Wednesday, July 23, 2008

Cognitive Dissonance

Who is Right: Professionals or the Populace ?
Monday, June 30, 2008 09:00 AM
in Economy Employment Energy Psychology/Sentiment

Portfolio has an interesting discussion on what they term the "He-Said-She-Said" economy:
"Inflation, energy, home prices, and tax rebates. Ordinary Americans and Wall Street professionals are at odds on issues like these and others at the center of the current economic malaise, according to the CNBC/Portfolio Wealth in America survey. And these differences have implications for both the Federal Reserve and this year's congressional and presidential candidates.

For example, while Wall Street forecasters predict inflation will be fairly tame in the next year, at about 2.5 percent, 71 percent of the report’s respondents think prices will rise by at least 4 percent, and 50 percent expect inflation to run at or above 6 percent.
In the past month, the Federal Reserve has been trying to put a lid on inflation expectations, culminating last week with what was seen as a benign outlook for price pressures in the statement following its monetary policy meeting. Still, Americans don't seem to be hearing that message."

I heard Steve Liesman discuss this poll on CNBC. Steve, like so many other economists, is having a hard time with this conflict. Many of the dismal scientists believe in the wisdom of crowds, but they also are somewhat compelled by training to buy into the methodologies of their profession.
When the two schools of thought are directly opposite, you end up with a form of cognitive dissonance. This has accelerated as prices continued to go higher, even with relatively modest core inflation.

I have been surprised by how many reality-based economists -- including those on the left like Professor Brad DeLong and NYT columnist Paul Krugman -- were so reluctant to embrace elevated inflation as a genuine threat. There was a bit of a circle-the-wagons mentality about economics as a discipline. That seems to have faded in the face of elevated food prices and $143 Crude Oil.

Here's a suggestion: If the professional economists' data states that inflation is contained and unemployment modest, and at the same time the population sentiment is screaming as if neither were the case, perhaps its time we consider that it might be the data, and not the population, that is the source of our dispute.

Sentiment is now at levels last seen during deep ugly recessions. Perhaps the fault lies not with us American whiners -- but with the way the data is gathered, massaged and reported.
Something else to mullover: We have "enjoyed" practically full employment (i.e., very low unemployment levels) for several years now -- but wage pressure has been non-existent. That seems to be unusual to say the least.

As someone who has been skeptical about the artificially low inflation and unemployment rates for quite sometime now, the public's reaction makes a whole lot of sense. If we believe the negative sentiment of the American people, then its likely that Inflation has been much more pervasive than reported by either the top line or the core. And the same thinking likely applies to the low unemployment rate. If we judge by sentiment, perhaps its not as low as advertised. Ignoring widespread distress in the population is a recipe for major electoral changes.
Regardless of who wins in November, its time for a major rethink of the methodology behind BEA/BLS data . . .

I too have been suspect for a while now of unemployment and inflation data. For people who are interested what they are not telling you check out

Mortgage Rates rise

Mortgage Rates Near a Year High
By RUTH SIMON and JAMES R. HAGERTYJuly 23, 2008; Page C14

Home-mortgage rates are nearing their highest levels in a year, adding to pressures on the already weak housing market.

Rates on conforming 30-year fixed-rate mortgages rose by nearly 0.40 percentage point in the past week to an average of 6.71%, according to HSH Associates in Pompton Plains, N.J. Rates on jumbo loans, which are too big to be eligible for purchase by Fannie Mae or Freddie Mac, currently average 7.84%.

The higher rates are making it more difficult for borrowers to refinance and putting another crimp on weak home sales. "It's a tough market and rates going up isn't helping it," said Steve Walsh, a mortgage broker in Scottsdale, Ariz.

Mortgage rates typically move in line with rates on 10-year Treasurys. Treasury rates have risen, but so has the spread between rates on 30-year mortgages and 10-year Treasurys, said Nicholas Strand, a mortgage strategist at Barclays Capital.

Banks set their interest rates on mortgages based on demand for those loans from investors, including Fannie Mae and Freddie Mac. When demand is weaker, they must offer investors a higher interest rate.

Walter Schmidt, a senior vice president at FTN Financial Capital Markets in Chicago, said the latest increase largely reflects fears that Fannie Mae and Freddie Mac wouldn't be able to buy as many mortgages in the months ahead as they have recently. The two companies are the biggest buyers of mortgages and related securities. Both are facing heavy losses on defaults, and investors believe they probably will have to raise large amounts of capital to cope with those losses.

Freddie added to jitters last week by saying it might sell some mortgage securities to reduce capital needs. And some smaller Asian banks have been selling mortgage securities, said Arthur Frank, a director at Deutsche Bank Securities in New York.

Can you say credit crunch?