approval for bank expansions and mergers. Often this means striking a deal with activist groups such as ACORN or unions like the Service Employees International Union (SEIU) and agreeing to allocate credit to poor and minority areas that are under-served.

In short, the CRA encourages banks to make loans they would not ordinarily make. What's more, these agreements often require that banks offer no-money-down mortgages and remove caps on how much debt a borrower can take on. All of this is done in the name of "financial democracy."

Liberals pooh-pooh the idea that a 30-year-old law could have contributed to the current sub-prime crisis and credit crunch. But what they ignore is the massive expansion of CRA-commitments forced on banks in the run-up to the 2008 financial crisis.

You see in the graph that since the second term of the Clinton Administration how commitments by banks under the Community Reinvestment Act have sky-rocketed - these were loans that were guaranteed by Fannie and Freddie (read the US government) and those that eventually went bad in bundles called mortgaged back securities.

Maybe this was just a benign attempt to increase home ownership in mostly disadvantaged areas - but it turned into the mother of all welfare programs that we are just starting to pay for now.

It's not time to double down - is it? 

BERK

HT: CARPE DIEM