August 25, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 122 basis points from 5.59% to its current 4.37%.

Oil continues to be the lead story in the US and today closed at a new high in NY trading at $67.49. Yes, I still believe that we are seeing a MAJOR top in the price of crude oil and that by Labor Day we will see prices begin a steep decline of at least 20%. But there are many who do not agree with my opinion and the State of Hawaii’s Public Utility Commission obviously believes that the only way to stop the price of oil from increasing further is to fix the price at a level and not let market forces determine the price where supply meets demand. Yesterday they decided to cap the price of gasoline in Oahu at $2.84 with a different price cap set each week for each separate island. This government edict will do nothing but make prices go higher and suppliers avoid the market entirely or charge the cap price + a service fee tied to some other product. It reminds me of anti-scalping laws for sporting event tickets in New York. You charge the limit price and then some exorbitant fee for delivery of the tickets or……For the story directly from Hawaii (yes I read the Honolulu Advertiser on a daily basis) http://www.honoluluadvertiser.com/apps/pbcs.dll/article?AID=/20050825/BUSINESS/508250316/1071

Oil traders are becoming pseudo weather forecasters as the fate of Hurricane Katrina has oil traders hoping and praying that it heads for the Gulf of Mexico and destroys more than a few oil platforms which theoretically would cut supply and then drive prices higher and higher. If you are long oil you cheer for every catastrophe that involves an oil refinery..it’s a dangerous game to play where the risks are high and the rewards are sometimes nothing more than an illusion. I remind those that believe oil can rise to $100 that the world is long (and soon to be wrong) and that every bad news event (other than war) is already priced into the market.

Tomorrow morning at 7am Fed Chairman Greenspan address a conference in Jackson Hole, Wyoming at 7am. The conference is titled “The Greenspan Era: Lessons for the Future” and although most of the proceedings will center around honoring the Fed chairman for his work over the past 18 years I expect him to have more than a few words about oil, housing and the strength of the US economy. The three leading candidates Bernanke, Hubbard and Feldstein) to replace Mr. Greenspan will be in attendance as they try to glean a few points in case they rise to the top position in January 2006. Unfortunately for the world, the US and every living body that cares about interest rates Mr. Greenspan will NOT leave a manual on how and what to do when the next crises occurs…..this job is purely learning as you go along and the world has been lucky that the last two Fed Chairmen (Greenspan & Volker) were the best in history. What this means for the future will assuredly be more volatility in US interest rates in 2006 as the markets adjust to the new Fed Chairman’s methodology. But I remind everyone that in the last 50 years the average number of months for a Fed tightening has been 19 months and with the Fed having begun its current Fed Funds (10 consecutive increases) climb on 6-30-04 we will reach 19 months on 1-31-06 and that coincides exactly with Mr. Greenspan’s retirement. (he’s smarter than anyone realizes)

There has been much written about the exploding US trade deficit and that if the foreigners that are financing our deficit pull out (where else could they go???) the effect on interest rates would not be pretty (up, up, up)……I remember the same exact articles in the mid-70’s (yes I am older than most of my readers, I have been watching interest rates daily for the past 38 years) when the fear of Saudi Arabia pulling out their petro dollars caused a brief increase in long term interest rates but they found they could not invest the Billions anywhere other than in US treasury securities. In 2005 we have Trillions of foreign money ($) invested in US treasuries but NOT in long term bonds where rates would rise if foreign sellers flooded the market. According to recent statistics from the US Treasury over 50% of the foreign money is invested in securities with a maturity of less than 2 years and only 10% is invested in 10yr.+ Treasury bonds. The short end of the yield curve (2yrs. & under) is mostly influenced by current Fed policy and with the Fed having 6 more months (see above) of short term rate increases the dollar (our rates are higher than every major country other than the UK, Australia and New Zealand) will stay strong giving foreign central banks no reason to sell…….Lastly US corporations are sitting on an all time record amount of cash ($450 Billion ++) and retained earnings and the majority of this is currently being invested in US Treasury securities.

Final note for the day: The Federal Reserve is well aware of the massive amount of mortgage debt that has been created by the housing bubble and probably has come to the conclusion that the bubble will NOT be popped by an increase in long term interest rates (as it hoped) so it is going full scale ahead with examining the risk the lenders are taking with their current loan production and the manner in which they hedge their interest rate risk. The Federal Reserve Board of New York has asked the 14 largest credit derivative (hedging risk) dealers to a special meeting in September to analyze what is certainly becoming a growing problem for a trillion dollar market….

August 22, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 116 basis points from 5.59% to its current 4.43%.

Crude oil is trading at $65.65 tonight in Asia and it’s amazing but oil actually received more press this weekend than real estate and that’s a first for 2005. Much of what has been written assumes that the American consumer and China have an insatiable appetite for oil and that demand does NOT fall as prices rise…I think that is true up to a certain point but may not be true now….one of the biggest supports for the high price of oil in the US has been the ability of homeowners to continue to treat their home like an ATM machine…keep refinancing every few months for needed cash (higher gasoline prices), new cars, vacations, etc. The main reason I firmly believe we are at a MAJOR top in the price of oil (after reading every paper published this weekend I am convinced that I am the only one predicting a top) is that everyone is focused on the wrong end of the oil price equation. Sure we have not had a new US refinery in over 25 years and eventually the world might run out of oil, Saudia Arabia is probably producing at near capacity, China continues to increase demand, worries over supply disruptions in Equador, Venezuela and Nigeria, forecasts for more hurricanes in the Gulf of Mexico, fear of a cold winter in the US, etc., etc., etc. but that news is already priced into the oil market….it’s the falling demand that is NOT priced in yet and the biggest surprise for the remainder of 2005 will be that with a slowing in house prices homeowners will find their personal ATM machines have run out of $$$$…..and the consumer will realize that high gas prices are affecting their spending more than they realized…in other words the psychology of the market place is changing…..the oil market is priced for non-stop demand and decreased supply and I think it would take something incredible (an attack on US soil) for the market to sustain its current momentum…The hedge funds are long, the speculators are long., there was an article about people buying call options on oil priced at $100 with the expiration of 12/31/05…that’s not an insurance policy, that’s worse odds than your state lottery…with less payoff if you are right….two other points…there was a picture in the NY Times last week that showed cars in the eastern part of China lined up for 5 miles to fill up their tank because of a shortage of oil…what wasn’t in the caption was the fact that the retail price of gasoline being charged in this part of China is $2.01, a price mandated by the government so of course there is a line….China is losing $$$ every time a driver fills up…that won’t last long and does nothing for the free market economy that everyone is waiting on in China…In today’s China Daily comes the story of construction of 24 new filling stations as the Chinese government has discovered that their oil supply is plentiful but the shortage is due to an an incredibly inefficient transportation system. Somehow those that bought oil last week after seeing the picture in the newspaper will not realize that the reason they bought is not really valid….. http://www2.chinadaily.com.cn/english/doc/2005-08/22/content_470980.htm

2nd point…Back to school sales are down dramatically in the south and midwest USA but up in the west and northeast…why??? where is the biggest growth in home prices….the west and northeast….why is Wal-Mart now saying that their store sales are soft in August??? people are spending more on gas and less on purchases….in this morning’s USA Today there was a story about families that are cutting corners because of the high price of gasoline… http://www.usatoday.com/printedition/money/20050822/gasprices22.art.htm … at some point (soon) people will adjust their purchase patterns and cut back on driving and spend $$$ they need to on basic necessities..

I am fully aware that the US economy has created an average of 190,000 jobs per month in 2005 and the current unemployment rate hovers at 5.0% but somehow we still have many who would jump at the opportunity to find a permanent job. In Oakland last week 11,000 people applied for 400 job openings at the new Wal Mart store. For the complete story: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/08/17/MNGDPE91AH1.DTL&hw=wal+mart&sn=004&sc=565 If you want a job that pays well how about moving to Northern Alberta Canada where the unemployment rate has fallen to 3.3% and the local oil and gas producers are talking about kidnapping people off the street to find workers..(I really don’t make this up) http://www.canadianbusiness.com/managing/article.jsp?content=20050815_69822_69822

For those that don’t want to work at Wal Mart how about a job making for sale signs that are planted in front of houses. It seems that Sacramento’s demand for these signs is the hottest it has been in 21 years. Yes there are pockets of weakness in the housing market and the inventory of homes for sale in four counties (Sacramento, Placer, El Dorado and Yolo) has risen to 9,141 the highest since 1998. Is this the end of the price advance??? probably not but we are getting closer and closer and closer to the end…and just like the game of musical chairs every time they pull away a chair the game becomes riskier and riskier……http://www.sacbee.com/content/homes/re_news/story/13439954p-14280992c.html

Did you know that inflation in India was just reported to be just 3.35% a level not seen in almost 3 years.

Fed Chairman Greenspan will be giving a MAJOR speech at 7am on Friday in Jackson Hole, Wyoming with a title of “Reflections on Central Banking” at a Kansas City Fed Conference. Every word will be analyzed to see if Mr. Greenspan gives any clues to future Fed policy changes……(doubtful) but he may have a word or two on the price of oil and its effect on the US economy.

I saw a great cartoon last week (I wish I could remember what newspaper) that had a man bringing a container of gasoline to a bank asking for a safe deposit box for his prize possession (very funny)

The Fed’s H8 report released on Friday (8-19) showed HELOC loans virtually flat for the past month while the commercial & industrial loan category showed that July’s explosive growth has turned into a August non event with loan demand on vacation. September will tell us whether the economy is on hold and if the gas price increase has created a major hurdle for consumer spending and commercial loan growth. (very likely)

Last thought for the night: The long term interest rate market seems to have weathered a significant amount of bad news in the last 4-6 weeks that should have sent these rates higher….But the peak for the 10 year US treasury was only 4.43% on August 8th so just like a ball that you try and keep under the water in your pool….it pops back up and I see long rates going lower over the next 8 weeks or so….Yes Mr. Greenspan would like long rates to be higher but with only 5 months left in his term of office he will soon come to the realization that even he is NOT bigger than world wide market forces.

August 17, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 113 basis points from 5.59% to its current 4.46%.

On July 18th I wrote:

In Lynwood, Washington (Yes I read the Seattle Times every day) a land auction yesterday found 2,000 anxious buyers willing to part with their hard earned money for a chance to buy one of 220 parcels that totaled 2,000 acres in 12 states. The auction proceeds of $2Million is substantially more than this land (raw, raw, raw) will bring in resale transactions that speculative buyers hope and pray for over the next 5-10 years. But I am sure that the man who bought 640 acres of Nevada desert for $75,000 believes he got the purchase of a lifetime. For the full and somewhat sad story: http://archives.seattletimes.nwsource.com/cgi-bin/texis.cgi/web/vortex/display?slug=landauction18m&date=20050718&query=brian+alexander

An article in this mornings Seattle Times followed up with many of these buyers and specifically Eric Lopez, the buyer of the 640 acres of Nevada desert land. It seems Mr. Lopez never researched the property before purchase and has just learned that the county where the land is located has assessed all 640 acres for $11,450 or 15% of his purchase price. Then when he tried to visit his land he found it was a mile from the nearest road with no easement across adjoining land for access. Finally he learned that those easements would cost three times more than he paid for the land. For more of these sad stories visit: http://seattletimes.nwsource.com/html/localnews/2002442840_landauction17m.html

In Thursday’s Wall Street Journal is a page one article about the boom in condo prices with the median price of a condo now higher ($223,500) than a house ($218,600). This is the area that I feel will be hit the hardest when the bubble finally bursts. http://online.wsj.com/article/0,,SB112433219383716375,00.html?mod=home%5Fpage%5Fone%5Fus . According to a research study released Tuesday 38.1% of house buyers put down 5% or less and 49.9% put down less than 10% for the first six months of 2005. The good news for home owners/buyers is that the price of oil has begun its drop for the remainder of 2005. Oil fell today over $2 and is trading in Asia at $63.45 and this is despite better than expected inventory numbers released early this morning. A market that doesn’t respond positively to good news is a good bet to fall and quickly…….

From Guangdong, China comes news that drivers are waiting for hours to fill up their gas tanks. How can China with millions of dollars flowing in every day have a shortage of oil??? The answer lies in the price being charged at the pump…The retail price of gas today is just $2.01 due to government decree and this is pushing domestic refiners into a massive loss position for the year. I expect Chinese refineries to soon boost exports to overseas markets where they can charge market (higher) prices. It is going to be many years before China has a truly market based economy…..Have US real estate speculators moved to China?? In the just released annual report by the Peoples Bank of China overseas buyers accounted for 23% percent of all purchases in Shanghai in the fourth quarter of 2004. In Beijing investors purchased 20% of all new homes with over 50% of these now sitting empty…….

Can gasoline in the US go to $5 or $10 a gallon??? I seriously doubt it…BUT according to a so called “expert” these prices are coming soon (2006) For the story from the Chicago Sun Times: http://www.suntimes.com/cgi-bin/print.cgi

The best decision of the day goes to the New York woman who is selling 50% of her apartment buildings after realizing that it would take her 15 to 18 years of rental income to reap the same profit that she could receive by selling now…..That’s a smart investor who will live to play again. http://online.wsj.com/article_print/0,,SB112423470689614965,00.html

Finally an update for the many real estate professionals who read this e-mail on a regular basis: We have now started a 8-10 week cycle where long term rates will decline despite Fed tightenings, inflation fears, etc. Since April 10, 2000 when the 10 yr. US Treasury peaked at 5.80% we have had 13 cycles of downward moves in long rates that have averaged 104 days and 87 basis points. I’m not sure we will achieve those averages for cycle #14 but we should at least hit the minimum of 40 basis points from the recent high of 4.43%.

August 15, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 111 basis points from 5.59% to its current 4.48%.

“When they’re yellin you should be selling and when they’re cryin you should be buying”…this quote reminds me of the current oil market where a few days ago I wrote that we are just days away from a MAJOR top in the price of oil. Currently trading just under $66 a barrel and despite almost a universal consensus that oil prices are headed to $70, $80, $90 and then 100++ (they are yellin for higher oil prices) I will take the other side and predict that we are done for at least the remainder of 2005. I know that US refineries are running at 95% capacity and that every newspaper quotes an “expert” that says we will have a tight supply of oil for at least the next 10 years. But I also know that with rising prices comes rising supplies and it’s amazing that no one has noticed that distillate stockpiles have risen for the past 12 consecutive weeks and show no sign of slowing……I also remember that in August 2004 with oil just under $45 a majority of oil analysts predicted that 2005 would see an average of $28…..and yes these analysts still have their jobs and are now predicting much higher prices…they will surely be wrong again but no one will notice….Finally one of the reasons I made the dollar my best investment for 2005 and went against all of the experts (Warren Buffett has lost $926 Million this year betting against the dollar) is because there was no one left to sell, everyone was long and soon to be wrong…..Oil has now come full circle and hedge funds, speculators, mutual funds, etc. are now riding the wave of higher oil prices to bigger and bigger profits but are about to drown when their current positions turn south in a few days.

One of the recent arguments for higher long term interest rates has been an increase in inflation caused by higher consumer demand. On Tuesday morning we have CPI and Wednesday morning PPI and both are expected to show a core (ex food and oil) 2% inflation rate. How can we have high inflation when flat panel TV prices are down 35% in the past year and attendance at movies, concerts and theme parks is down 5-10% for 2005. In Monday’s USA Today there was a fascinating article about back to school shopping. http://www.usatoday.com/money/industries/retail/2005-08-14-school-usat_x.htm . The article points out that shopping this year is expected to drop 9.5% or $1.4 Billion which is not a small amount and certainly NOT inflationary. What I found most interesting was a table that broke down the shopping by geographic region and that the West and Northeast would show growth while the Midwest and South would decline from last year. That’s quite unusual especially for something as solid as back to school shopping…but then it became obvious….where are the biggest increases in home prices??? The West and Northeast….so consumers just tap into their rising equity and have more spending $$$ while those in the central part of the country send their kids to school in last years clothes…..America is being split apart by the real estate bubble…..

Next we find a story from Bloomberg titled: “Pricey oil causes no pain for the expanding economy” and talks about economists wondering why record oil prices not affecting consumer spending. The answer remains the same as the back to school shopping…real estate,real estate and more real estate. How can oil have any affect when the price of the homeowner’s house is rising faster than the price of oil. When not if the housing bubble loses froth it create pain for the average driver…… http://www.bloomberg.com/apps/news?pid=71000001&refer=columnist_pauly&sid=agr1rwVZIwLg

Attention stock market players: Did you know that the only month of the year to show a losing record since 1926 (78 years) is September with an average decline of 1.28%..

This afternoon the Federal Reserve released its quarterly survey of Bank Lending Practices from Senior Loan Officers: http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200508/default.htm Included were more than just a few juicy morsels of information some more obvious than others. While it is no surprise that a notable amount of lenders reported an increase in loans to purchase homes it might not be apparent to many that a large number of lenders did NOT securitize over 75% of their nontraditional mortgages that were originated this year. Non traditional mortgages include option ARMS, interest only loans, non-owner occupied properties, etc. This puts many of these lenders at greater risk because they have chosen to hold on to these mortgages thus putting more of their capital at risk for lengthy periods of time. Last week Freddie Mac reported that 74% of all refinancings this year were for cash out of at least 5 percent….Lenders are easing their underwriting standards, lowering their profit margins in an effort to book as much business as they can before the door is slammed shut by Mr. Greenspan and his Fed posse….According to a Robert Novak column in Sunday’s Chicago Sun Times Mr. Greenpsan recently made a private call to federal regulators about recent real estate speculation. http://www.suntimes.com/output/novak/cst-edt-novak14x.html It may be a statistical fluke that is corrected this Friday but last week’s H8 report showed real estate loans jumped $19.5 Billion last week which would be a 36.9% annual growth rate. This all has the feel of a last desperate push to find the last few pennies in the piggy bank (home equity).

Did you know that since 1958 the average period for a Fed tightening is 19 months which would be January 2006 (the Fed began raising the Fed Funds rate in June 2004) which is coincidentally the month Mr. Greenspan hands the baton to a new Fed Chairman. (Ben Bernanke??) This is only one of the many reasons I see the Fed raising the Fed Funds rate three more times in 2005. (9/20, 11/01, 12/13). It would NOT surprise me if in his last action as Fed Chairman he put a firm nail in the Fed Funds coffin with a 50 basis point increase which surely would have the bond “gurus” wondering what to do next…..How about a Fed easing in 2006 which will create a new LOW in long term rates for this cycle…..If the Fed couldn’t get the long term rates to rise after 10 consecutive Fed Funds rate increases guess what happens when they finally ease in 2006?????

Final thought: We are less than 5 months from a new Fed Chairman (Greenspan retires in January 2006) and Mr. Greenspan has been in office for 18 years. Markets don’t like change especially when someone replaces a legend and I remember clearly June 2, 1987 when President Reagan announced the nomination of Mr. Greenspan to replace another legend Paul Volker. The bond market reacted with one of its worst days ever….a 35 basis point increase….just something to think about as we get closer and closer to the end of the Greenspan era…..

August 11, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 107 basis points from 5.59% to its current 4.52%

We are just days away from a major TOP in the price of crude oil. That’s right I am going against the consensus and predicting that we will see the high price for the remainder of 2005 before the end of August. Oil closed at another new high today in New York trading ($65.74) and yes all of the newspapers are screaming with headlines about $75 and higher coming soon….but when you have a hunch it’s a good time to bet a bunch and remember the laws of supply and demand have not gone away. I have written all year about supply increases in commodities when prices rise (remember silver in the 70’s??). Inventories of oil are increasing almost every week and with the price of gasoline rising to a new national high of $2.40 a gallon we will soon witness a reduced amount of demand from consumers as the % of money spent on gasoline rises and thus forcing families to spend less on other household items. Again the good news is that I am predicting a sharp decrease in the price of oil to occur between Labor Day and the end of the year.

Turning to interest rates most of you will be happy to know that we are very, very close to a another leg DOWN in long term rates. The current rise in rates began on June 2nd and is now tiring even though the news all points to higher rates. It has become obvious to everyone that Mr. Greenspan has decided that the best way to bust the housing bubble is for long rates to rise thus making it more expensive to borrow against a house. It’s important to note that the Federal Reserve can move short term rates (Federal Funds) but long term interest rates are and have always been a function of future inflationary expectations. So if Mr. Greenspan wants long rates higher he needs to create inflation and that’s not easy to do when the money supply is growing at a 2-3% rate….I’m afraid that Mr. Greenspan is going to have to find another way to make housing prices fall…….How about making it more difficult for lenders to underwrite 100% loans????

This morning it was announced that retail sales rose in July by a less than expected 1.8% which on the surface shows the US economy as healthy and growing…BUT when we take out auto sales we find that the growth rate was only 0.3%. Because of the car dealers price discounts much of the sales for the remainder of 2005 has already occurred and the only way for retail sales to continue increasing is for the US consumer/house owner to keep tapping into their house equity (ATM machine) until they have no more equity….and that will be occurring sooner than later….house prices don’t grow to the sky despite what most people in America believe to be true…..

Did you know that the rental vacancy rate for single family houses is now at just under 10% compared to 5% just 10 years ago???? Many months ago I asked who is going to live in all of these newly built houses/condos after they are finished??? Unless we are about to have 500,000+ new wealthy immigrants arrive in the US in the next few months there are going to be many “for rent” signs popping up all over the country….The most common response I receive from people is “as long as what you are predicting only happens in other parts of the country, I will be ok”……that’s the equivalent to betting that when a major thunderstorm hits LA that your house will somehow stay dry…..it’s possible but not probable….but I guess people will bet on anything….you have a better chance of hitting the lottery than surviving the coming real estate storm if you are buying houses/condos that will NOT be occupied by the owners….

Final thought: On 4/19/05 I wrote:The price of sugar has reached multi year lows and pessimism is high (yes sugar is traded) so you might want to stock up…….. on 4/19/05 the price of sugar closed at 8.33 and is trading today at 9.34 so if anyone took my advice (please let me know) it’s time to SELL as sugar now looks expensive…..

August 9, 2005

Since June 30, 2004 the Fed Funds Rate (short term) is UP 250 basis points from 1.00% to its current 3.50%. The US Treasury 30 yr. interest rate is DOWN 98 basis points from 5.59% to its current 4.61%

At 11:17pm today the Federal Reserve (Alan Greenspan) raised the Federal Funds rate to 3.50% from 3.25%. In the accompanying announcement the Fed said: “Aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually.” Most importantly there was no mention of housing prices but believe me the FOMC spent much of the time at the meeting discussing how to protect the economy against a collapse in housing prices. http://www.federalreserve.gov/boarddocs/press/monetary/2005/20050809/default.htm

Over the past week we’ve had more than the usual amount of economic news and analysis. Last Friday the jobs number was released and it showed that the US economy continues to grow at a moderate pace (207,000 new jobs). Most importantly the main ingredient behind inflation is labor costs and this mornings announcement showed they are increasing at an annual rate of only 1.3%. I expect for 2005 that this key economic number to increase by just under 2%. Unfortunately we also saw that the US personal savings rate has hit 0.0% which is not surprising since there really is no reason for anyone to save when they can invest/borrow in real estate that continues to increase in value every month. I fully expect the savings rate to plunge below zero in the next few months as consumers continue the leverage pyramid to real estate riches. Last weeks’s Fed H.8 report showed a $51.9 Billion increase in real estate loans for July. This is an incredible 22.8% annual increase and is one of the main reasons that the Fed will continue to raise the Fed Funds rate at each of the remaining 2005 FOMC meetings. (9/20,11/01,12/13). With less than six months remaining before Mr. Greenspan’s mandatory retirement (1/06) the Fed Chairman will be stepping up the pressure on the real estate lenders to tighten underwriting guidelines thus making it much harder for investors to qualify for high leverage loans. Barbara Grunemeyer, deputy controller of the currency is preparing new underwriting and credit-risk guidelines on Option ARMS, interest only loans and stated income loans. I expect this memorandum to be sent in September.

Last Wednesday (8/03) an article written by Grep Ip of the Wall St. Journal pointed out that the Fed now believes that the world of monetary policy/inflation has now changed and that higher long term interest rates will stop the Fed from raising future short term rates.The article was titled: “Fed Sees Bond Market Hindering Its Effort” and is a must read for the very reason that the author is wrong and more importantly the phrase “This time is different” is the same thing we hear and read at the end of every cycle when the last of the contrarians “throw in the towel”.http://online.wsj.com/search. The fear that is driving the long term bond market lower and interest rates higher is being driven from this bizarre idea that higher long term rates (a function of inflationary expectations) would cause the Fed to stop raising short rates because if long rates rise the housing bubble will burst and then the Fed’s biggest worry is gone……This is just plain wrong and if long rates rise due to inflation rising the Fed would then be forced to raise short rates even more than expected and that has a probability of less than 1%. The US economy continues to grow despite higher oil prices ($63) because the insatiable consumer is able to tap into their rising equity and refi over and over and over…$59 Billion was cashed out in the 2nd quarter of 2005 and that is up from $43 Billion in the 1st quarter. In 2004 the total cash out was just $126 Billion and for 2005 the total should be over $200 Billion. The big question is NOT what happens when real estate prices fall but what happens if real estate prices just go flat???? Where will the consumer find more spending money if real estate prices don’t keep rising??? There is only one answer and it is obvious…they won’t and with a 0.00% savings rate the only way out at the end will be for the Fed to ease and quickly but that is a story for 2006 and beyond….Of course the if the price of oil falls it does add $15 billion (for every 10 cent decline in the price of gasoline) to consumer cash flow.

For those that remain in variable rate mortgages I still anticipate another six months or so of pain from higher short term rates BUT a MAJOR low in long term rates will arrive in 2006 when the Fed begins a new easing (lowering short term rates) cycle. Over the next few weeks we will hit another short term high in long term rates as the current cycle is 67 days old and the longest up move since 4/10/00 has been 90 days.