From Volume 4, Issue Number 23 of EIR Online, Published June 7, 2005

U.S. Economic/Financial News

Just What Is the Fed Thinking?

The Federal Reserve is "debating pricking the U.S. housing bubble," moots an article in the New York Times Business section May 31. The article then goes on to show exactly the opposite: that the Fed created the bubble and is unlikely to do anything to change it. They quote one "chief economist," who argues, "The Fed chairman cleaned up the mess caused by the bursting of the technology and telecom bubbles, by creating another bubble. Now he [Alan Greenspan] has failed to stop the alarming deterioration of mortgage lending standards to stop the housing bubble." This is an echo of the argument of Steven Roach (chief economist at Morgan Stanley), who has said that the housing bubble is basically a continuation of the tech bubble, which burst in 2000. Ted Meyer, a former Fed governor, said the "evidence of risky lending practices" is abundant, mentioning the interest-only and adjustable-rate loans. The Fed is in a tight spot, because, even though they have been steadily raising the prime rate, the rates on home loans are actually lower than they were a year ago.

Even though they acknowledge that their policies bear much more directly on the creation of the housing bubble than the tech bubble, the Fed is loath to raise rates, saying that their job is not to control asset (home) prices, only to monitor and control inflation. "For the Fed to be an 'arbiter of security speculation or values' is neither desirable nor feasible," said former Fed governor Ben Bernanke, back in 2002. Why, if the Fed had intervened in the tech bubble in 1997, the way some were counseling, they would have "choked off growth" and perhaps "prevented the big increases in productivity" that occurred before the market blew.

U.S. Housing Prices Still Soaring

Housing prices rose by 12.5% from March 2004 to March 2005, compared to a rise of 11.9% for the comparable period a year earlier, according to the quarterly report of the Office of Federal Housing Enterprise Oversight. The index does not even include mortgages valued above $359,000.

The highest price appreciation occurred in Nevada (31.2%), California (24.5%), and Hawaii (24.4%). The lowest was in Texas (3.8%) and Indiana (4.1%).

Anatomy of the Housing Bubble

A Reuters report, "Housing sector sales hit record highs," dated June 1, offers the following picture of the red-hot housing bubble:

"The hot U.S. housing market powered forward in April which propelled U.S. construction spending and pending sales on existing homes to new highs, even as home prices continued to soar across the country. Prices in the first quarter of this year from the first quarter of 2004 surged more than 10% in 23 states and by more than 20% in five states and Washington, D.C. Construction spending has hit a new high every month since February 2004, while residential outlays have been hitting new monthly highs since November on persistently low interest rates. [T]he National Association of Realtors said pending sales of existing U.S. homes hit a record in April. The Pending Home Sales Index, based on data collected in April, stood at 128.2, up 3.6% from March and 9.2% from the same month a year ago. Meanwhile, average home prices in the first quarter climbed 12.5% from a year earlier, according to a report from the Office of Federal Housing Enterprise Oversight. Home values appreciated 2.21% during the first quarter from the fourth quarter of 2004, or at an annual rate of 8.82%. According to the Mortgage Bankers Association, [f]ixed 30-year mortgage rates averaged 5.61% last week, excluding fees, down two basis points from the previous week and down from 6.24% a year ago."

Ford, GM Auto Sales Collapse Further in May

Ford sales fell 10.5% in May for their fifth monthly drop this year, it was reported June 1. In May, Ford sold 283,994 vehicles, its 12th straight month of decline, compared with 317,471 vehicles in May a year ago. Ford set its third-quarter production 2.3% below year-ago levels, reducing its production from 747,000 cars and trucks to 730,000.

GM sold 393,197 cars and trucks in May compared with 446,787 a year earlier. However, in contrast to Ford, GM cheated by adjusting its results for the two extra selling days in May 2004, thus claiming that its sales were down only 5%. GM set its third-quarter production target 9% below its year-ago level.

GM said it will try to boost sales by offering its employee-discount program to all customers through July 5. The program will let consumers buy new GM vehicles for about 2% to 3% less than the regular dealer price. GM then reimburses the dealer for the discount. Buyers will still be able to apply existing rebates to cut the price even more.

Shares of GM have fallen 21% this year to $31.53. The yield on GM's 8.38% bond, maturing in 2033, is 11.08%, compared with a 7.85% yield at the beginning of the year.

Ford Takeover of Visteon: Wages To Be Slashed by Half

As the United Auto Workers in Michigan and five other states vote on whether to allow Ford to reabsorb Visteon, the parts supplier Ford spun off not so long ago, word has it that many of the factories will be sold to suppliers, two factories will be reabsorbed by Ford, and a small number of the factories will be closed, the Detroit Free Press reported June 1.

The biggest change will happen in the hourly wage at Visteon. When the deal goes through, current and new-hire employees at Visteon plants will have their wages cut in half, from $38 an hour to $17, but there is an exception: the minority of employees at Visteon who are Ford employees will retain their current pay.

Delphi, a leading auto parts supplier to GM, is eyeing the announced deal as a way to sell off unproductive plants to suppliers, or, as in the case of Ford, get reabsorbed by GM. Delphi is looking to dump four to six of its 20 high-wage UAW plants in the U.S.

GM, Ford Bonds Move Into Junk Bond Market

Bonds of General Motors and Ford made the official transition into the junk-bond market at the end of trading May 31, as the Lehman Brothers Aggregate Bond Index—an index of investment-grade bonds, used as a benchmark by 90% of investment institutions—will push both car companies' bonds out of the index. The May 30 MarketWatch reported, "bonds issued by General Motors Corp., and Ford Motor Co., are likely to create turmoil this week."

The official transition into junk-bond status will not only affect GM and Ford, but other companies now in junk bond status, which will find the cost of selling their bonds rise. There are only a certain number of funds that can invest in junk-bonds, and some investment funds will sell-off the junk bonds of other companies to make room for GM and Ford bonds. GM, in particular, will have to depend, to a significant extent, on hedge funds and junk-bond mutual funds to buy up GM junk bonds, of which the total amount outstanding is more than $275 billion. Not all of GM's bonds may be purchased initially. "GM's bonds may become more volatile, leading to wider credit spreads," Dennis Adler, a corporate bond specialist at Citigroup, told Bloomberg May 31. This could unsettle the volatile junk-bond market, and the derivatives contracts based on that market.

U.S. Manufacturing Indices Continue Precipitous Decline

The National Association of Purchasing Management-Chicago reported May 31 that its index of business activity in the Midwest area fell to 54.1 in May from 65.6 in April. On June 1, the Institute of Supply Management issued its report which showed that U.S. manufacturing expanded in May at the slowest pace since June 2003. Its factory index fell to 51.4 in May, the sixth straight decline, from 53.3. A reading of 52 was forecast for May.

The employment index decreased to 48.8 in May, compared to 52.3 in April, the lowest since October 2003, ending 18 months of alleged expansion. The backlog of orders gauge fell to 51 from 53. The index of supplier deliveries declined to 50.5 from 51.5. The inventories index dropped to 47.8 from 47.9.

Medicaid Cost-Cutting Benefits No One

The Center on Budget and Policy Priorities (CBPP) held a teleconference on May 31 to release its overview of several studies carried out in different localities, of the devastating effects resulting from the cutbacks in the Federal-state funded Medicaid program, which provides health care for 54 million poor, disabled, and elderly people in the U.S. Unable to cover the Federal government's cuts themselves, scores of states instituted co-payments which Medicaid beneficiaries have to pay for each prescription they need, or for each visit to the doctor or hospital, and some states began charging a monthly premium for beneficiaries to get services.

What the studies found, is that when "out-of-pocket" costs go up for an insured person, they may skip care but not suffer serious consequences. But, since Medicaid beneficiaries tend to have multiple problems or are disabled, when their costs go up, and they cannot afford the care, they become sicker, and end up in emergency rooms, or are hospitalized.

For example, when co-payments for doctor visits went up by just $1 in California, many on Medicaid skipped needed visits and ended up in the hospital. The study found that the state saw no "savings," because the increased costs of hospital care completely offset what co-payments "saved" the state.

When premiums were raised in Oregon's expanded Medicaid program from $6 a month to $20 a month, half of the people (50,000 people) dropped out of the program, and three-quarters of them became uninsured. The dis-enrolled were four-five times more likely to end up in Emergency Rooms.

One study of the effect of similar policies applied in Quebec, Canada to its welfare program, found that after co-payments for prescription drugs were added, patients stopped taking essential medications, which led to a 78% increase in "adverse events," including deaths, hospitalizations, and nursing home admissions. The co-payments led to an 88% increase in Emergency Room use.

Medicaid Beneficiaries Pay More Than Insured Patients

Medicaid beneficiaries pay up to eight times more out-of-pocket health-care costs than privately insured patients, according to a study by the Center for Budget Policy and Priorities. Adult Medicaid beneficiaries living at the Federal poverty level ($16,000 for a family of three), spend three times more on out-of-pocket medical expenses than insured individuals, who spend an average of 0.7% on out-of-pocket health-care cost.

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