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  • The amazing February new home sales report… Supply surges amid evaporating demand, yet prices climb
    It's absolutely appalling how little the average American understands about the U.S. economy, especially given the wealth of news and data in the public forum. The problem is that most stories are written for traders and economists, but distributed to a general audience that doesn't really understand them.
    As a voter, you can't cast an intelligent ballot or interact intelligently with your elected representatives if you don't know what's going on with the economy. You need to know "how bad is bad" and "how good is good," but that information isn't always available to you.
    I'm going to try and bridge that gap for the latest New Homes Sales report, which the U.S. Commerce Department released this week for February. It's a perfect example of the gaping disconnect between what economic journalists write for their sources and for financial industry subscribers and the intellectually accessible information that normal readers need so desperately.
    If you're thinking of buying or selling a home, you better read this.
    The February sales numbers are the worst ever recorded in a single month since the U.S. Commerce Dept. started tracking them in 1963. They show up as a 2.2 percent decline from January and are down 13 percent from February of 2009. The decline would be even worse if we were comparing February sales to a normal month, but new home sales have been pretty bad since we entered the deepest U.S. economic contraction since The Great Depression in December of 2007.
    This is like comparing a short kid to another short kid. The disparity between them and the norm appears less pronounced.
    To really understand how bad things are you need a historical norm for new home sales, but the economic reporters covering this thing were so hell-bent on turning copy quickly that they never put a good one together.
    All of the stories I saw told readers that sales were down, but only one emphasized that sales had fallen to a record low. They all mentioned harsh weather as a contributing factor.
    Here's what they didn't tell you:
    They didn't tell you how bad sales really were, because they didn't make any attempt to define normal. I'm not playing here – the situation really is far worse than you know (I'll tell you how and why lower down).
    They also didn't explain clearly that the February sales data was seasonally adjusted to remove the normal annual decrease in home sales that takes place each winter. So, a certain amount of cold weather was already cooked into the numbers.
    Finally, they didn't work the historical data available to them to give the February sales level more size and scope by adjusting them for population growth.
    Here's what happened in a nutshell: 24,000 deals were made in February to sell newly built homes that had never been occupied before. Economists adjusted that figure to remove the normal decrease in sales that takes place each winter. This is called a seasonal adjustment.
    Economists also calculated what the February sales pace would equal if it were sustained a full year. In this case, the 24,000 deals in February represent a "seasonally adjusted annual pace" of 308,000 sales a year.
    Don't be intimidated by this statistical information. It's really no different than saying "Basketball star Dwayne Wade scored 24 points last night against the league's best defensive team. That tally represents an adjusted annual rate of 28 points per game over the course of a full season." In this case the adjustment would reflect the defensive prowess of each team on the Miami Heat schedule as determined by the points being scored against them.
    OK?
    The seasonally adjusted annualized sales pace for new homes sales has two problems. First, you have to know what average annual sales have been since 1963 to put it in the proper historical perspective. Without that average you can't tell how bad is bad. And second, the new home sales data completely neglects U.S. population growth.
    I've reddressed both of these sins of ommission.
    First, there has been an average of 685,000 new homes sales every year in the U.S. since 1963. In other words, 658,000 is the norm and we had less than half of that in February with our annualized pace of 308,000 units.
     Part of the February decline was due to weather, but only to the degree that we had an abnormally harsh February across the entire nation. The seasonal adjustment applied to new home sales by economists accounted for the kind of winter weather that normally inhibits sales.
     I can make things even simpler if you are still confused.
    If we don't seasonally adjust the number of new homes sold in February then only 24,000 homes were sold. Unadjusted means straight sales. One equals one. OK?
    That compares with an unadjusted monthly average of 57,000 new homes sales since record keeping began in January of 1963. The average has dipped to 35,000 units a month, on an unadjusted basis, during the present recession. The monthly average for the three Februaries during that span is 34,000 sales.
    All of which means that 24,000 sales in February of 2010 is really, really bad. Things suck man. They suck bad.
    Weather alone does not explain what happened in February. I don't buy that. Here's one reason why: The Commerce Dept. has measured new home sales in 688 months since January of 1963.
    In all that time there have only been 22 months in which fewer than 30,000 homes were sold on an unadjusted basis. We've recorded eight of them in the 27 months since this recession began. We haven't reached 27,000 monthly sales since October.
    So, we're off by a helluva lot. And it gets worse. Here's why: None of the seasonally adjusted rates reflect population growth.
    Once upon a time in 1963, a population of 189 million Americans purchased 560,000 new homes. That's means one new home was sold for every 337 people. During the lifespan of the new homes sales report, we've averaged one new home sale for every 468 Americans.
    Our population is now considerably larger than it was in 1963 – nearly double at 309 million. If the seasonally adjusted February sales pace of 308,000 were sustained this whole year that would equal one home sale for every 1,003 Americans.
    In other words, you are three times less likely to meet a fellow American buying a new home right now than you were in 1963. And half as likely as you normally would be.
     Want a little more historical perspective? OK…
    We were in the middle of a deep recession in 1981, due partly to extremely high interest rates. Inflation pushed the effective federal funds rate to a record 19.1 percent in January of 1981, compared with nearly zero today. Banks have to charge more than that rate to have any chance of generating a profit.
    Still, the average number of Americans per new home sale throughout 1981 was 655. It was a dire time of sky-high interest rates, but new home sales were still way better than they are now.
    To reiterate, we were at one home sales for every 1,003 Americans in February. That's amazingly bad. More so given how low borrowing costs are.
    Some economists are trying to blame the decline entirely on the harsh winter weather in February. Sorry, but that doesn't wash. The February new home sales report is seasonally adjusted. So, it already takes into account the normal decline in sales that occurs every winter. Yes, this was a harsher than normal winter, but the housing market is the only part of the world that entered a new Ice Age.
    We've been through harsh winters before without setting this kind of record.
    The supply of homes at the current sales rate also increased in February. It rose to 9.2 months worth from 8.9 months in January. That means it would take 9.2 months to run out of new homes if we stopped adding more units to the market right now.
    I'm too tired to run those numbers to tell you what the historical norm should be, but three to five months was pretty common in past years. In short, the market is glutted with inventory. Supply has outstripped demand.
    In a free market, prices go down when supply outstrips demand as it has during this recession, but that's not happening. Prices actually rose in February as we were putting together the worst monthly new home sales in U.S. history. The median sales prices rose to $220,500 in February from $207,900 in January.
    That big gain in prices is the best indication that we don't have a free market in new home sales, or in any industry that can afford to hire hordes of lobbyists to influence lawmakers in our pay-to-play government. If we really had a free market in health care for example, somebody would be targeting the 40 million uninsured Americans just as Burger King has targeted all the people who want to pay $1 for a double cheeseburger.
    Rising new home prices are one illustration of the degree to which the legal concept of "fiduciary duty" has undermined free markets in the U.S. This legal provision requires executives at publicly traded companies to maximize profits.
    As a result we've got housing industry executives and lobbyists successfully persuading our government to introduce price supports for new home purchases. These incentives were extended in November, yet sales have averaged 23,000 homes a month since that extension.
    Buyers think these financial incentives are for them – but they're not. Without these price supports, buyers would be getting better deals and paying less. The only thing the price supports do is support higher home prices and higher housing industry profits than would otherwise be the case.
    In short, the purchase incentives represent a gaming of the free market. My best guess is that the industry pushed them through because it's desperate to save itself until hiring picks up. The only other recourse is lower prices.
    That would be a real boon to the average American who is paying the taxes that bankroll these subsidies. Until then, all the housing industry is doing is putting off today's pain until tomorrow. They're also creating a disincentive for smart buyers to sign on the dotted line. 
    I think a lot of prospective buyers suspect there may be another tremendous decline in home prices on the horizon. If you pay $300,000 for a home today that drops to $250,000 during this decline you're throwing away $50,000 of hard-earned money.
     How many years would it take you to make that money after taxes? Can you afford to count on the veracity of the housing industry and the government it influences? I can't.
    I'm not buying anything until home prices begin to track with demand again. I don't know about you, but I can't afford a lobbyist and I can't afford to keep bailing out the industries that can...

    If you enjoyed this post, please check pout my blog at
    http://www.victorepstein.com/apps/blog/


    Disclosure: I have no housing sector investments.
    Mar 26 6:27 PM | Link | 1 Comment
  • Why simply throwing government money at problems creates new problems

    There's an interesting story in The New York Times today that illustrates why throwing money at a problem isn't always a solution and often creates more numerous and deeply seated problems.

    It talks about the exploitation of students by vocational schools like ITT, which routinely burden them with $40,000 in debt for a two-year degree. The hook is the idea that they're going to make big bucks after graduation as chefs and IT professionals. The reality is very different.

    The bigger issue is that fiduciary duty - the legal obligation of executives at publicly traded companies to maximize profits - dictates that every lasting profit opportunity in this nation is rapidly exploited until the resources no longer serve the purpose for which they were originally intended. It's a race to kill the golden goose. In the case of the Times story that goose is for profit vocational instruction.

    We could just as easily be talking about undergraduate and master's degrees in poor paying fields like social work, art and journalism. Those fields were widely viewed by their practitioners as nonprofit enterprises for decades - even centuries - and still are in many parts of the world. However, rising tuition costs for them here in the U.S. mean that a new social worker making $30,000 a year could very easily graduate with more than $100,000 in student loan debt if they attended a top private university.

    That optimistic scenario assumes they can find employment in the middle of the deepest economic contraction since The Great Depression at a time when hiring has been frozen in so many states. Those who can't find work are sentenced to bankruptcy and a room at mom and dad's house for 20 more years, or worse.

    A similar situation exists in agriculture and housing - industries where profits have been inflated by generous government subsidies - tax dollars. We've all heard of predatory lending in the housing industry, which former Fed Chairman Alan Greenspan routinely noted, but refused to police. (Greenspan preferred to allow the market to regulate fraud, which is a policy that encourages predatory behavior).

    Well, the Times story is really talking about predatory lending by vocational schools. The uninformed are being exploited by the informed, who are saddling them with loans they may never be able to pay off. It's a perverse form of corporate welfare in which elite citizens parasite on the needy, instead of trying to aid them, by exploiting their dreams of upward mobility.

    Those of you that enjoy the role of Devil's Advocate (and it's a wonderful role) might point out that this kind of behavior has been with America since the Pilgrims landed at Plymouth Rock. I disagree. What's different now is that government has become complicit in this behavior because it only responds in a meaningful way to individuals and interests that can afford a political lobbyist in Washington, D.C.

    There's an old saying in Washington that you're either at the table or on the menu. Well, the middle class has been on the menu since the days of Ronald Reagan and Gordon Gecko. They don't have a lobbyist.

    The dominant position of lobbyists for the monied elite has become a kind of modern-day poll tax that excludes the average American voter from playing a meaningful role in their own life and their own government. Middle-class Americans have also been priced out of the market for legal services, which guarantees they are screwed and exploited at every level.

    The only exception occurs when middle class voters act together, but people are too distracted to do that by wedge issues such as abortion, immigration, school prayer, urban firearms possession and illegal drug use.

    (I don't consider health care reform a wedge issue so much as one of intellectual captivity as there are only three notable groups in the debate: those who benefit from the current system, those who don't and those who don't and are being misled).

    To get back to the Times story - the reality for those vocational grads who secure employment in their chosen field is that it's usually at an entry level wage inconsistent with repaying their student loan, even if they forgo personal aspirations like a decent place to live, a new car, marriage, children and personal travel.

    I can relate as someone who lived on $13,000 a year at the Pekin Daily Times as a baby journalist in 1992, while paying $300 a month on my undergraduate and graduate student loans. Try doing the math on that one.

    The numbers add up quite differently for ITT Educational Services Inc., a publicly traded, for-profit company. It's based in Carmel, Ind., and trades under the ticker ESI. You won't find any mention of their profits on the Web site page for prospective students.

    However, you will find some damning details if you dig into the separate web site for ITT's investor relations team.

    It's latest quarterly earnings statement goes into great detail on the degree to which ITT executives have succeeded in fulfilling their fiduciary duties on the backs of their students.

    1. Revenue (aka sales) in 4Q2009 (the fourth quarter or final three months of last year) increased 34 percent to $374 million from the same period of 2008.
    2. Profit rose 49 percent to $94 million.
    3. Earnings per share (aka EPS) of ITT stock - a metric dear to investors - rose 59 percent to $2.56.

    Clearly, it's not a sin for revenue and profit to rise along with enrollment as more unemployed workers enroll at ITT to learn new skills. Sustained profit growth is not an inherently bad thing from a Societal perspective. It all depends on how it's being done.

    It's being done badly at ITT because the vocational giant didn't grow its profits with some innovative new gizmo, like the iPhone. It grew its profits by spending less tuition money on educating each of the students paying that money to be educated at ITT. And that is a damn sin and a terrible thing from a Societal perspective.

    To add insult to injury, much of those tuition dollars come from government backed student loans and grants. In short, middle class taxes subsidizing the exploitation of middle class students.

    What's missing? If you said enrollment growth and expenditures per student you're right on target. We have to know that and here it is:

    1. Revenue (aka sales) in 4Q2009 (the fourth quarter or final three months of last year) increased 34 percent to $374 million from the same period of 2008.
    2. Profit rose 49 percent to $94 million.
    3. Earnings per share (aka EPS) of ITT stock - a metric dear to investors - rose 59 percent to $2.56.
    4. Enrollment rose 30 percent
    5. Revenue Per Student rose 4 percent to $4,727
    6. Education costs (as a percentage of revenue): 32 percent, down from 36 percent.
    7. Student services and administrative expenses:  26.8 percent, down from 27.3 percent

    Net income, revenue and earnings per share all outpaced ITT enrollment growth by a great deal in 4Q200. Yet the amount of money spent on students is down.

    ITT has given us a lesson in how a company can boost profit beyond enrollment growth. One way is to spend less tuition money on students and that's exactly what appears to have been done here even as ITT was charging those students more and wallowing in a bonanza of cash from new students.

    OK, now what am I really saying? I'm saying ITT was set to increase profit tremendously just on the basis of all its new students - by 30 percent if everything stayed the same. Most investors look for sustained profit growth of 8 percent to 12 percent. So, that's fantastic, but it wasn't good enough for the "Masters of the Universe" in charge of ITT. It never is.

    Net income, revenue and earnings per share all outpaced ITT enrollment growth by a great deal in 4Q200.

    The executive leadership team at ITT wasn't content with increasing profit, they had to screw students at the same time to show how really talented they are as corporate managers. This is akin to Neo turning with his leg in the air during the climactic scene at the end of "The Matrix" after he had obliterated Agent Smith. It's like saying "look how badass I am."

    Non-traders need to remember that information like this is often right in front of you on the Web in reports and statistics. The savage elites are betting you're too stupid to figure it out. They're right most of the time.

    Traders need to ask themselves if they want more from a company than predatory conduct like this. Warren Buffett does and he seems to be doing quite well.

    The rest of us need you guys to raise your sights and punish the ITTs of the world. Of course, you have to decide whether you're a citizen of the world or an American first and whether it matters to you if your children, relatives and neighbors are exploited by companies like ITT.

    If you're still an American, the rest of us are looking to you for help.
    We need the working-class-done-good out there to let their hands go already and stop bemoaning the terrible beating we're taking.

    Disclaimer: ITT Technical Institute, which trades under the ticker ESI, is not the same as ITT Corp., which trades under the ITT ticker and is a high-tech engineering and manufacturing company.



    Disclosure: I have no direct ownership of any stock.
    Tags: EIS, education
    Mar 14 5:08 PM | Link | Comment!
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