The Recovery: Still Sluggish

The index of leading economic indicators for May was rolled out this week, and the numbers are in positive territory, although just barely. After not rising at all in April, the index rose by 0.4 percent in May. Of the ten indicators, five were up in May, and five were down, with the stock market decline being the biggest culprit on the downside.

All told, the Conference Board thinks that adds up to a recovery that will continue but at a very slow pace. One forecast out of UCLA calls for 3.4 percent GDP growth throughout 2010, followed by 2.4 percent in 2011 and 2.8 percent in 2012. That would be OK for ordinary times, but it's not going to be enough to move the unemployment numbers a whole lot. One common estimate is that it takes 5.0 percent GDP growth for any kind of real jobs growth. According to the UCLA figures, their growth forecast leaves unemployment at 8.6 percent by 2012.

So the vicious cycle continues: We won't see a big movement in the unemployment figures until we get robust GDP growth. We won't see robust GDP growth until we get big movement in the unemployment figures. So it looks like the recovery will just keep plodding along.

Jersey Schemer

It appears that we've got our own little version of Bernie Madoff here in New Jersey, not that that's something to be proud of. A woman named Antoinette Hodgson from Montclair was running a real estate investment fund that supposedly was buying up homes and lots around the country. All told, she bought around $16 million worth of residential real estate. The problem: She had actually taken in $45 million from around 20 investors.

Prosecutors have charged that Hodgson was running a classic Ponzi scheme, where the money she took in from new investors went to pay off the old ones. They've also alleged that she spent much of the money at casinos in Atlantic City, gave huge sums to family members, and bought a Dunkin Donuts freanchise in Arizona.

Much as with Madoff, there were pretty clear signs that something might be amiss here. People running aboveboard investment funds keep scrupulous accounts of where the money is going, and should be only too happy to let you see all the records. But more obviously, this scheme was in operation between between 2006 and 2009. Hardly anyone was making money by investing in residential real estate in that era; anyone who claims to be doing so needs to be treated with extreme skepticism.

The Bond Vigilantes

There's been some talk recently of the return of the so-called bond vigilantes, investors who look to punish the federal government for their profligate ways. Who are these bond vigilantes? The term was coined back in 1983 to define investors who sold off massive amounts of government debt when they saw inflation ahead. What makes them vigilantes is that these sales were supposedly protests against inflationary policies, rather than pure investing decisions.

But that may not be the right way to look at what these people are doing. Most investors are far more interested in their monetary returns than they are in protesting anything the government is doing. If large groups of investors are staying away from Treasury bills, it's probably for the simple reason that they fear inflation will drive down their prices. The Treasury then has to offer higher yields to get investors to buy its bonds, driving up the price of borrowing, and starting a vicious cycle.

Fed chair Ben Bernanke has tamped down some of the bond vigilantes' fears by keeping short-term interest rates at near-zero levels, which has helped tamp down inflation to near-zero levels as well. So are these vigilantes concerned about inflation, or simply concerned about the value of Treasury bills? It might well be the latter.

Housing's Grim Outlook

Harvard's Joint Center for Housing Studies released its annual State of the Nation's Housing Report on Monday, and the outlook was pretty grim. The bottom line is that we won't see a full turnaround in housing until we see robust jobs growth.

Home values have declined by an estimated 30 percent since 2006, according to the study, but if anything, that understates the problem. Because most of the houses in the U.S. were bought at what are now inflated prices - and because incomes have stalled out instead of growing - millions of American households are now devoting half their income to their mortgages. More than 11 million homeowners are underwater on those mortgages, so they can't even sell them and move into more affordable housing. Two million mortgages are in foreclosure, quadruple the amount from four years ago.

Is there any good news in all of this? The Harvard researchers do foresee something that could end the housing slump: They think a leap upward in those jobs numbers could have a huge impact on the housing market. With all the pent-up demand from people who basically haven't been able to move over the past five years, a bit of a jump-start from the employment numbers could have a big ripple effect.

Sentimental Journey

Are you optimistic about this stock market's prospects yet? If you're not, you're not alone. A recent survey from the American Association of Individual Investors found that 43 percent of investors are still having bearish sentiments about the future of the market. That's the highest it's been in almost a year, which apparently reflects the cooling-off in May after a generally positive 12 months prior to that.

That's not a terrible figure, of course, although it's above the historical average of 30 percent of investors feeling bearish. By contrast, 35 percent of individual investors are feeling bullish right now, with 22 percent reporting neutral thoughts.

Among investment advisors, the sentiments are a bit more positive. Only 32 percent of investment advisors report their outlook as bearish, while significantly more - 39 percent - consider themselves bullish. It's interesting that the professionals' sentiments are basically flip-flopped from the individual investors'. We'll see who has the better grasp of the situation in the end.

Quarterly Stats

Lots of statistics came out this week, looking back to the first quarter of 2010 for some key macroeconomic figures. Let's just throw some out there:

* Household wealth increased by over a trillion dollars in the first quarter of '10. That's a gain of 2.1 percent. It was the fourth consecutive quarterly gain.

* But the value of the nation's real estate investments dropped by $26.8 billion. American home values fell by an average of 0.4 percent.

* Personal spending grew by 3.5 percent in the first quarter. That's the highest such number in three years.

* Household debt fell by 2.4 percent, the seventh consecutive quarter in which it declined.

* But the federal government's debt grew by a whopping 18.5 percent.

* And the debt of state and local government combined grew by 4.3 percent, the fifth straight quarterly increase.

The Volcker Rule

One of the holdups preventing the financial reform bill from making it through the joint House-Senate committee continues to be the so-called Volcker Rule, which would greatly inhibit the ability of banks to move beyond their traditional lending role. The rule would keep banks from making proprietary trades with their customers’ money, keep them from sponsoring or investing in hedge funds and private equity funds, and cap their market share in order to keep them from becoming “too big to fail.”

People who study the banking industry say that imposition of such a rule could cut banks’ profitability by anywhere from 12 to 35 percent. But Paul Volcker, the former Fed chair under Ronald Reagan who is widely credited with wringing the double-digit inflation of the late 1970s out of the economy, has redoubled his support for the rule. He argued yesterday against providing exemptions for larger banks and allow them to invest in outside funds.

What’s interesting about the Volcker Rule is the momentum it has gained. In the House version of the financial reform bill, passed last December, it wasn’t mentioned at all. (It was formally proposed by Volcker and President Obama in January.) The Senate version included the language, but with a two-year study period for regulators to see if the rule was feasible and sensible. Now, Senate Democrats are reportedly trying to insert an even tougher version of the rule they passed just a few weeks ago.

With the stabilization of the financial sector, we might have expected to see the reverse, with tough new rules for banks being watered down over time as the banking crisis receded in memory. Instead, we have just the opposite.