Economy: from freefall to downhill roll

Flickr credit: The Pocket.

Three battles are under way: Treasury borrowing vs. interest rates; slower economic decline vs. bottom; and banks vs. everybody else.

Total Treasury new-cash borrowings this week and next: $171 billion, a tad high (the 2009 two-week average: $75 billion). The Fed on March 18 said it would buy $300 billion in Treasurys this year -- many thought in an effort to control Treasury interest rates, specifically holding the 10-year under 3 percent. Not so: the 10-year is trading at 3.16 percent today. One-quarter of the $300 billion has already been spent. The purpose was to get cash in the economy around broken banks, not to rig Treasury rates.

The Treasury market is too big and too important to the world, and the Fed already has the other credit markets on life support. The longer you keep a patient on a ventilator, the harder to get him off, and we have a whole ward on "vents."

The good news: Mortgage rates have not risen in tandem, holding in the high fours. The Fed's $1.25 trillion effort to push down mortgage rates is working because rollover refis don't require new money, and even purchase loans are a wash vs. payoff and foreclosure drains. Fannie, Freddie and Ginnie already either own or guarantee half the outstanding $10 trillion -- and they are on the vent for good.

The April Institute for Supply Management survey does show a slower rate of decline: 40.1 versus 36.3 in March and cycle-bottom 32.9 in December. However, the ISM data show only changes in the rate of change. Any reading under 41.5 is deep recession -- growth begins way up at 50 -- and a shift from freefall to rolling downhill should not be confused with stability.

Another key indicator of cycle turn: new claims for unemployment insurance. Down a hair to 631,000 last week, they are holding below the early-April top at 668,000.

The precise location and timing of bottom does not matter. The important things: how solid the floor, and the shape of the recovery. The stock market yahoos all have out the "V" charts, and I believe they are dead wrong on one cycle-marker: the lag between Fed-on-the-gas and economic acceleration. In cycles going back to World War II, the lag has been six to nine months, and theoretically the Fed put pedal to metal in September, eight months ago. However, this time the linkage is busted: No matter how hard the Fed hits the throttle, nothing is coming out of the fuel pump -- no credit.

Banks of all sizes have been on the run since fall: Stripped of mortgage refis (banks just processing loans on the way to the Fed's balance sheet), the Treasury says that October to February bank lending contracted almost 40 percent. Credit contraction entered a whole new stage about six weeks ago, pullback heaviest from second mortgages (now 85 percent loan-to-value ratio max, at best), commercial real estate loans, and credit for consumers. ...CONTINUED

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