Why gas prices are so low

Global crude oil prices have sunk dramatically, falling to nearly $80 a barrel – a 30 percent drop from June. Unleaded regular gasoline prices are now under $3 a gallon. Falling prices are a boon to industrialized nations, but they shouldn’t make the mistake of assuming that oil will remain cheap indefinitely.

If you ask 10 experts why oil prices are so volatile, you are likely to get 10 different answers. But they all boil down to supply and demand.

In recent years, the ranks of major economic achievers were swelled by the emergence of formerly developing third world nations – especially population giants like India and China. The result was a significant increase in the number of middle- and upper-class consumers eager to enjoy a more lavish lifestyle. Such a lifestyle inevitably meant higher consumption of oil products, which generated upward price pressure.

The reason crude oil prices have been falling since early June is the global economic slowdown, especially in Asia and Europe. Demand is down at a time when oil is abundant, especially with substantial increases in U.S. production, which is at its highest level in 30 years thanks to shale oil drilling in North Dakota and Texas. United States crude oil production has climbed to just over nine million barrels a day and is projected to approach 9.5 million next spring. Adding to the excess supply, production is up in Russia as well.

As a result, imports from the 12 OPEC countries responsible for about a third of global production have been cut in half. OPEC members who rely on higher oil prices to balance their budgets wanted to announce production cuts at their Thanksgiving Day meeting in Vienna and are looking for Saudi Arabia to take the lead.

The decline in crude oil prices accelerated last month when the Saudis, the world’s largest oil producer at 9.6 million barrels daily, cut the price of exports to the United States in an effort to retain its shrinking market share and, some speculate, undercut America’s oil shale bonanza. The thought is that the Saudis can push the price of crude oil below $50 per barrel and still make money.

In the past, oil producers struggled to respond to the problems of letting supply run wild by developing “gentlemen agreements” to control supply in “rational” ways. The most notorious of these producer cartels is OPEC.

The difficulty with the cartels is that many of their members aren’t gentlemen. They can’t resist opportunities to make hay while the sun shines by sneaking extra oil onto world markets to take advantage of temporary price spikes or marching to the beat of their own drummer and cutting prices, causing other members to wrinkle their noises in disgust- before joining the party so they don’t get left behind.

One of the few economic laws that’s truly ironclad is the practical impossibility of enforcing cartel supply and price restrictions without the kind of outright physical violence that is generally only acceptable among New York’s Five Families.

Falling oil prices are providing a boost to the U.S. economy with lower costs for consumers and energy­ sensitive industries. It has been estimated that the cut in crude oil prices to $80 a barrel is the equivalent of a $600 tax cut for every household. This should be music to the ears of retailers who had been bracing for a slow-growth holiday shopping season.

originally published: November 29, 2014

Why gas prices are so low

Global crude oil prices have sunk dramatically, falling to nearly $80 a barrel – a 30 percent drop from June. Unleaded regular gasoline prices are now under $3 a gallon. Falling prices are a boon to industrialized nations, but they shouldn’t make the mistake of assuming that oil will remain cheap indefinitely.

If you ask 10 experts why oil prices are so volatile, you are likely to get 10 different answers. But they all boil down to supply and demand.

In recent years, the ranks of major economic achievers were swelled by the emergence of formerly developing third world nations – especially population giants like India and China. The result was a significant increase in the number of middle- and upper-class consumers eager to enjoy a more lavish lifestyle. Such a lifestyle inevitably meant higher consumption of oil products, which generated upward pnce pressure.

The reason crude oil prices have been falling since early June is the global economic slowdown, especially in Asia and Europe. Demand is down at a time when oil is abundant, especially with substantial increases in U.S. production, which is at its highest level in 30 years thanks to shale oil drilling in North Dakota and Texas. United States crude oil production has climbed to just over nine million barrels a day and is projected to approach 9.5 million next spring. Adding to the excess supply, production is up in Russia as well.

As a result, imports from the 12 OPEC countries responsible for about a third of global production have been cut in half. OPEC members who rely on higher oil prices to balance their budgets wanted to announce production cuts at their Thanksgiving Day meeting in Vienna and are looking for Saudi Arabia to take the lead.

The decline in crude oil prices accelerated last month when the Saudis, the world’s largest oil producer at 9.6 million barrels daily, cut the price of exports to the United States in an effort to retain its shrinking market share and, some speculate, undercut America’s oil shale bonanza. The thought is that the Saudis can push the price of crude oil below $50 per barrel and still make money.

In the past, oil producers struggled to respond to the problems of letting supply run wild by developing “gentlemen agreements” to control supply in “rational” ways. The most notorious of these producer cartels is OPEC.

The difficulty with the cartels is that many of their members aren’t gentlemen. They can’t resist opportunities to make hay while the sun shines by sneaking extra oil onto world markets to take advantage of temporary price spikes or marching to the beat of their own drummer and cutting prices, causing other members to wrinkle their noises in disgust- before joining the party so they don’t get left behind.

One of the few economic laws that’s truly ironclad is the practical impossibility of enforcing cartel supply and price restrictions without the kind of outright physical violence that is generally only acceptable among New York’s Five Families.

Falling oil prices are providing a boost to the U.S. economy with lower costs for consumers and energy­ sensitive industries. It has been estimated that the cut in crude oil prices to $80 a barrel is the equivalent of a $600 tax cut for every household. This should be music to the ears of retailers who had been bracing for a slow-growth holiday shopping season.

originally published: November 29, 2014

The beginning of another bank crisis?

One definition of insanity is doing the same thing over and over and expecting a different result. Late  last month, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced that the two institutions would start purchasing mortgages with down payments as low as 3 percent instead of the already absurdly low 5 percent minimum both institutions currently require. These FHFA-insured loans are for borrowers with weak credit.

Also, the federal regulator announced loosened mortgage lending rules. It removed the 20 percent down payment requirement for high-quality mortgages that banks determine to have low risk of default and made it less likely that Fannie and Freddie will force lenders to buy back mortgages that go bad.

By expanding the types of mortgages Freddie and Fannie will buy, the FHFA hopes to spur banks to make more loans to first-time buyers and increase homeownership among those with low and moderate incomes. These watered-down underwriting standards are a big win for affordable housing advocates and the banking and real estate industries.

But the feds are sowing the seeds for another meltdown by loosening recently enacted safeguards. Bookshelves sag with encyclopedic volumes arguing that a major factor in the financial apocalypse of 2008 was relaxed lending practices that led to the housing bust. How quickly we forget.

Back then the weakening of underwriting standards, and especially low down payments, increased home ownership and housing prices, which led to a housing price bubble. The banks had packaged and sold to investors bundles of risky mortgages with teaser rates that ballooned after a few years. Many borrowers ended up defaulting on the loans when the interest rates spiked. As a result, the value of the mortgage securities plummeted, and banks and investors holding them lost billions.

The debacle helped ignite the financial meltdown that plunged the economy into the deepest recession since the 1930s and necessitated taxpayer bailouts of banks and Fannie and Freddie. Following this debacle, there was a push to tighten mortgage lending standards and have banks retain a small portion of the loans they sold as stipulated in the Dodd-Frank Act of2010.

Those of you who’ve seen the classic movie “It’s a Wonderful Life” will remember George Bailey describing to his nervous depositors how the home mortgage business worked. You would visit your local bank and, among other things, the institution would require you to pay a significant portion (like 20 percent) of the purchase price upfront. Along with this down payment, purchasers would be required to demonstrate proof of income.

By granting a home mortgage, George’s thrift institution was exposing itself to risk. A buyer could fail to make the monthly mortgage payments. And since the institution kept the mortgage on its books as an asset, it remained exposed to this risk until the mortgage was paid off.

This process meant the initial lending decision was based on careful consideration of the customer’s creditworthiness. To the extent feasible, the institution would seek to grant mortgages only to its own customers so it could be confident that the homebuyers were safe credit risks. The pluses and minuses of this simple model are obvious.

By selling the packaged loans to others, banks could remove the loans from their balance sheets, which allowed the banks to increase their loans without technically violating the rules in regard to minimum capital ratios.

Providing low down-payment loans to borrowers with weak credit, then bundling and selling those loans drove the American financial system to the brink of collapse. Less than a decade later it appears that no one remembers.

originally published: November 8, 2014

The beginning of another bank crisis?

One definition of insanity is doing the same thing over and over and expecting a different result. Late  last month, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced that the two institutions would start purchasing mortgages with down payments as low as 3 percent instead of the already absurdly low 5 percent minimum both institutions currently require. These FHFA-insured loans are for borrowers with weak credit.

Also, the federal regulator announced loosened mortgage lending rules. It removed the 20 percent down payment requirement for high-quality mortgages that banks determine to have low risk of default and made it less likely that Fannie and Freddie will force lenders to buy back mortgages that go bad.

By expanding the types of mortgages Freddie and Fannie will buy, the FHFA hopes to spur banks to make more loans to first-time buyers and increase homeownership among those with low and moderate incomes. These watered-down underwriting standards are a big win for affordable housing advocates and the banking and real estate industries.

But the feds are sowing the seeds for another meltdown by loosening recently enacted safeguards. Bookshelves sag with encyclopedic volumes arguing that a major factor in the financial apocalypse of 2008 was relaxed lending practices that led to the housing bust. How quickly we forget.

Back then the weakening of underwriting standards, and especially low down payments, increased home ownership and housing prices, which led to a housing price bubble. The banks had packaged and sold to investors bundles of risky mortgages with teaser rates that ballooned after a few years. Many borrowers ended up defaulting on the loans when the interest rates spiked. As a result, the value of the mortgage securities plummeted, and banks and investors holding them lost billions.

The debacle helped ignite the financial meltdown that plunged the economy into the deepest recession since the 1930s and necessitated taxpayer bailouts of banks and Fannie and Freddie. Following this debacle, there was a push to tighten mortgage lending standards and have banks retain a small portion of the loans they sold as stipulated in the Dodd-Frank Act of2010.

Those of you who’ve seen the classic movie “It’s a Wonderful Life” will remember George Bailey describing to his nervous depositors how the home mortgage business worked. You would visit your local bank and, among other things, the institution would require you to pay a significant portion (like 20 percent) of the purchase price upfront. Along with this down payment, purchasers would be required to demonstrate proof of income.

By granting a home mortgage, George’s thrift institution was exposing itself to risk. A buyer could fail to make the monthly mortgage payments. And since the institution kept the mortgage on its books as an asset, it remained exposed to this risk until the mortgage was paid off.

This process meant the initial lending decision was based on careful consideration of the customer’s creditworthiness. To the extent feasible, the institution would seek to grant mortgages only to its own customers so it could be confident that the homebuyers were safe credit risks. The pluses and minuses of this simple model are obvious.
By selling the packaged loans to others, banks could remove the loans from their balance sheets, which allowed the banks to increase their loans without technically violating the rules in regard to minimum capital ratios.

Providing low down-payment loans to borrowers with weak credit, then bundling and selling those loans drove the American financial system to the brink of collapse. Less than a decade later it appears that no one remembers.

originally published: November 8, 2014