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Five Things You Need to Know: Credit Crunch Wins in Split Decision


To place the bottom of the housing market at the doorstep of expanding loan limits is, well, just a sad failure to discern reality.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Credit Crunch Wins in Split Decision

The Bank of England today cut interest rates for the second time in three months, lowering the benchmark by a quarter point to 5.25%, while the European Central Bank kept its key rate unchanged at 4%; call it a split decision.

The Bank of England decision was largely expected and BoE Governor Mervyn King has recently acknowledged the "difficult balancing act" between what they are perceiving as inflationary pressures and credit market issues.

The wild card was the ECB decision. ECB President Jean-Claude Trichet's comments following the decision to leave the key rate unchanged were noteworthy. On the one hand, Trichet said he has never subscribed to a global "decoupling theory" where a slowdown in the United States, for example, could remain isolated from growth in the rest of the world. "If any component of the world goes up or down it influences the rest of the world," he said. On the other, he apparently remains unconcerned about credit market contagion, saying, "Continued strong loan growth suggests that the supply of bank credit in euro area has not been impaired by financial turmoil so far."

2. As Expected, Pending Home Sales Fall More Than Expected

Pending home sales fell more than forecast in December, which was largely expected. The National Association of Realtors reported that their Pending Home Sales Index, which is based on contracts signed but not yet closed, fell 1.5% in December. The drop follows a revised 3 percent decline for November that was larger than previously reported. The index was down 24.2% year-over-year.

Meanwhile, the NAR lowered their forecast for existing-home sales this year to 5.38 million units from their January forecast of 5.7 million. However, Lawrence Yun, NAR chief economist, is optimistic that "pent-up demand" will return, especially if loan limits for the GSE's, Freddie Mac (FRE) and Fannie Mae (FNM), are increased. "Existing-home sales have moved narrowly since last September, but when the full impact of higher loan limits for conventional mortgages begins to impact the market there is likely to be a notable rise in home sales and prices," Yun said.

The problem with this optimism is that there are actually few loans being originated that do not already qualify under current loan caps, and at the rate prices are declining, the need to expand the caps will soon be a moot point. This is an oversupply issue, not a loan cap issue, and to place the bottom of the housing market at the doorstep of expanding loan limits is, well, just a sad failure to discern reality.

3. Fed's Plosser Covers All the Bases

Taking a look at Philadelphia Fed President Charles Plosser's speech delivered yesterday to the Birmingham Rotary, it's noteworthy that not one, not two, but three different forms of "-flation" were mentioned or alluded to.

Plosser began with inflation and an allusion to stagflation: "Unfortunately, I expect little progress to be made in reducing core inflation this year or next, and I am skeptical that slower economic growth will help. All you have to do is recall the 1970s when we experienced both high unemployment and high inflation to appreciate that slow economic growth and lower inflation do not necessarily go hand in hand."

But he also uttered the central bank's dreaded D-word: "Taking expected inflation into account, the level of the federal funds rate in real terms - what economists call the real rate of interest - is now approaching zero. That is clearly an accommodative level of real interest rates. The last time the level of real interest rates was this low was in 2003-2004. But that was a different time with a different concern - deflation - and we were intentionally seeking to prevent prices from falling. Recently we have had reason to be worried about rising inflation, not declining prices."

By now, you know I think that will change.

Finally, Plosser noted the limitations of monetary policy. Increasingly, as we have seen in Fed Chairman Ben Bernanke's recent comments, the Fed is doing what all worthy bureaucratic institutions do - distancing itself from shouldering full responsibility for solving the debt crisis:

"Although it might be tempting to think that monetary policy is the solution to most, if not all, economic ills, this is not the case. I think it is particularly important, for example, to recognize that monetary policy cannot solve all the problems the economy and financial system now face. It cannot solve the bad debt problems in the mortgage market. It cannot re-price the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies because some of their assets are now worth much less than previously thought. The markets will have to solve these problems, as indeed they will. But it will take some time."

4. We're Talking Ourselves Into This Slowdown

Cisco (CSCO) last night warned that revenue growth in the third quarter will fall to 10%, well below the 15% level most analysts were expecting. And just who or what is to blame for this revenue slowdown? According to Cisco Chief Executive Officer John Chambers, we have no one to blame but ourselves.

Sure the overall slowdown in the U.S. and Europe is being felt as much by Cisco as other companies, but it's not a "real" slowdown, according to Chambers, but an imagined one. On the company's conference call, Chambers said, "I think we are actually talking ourselves into this slowdown."

He then used what he called "the treadmill example" to illustrate how we are responsible for the company's missed forecast. "Over the last three or four months, I felt pretty good about business until I got on my treadmill and then I quit early because of the pessimism that exists in the market.

We'll simply point out that, in a sense, Chambers is right: we are talking ourselves into this slowdown. The question is, why? Because, that's what happens in every slowdown.

Remember, social mood drives social action; social action does not drive social mood. This is counterintuitive, but a negative social mood de-motivates people to produce more, purchase more and behave generally in an upbeat manner. A positive social mood, on the other hand, motivates people to produce more, spend more, take on more credit and expand businesses.

5. Daily Contrary Indicator: Euros Being Accepted in Manhattan Stores?

This weekend while going through one of the closets, my wife and I found a decent pile of euros we had forgotten to exchange following a trip. It wasn't quite like winning the lottery, but it was close. That's how beaten down the dollar is.

Anyway, I was running through my head where the least expensive place to exchange them would be when my wife pointed out an article in the New York Times Travel section, "The Greenback Is Losing Appeal." According to the article, East Village Wines, a liquor store on First Avenue, accepts payments in euros as well as dollars.

And this morning we noticed a Reuters article on the proliferation of retailers in New York now accepting euros. Meanwhile, the lowly dollar is up .8% year-to-date even as the Federal Reserve has slashed interest rates by 125 basis points.

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