The Sleeper’s Home at 215 Cave Drive in Festus, Mo. Associated Press

Sushil Cheema reports:

The housing crisis is now affecting cave dwellers.

At least, that’s the case for Curt and Deborah Sleeper of Festus, Mo. They have less than 90 days to pay off the $83,000 balance on their home, located just outside of St. Louis in a former mine that once produced limestone and sandstone.

The family of five — a new baby was born in the cave just recently — has put their dwelling, located at 215 Cave Drive, up for sale on eBay priced at $300,000.

The Sleepers bought the 15,000-square-foot cave through the auction site in 2004. They paid about half of the $160,000 purchase price in cash. The sellers loaned them the balance with a five-year interest-only loan. The initial idea was to build a regular home outside and use the cave as a place for the kids to play, Mr. Sleeper says. Later, he decided to build the house inside the cave. Mr. Sleeper says that he intended to refinance his mortgage, using the new home as equity once it was completed.

Then came the housing bust and the credit markets tightened up. Mr. Sleeper says he has been unable to secure a new loan. “I’m self-employed, my credit score is somewhere between 600 and 710, depending on who you talk to. I live in a cave with no comparable homes in the area and I gave up credit cards 10 years ago,” he says.

Mr. Sleeper says he is sorting through some 5,000 emails — sent to him through eBay and a message board at Caveland.us — from people who want to buy the property, those who want to loan the family money, or those who “want to steal it from me” by buying it and renting it back to the family.

Courtesy of Curt Sleeper

The family spent four years and about $150,000 in materials constructing the three-story home, adding another 2,000-square-feet of living space. They funded the project using a combination of personal income and Ms. Sleeper’s inheritance, Mr. Sleeper says. Friends in the construction industry helped Mr. Sleeper, a self-employed Web designer and small business consultant, build the structure. Ms. Sleeper, a stay-at-home mother who is working on a degree in creative writing, washed laundry in buckets during construction, and the family lived in a tent inside the cave. The city required six different inspections on the cave, Mr. Sleeper says, and it granted the family an occupancy permit last year.

The family was planning to stay in the cave for life, and moving out is not an appealing option. “I frequently joke that there’s got to be some barge or corn silo screaming my name,” Mr. Sleeper says of where he will go should he be forced to move. “I can’t imagine going back to a box.”

A roundup of economic news from around the Web.

Compiled by Phil Izzo

By Ricardo J. Caballero

The basic principles underlying Secretary Geithner’s sketch of a financial stabilization plan are the right ones: To stabilize the financial system without nationalization; to jump start frozen financial markets by reducing the perceived tail risk from private investments; and to reduce the risk, especially systemic risk, being held by banks and other leveraged financial institutions. Politics require that a “good deal for the taxpayers” is added to these principles, but the truth is that the best deal for the taxpayers, once one considers the endogenous response of the economy, is anything that works to stabilize the financial system, almost regardless of how many short-term transfers the financial institutions may receive.

It is true that the recent announcements are lacking specific details, and perhaps revealed that the Treasury’s economic team overestimated people’s ability to distill the good news in an abstract message of principles when in panic mode. But there is good news in them, as they reflect a much deeper understanding of the fundamental uncertainty problem ravaging insurance and credit markets than commentators and politicians have. It is time for all of us to focus on facilitating their difficult task and to try to fill some of the gaps.

My preferred (part of a) solution is to provide universal insurance for the assets that are currently clogging the balance sheets of banks and other financial institutions. There are two issues often raised in the context of an insurance arrangement of this kind: How to determine the fair price of insurance in an environment where there are no sensible market prices? And, how to prevent financial institutions from selectively insuring their worst assets without disclosing them as such?

Fortunately, once the policy decision is made that these key systemic institutions will survive no matter what, these problems have a relatively easy solution. The great advantage of dealing with long-lived institutions holding a large number of assets is that there is no need to resolve the thorny issue of the insurance price and the quality of the assets right now. We can wait for the passage of time and a return to normality to determine whether their assets were worse than the representative asset in the corresponding asset class. Concretely, I would suggest that:

A key aspect of this insurance arrangement is that it is aimed mainly at removing the aggregate risk from the balance sheet of financial institutions, although it does so asset-class by asset-class, so it considers the different portfolio composition of different financial institutions. Moreover, since these institutions have a large number of assets within each asset-class, one can rely on the law of large numbers to net out idiosyncratic accidents.

One potential criticism to this mechanism is that it does not resolve an adverse selection problem faced by potential equity investors: Since banks that choose to lie now will be eventually punished retroactively, then how can investors be reassured that the bank they are choosing to recapitalize is not lying? My reaction to this valid concern is twofold: First, my sense is that at this point in time the main risks are aggregate rather than of this kind. Thus, if enough aggregate uncertainty is removed from their balance sheets, the banks will not need, for the time being, much new capital. Second, the aggregate insurance arrangement need not work in isolation, but it can be implemented very quickly and be used as a stopgap. It can then be followed by the much slower process of getting onto the books of the banks to build more public trust. Moreover, by proceeding in this sequence, the stress tests do not put the burden of further negative aggregate shocks on the banks balance sheets, and hence further reduce the need for nationalizations and other remedies that have brought great distress to equity markets and taxpayers wealth in recent days.

I view this insurance proposal as complementary to and in the spirit of Secretary Geithner’s two-step proposal. On one hand, the former appears to have two advantages over the latter: First, it is simpler and faster to implement since it is done in one step, instead of having to go through a bad bank and then enticing the private sector to buy these assets. My sense is that the non-banks private sector will require more insurance than the banks themselves, since they will be exposed to an additional layer of adverse selection as they will be buying assets from the banks. Second, it immediately raises the tangible capital of the distressed financial institutions, without further need for capital injections. On the other hand, the two-step approach also has two advantages over the single-step insurance proposal: It addresses, more directly, the illiquidity problem in underlying asset markets, and it provides a channel to inject resources into the harder-to-get-to shadow financial system.

Clearly, there is no single dominant strategy to deal with the current crisis, but whatever we do, it is central that we focus on the whole system and on the role played by uncertainty. Standard recipes used to deal with isolated problems in a bank or two can easily backfire. Nationalizations and related measures are fine solutions in partial equilibrium, but they are recipes for disaster in an environment where systemic risk and uncertainty are at the core of the problem.

Mr. Caballero is the Ford International Professor of Economics at MIT

One of the biggest questions surrounding the Obama administration’s economic plan is how will the country know it is working. In his press conference tonight, President Barack Obama outlined some metrics, but judging success using them won’t be easy and it will surely take some time.

“I think my initial measure of success is creating or saving 4 million jobs,” Obama said. “That’s bottom line number one, because, if people are working, then they’ve got enough confidence to make purchases, to make investments. Businesses start seeing that consumers are out there with a little more confidence, and they start making investments, which means they start hiring workers. So step number one: job creation.”

On the surface, that looks like a relatively easy metric. The Labor Department provides the relevant data every month on changes in the job market. However, measures of success are going to take some time, and if they do emerge they may be hard to gauge. The goal of the stimulus package as it was first proposed was to save or create four million jobs over two years. Already, Berkeley economist Brad DeLong estimates that the changes in the Senate may have trimmed 600,000 jobs off the original estimate. New jobs are going to show up over time, and there even will be a lag once the stimulus is signed for jobs to begin showing up. Meanwhile, the labor market traditionally continues to feel pressure even when the economy recovers from a recession.

But even though the situation remains difficult, there might be some signs that things are getting better. For the past three months, the economy has shed more than a half a million jobs a month. If that figure starts to abate, it could offer a sign that the president’s plans are having an effect.

“Step number two: Are we seeing the credit markets operate effectively?” Obama said, outlining a second metric of success. This one is probably hardest to gauge. The Calculated Risk blog has pointed to several credit crisis indicators in a running series. Those measures have shown some improvement over the last few months. If things continue to stabilize that’s one way to check that the credit markets are returning to normal.

Another sign could come when banks report first-quarter earnings. The Journal did an analysis of lending practices based in part on data from fourth-quarter results. Banks remained tight fisted, which is to be expected in a recession, but if the situation begins to improve in the first quarter, it may show up in earnings reports in April.

Also in April, the Federal Reserve will release its next loan officer’s survey. The January report showed a continued tightening of lending standards, but stable credit markets may get banks to loosen the purse strings.

“Step number three is going to be housing,” Obama said. “Have we stabilized the housing market? Now, you know, the federal government doesn’t have complete control over that, but if our plan is effective, working with the Federal Reserve Bank, working with the FDIC, I think what we can do is stem the rate of foreclosure and we can start stabilizing housing values over time.”

It’s a tall order to expect the government to be able to stabilize home prices. A recent report from Moody’s economy.com said that the S&P/Case-Shiller home-price index still has another 11% to fall from the fourth quarter before stabilizing late next year. Some economists even argue that the government shouldn’t focus on propping home prices.

But there is wider opportunity for action of foreclosure rates. The Obama administration plans to work to stem foreclosures through loan modification programs. Democratic officials also have voiced support for allowing bankruptcy judges reduce the principal on mortgages, a process known as a “cram down.” That provision wasn’t part of the stimulus package in the House or the Senate, but the issue could move through with separate legislation later.
The Mortgage Bankers Association and RealtyTrac both compile data on foreclosures. The Commerce Department’s data on home vacancies also may offer some clues on whether foreclosures are ebbing. However, success isn’t likely to be apparent until much later this year.

Finally, Obama said: “The most — the — the biggest measure of success is whether we stop contracting and shedding jobs and we start growing again.” He appeared to be talking about general economic growth, apparent in the Commerce Department’s report on gross domestic product. In last month’s Journal forecasting survey, economists didn’t expect to see growth return until the third quarter of this year, even factoring in a stimulus package.

No matter what metric is used, it will take some time to see whether the president’s plans have been successful. But for his part, Obama knows recovery isn’t going to happen overnight. “Now, you know, I don’t have a crystal ball. And as I said, this is an unprecedented crisis,” he said. “But my hope is that after a difficult year — and this year is going to be a difficult year — that … if we get things right, then, starting next year, we can start seeing significant improvement.” –Phil Izzo

A roundup of economic news from around the Web.

Compiled by Phil Izzo

A senior fund manager at bond fund giant Pacific Investment Management Co. said Tuesday that purchasing risky assets rather than Treasurys should be the top priority for the Federal Reserve.

Steve Rodosky, head of Treasury and derivatives trading at Newport Beach, Calif.-based Pimco, said he is “suspicious” about the argument that buying long-dated Treasury securities will help improve credit markets.

“The risk of buying Treasurys is that you would widen the yield spreads between Treasurys and risky assets,” said Rodosky in an interview.

That would run against the Fed’s stated intention of bringing down mortgage rates and corporate bond yields. Supporters of Fed purchases argued that yields on long-dated Treasurys are anchors for many types of fixed-rate corporate and consumer loans, including home loans.

But others, including Rodosky, counter that Treasury bond yields are already at very low levels. Purchases by the Fed would only serve to drive yields on government bonds even lower without having any impact on debt sold by the private sector as it wouldn’t change the concerns investors have about the economy’s outlook and the problems plaguing the banking sector

Rodosky said the Fed has other options to help keep rates low in the broader economy: The central bank could expand existing programs by increasing its purchases of mortgage-backed securities and agency debt.

Policymakers could also step in to relieve banks of their bad assets or even provide aid to the municipal bond market, said Rodosky. He supports the idea of setting up a “bad bank” to remove toxic assets from banks, though many issues need to be resolved.

Rodosky said a rebound in the economy in the second half of the year, as some have forecast, seems “pretty early” because there is still a lot of uncertainty, with much depending on the impact of the economic stimulus plan.

Rodosky said he continues to favor high-quality agency mortgage-backed securities and agency debt over U.S. Treasurys, as well as high-quality corporate bonds and bank debt insured by the Federal Deposit Insurance Corporation. –Min Zeng

Economists and others weigh in on the Fed’s statement accompanying its interest-rate decision.

Compiled by Phil Izzo

Offer your reactions in the comments section.

Dig into an interactive summary of economists’ forecasts for the coming year from the latest WSJ.com survey.

For U.S. consumers, 2009 is likely to be the year of saving, rather than spending.

Although some burdens, such as gasoline prices, have lightened considerably, the cons for the household sector still outweigh the pros. That’s why economists are downbeat on overall economic activity in 2009. A full-fledged recovery will depend on a resurgent consumer, who even after the recent pullback still accounts for 71% of all spending.

The biggest headwind for consumers is, not surprisingly, the weakening labor market.

It isn’t just the loss of 1.9 million jobs so far in 2008; it’s the job jitters triggered by those layoffs. If consumers worry they may be laid off, they will spend less whether or not their fears turn into reality. But less spending weakens the economy and job markets further.

Mending the job markets will be pre-eminent to turning around the economy. That’s why President-elect Barack Obama has upped the ante in his stimulus package, now promising to create three million jobs, instead of 2.5 million.

But an offshoot of the weak labor market — wage freezes, benefit cuts and smaller pay raises — also will hamper consumers.

The Conference Board reported last week that since the credit markets have gone into the tank, businesses have scaled back on their 2009 salary plans.

When the board surveyed companies in April and May, pay increases of 2.86% were planned for hourly nonunion workers; executive pay raises were set at 3%. But the board’s survey in October showed the raises were lowered to 2.5% for hourly workers and 2.8% for executives.

Financial blog Calculated Risk posted a listing Tuesday of media reports of salary freezes, ranging from energy group Duke Energy Corp. and tech services group Unisys Corp. to city workers in San Francisco and teachers in South Carolina.

Luckily for consumers, their purchasing power should improve as prices fall or increase at slower rates.

The plunge in energy prices is the biggest plus going for consumers right now.

Gasoline prices are down about $2 per gallon since the peak in July. Joseph LaVorgna of Deutsche Bank estimates that every $1 drop in gasoline adds about $100 billion to household cash flow — meaning households have an extra $200 billion to spend on items besides gasoline. That amount is bigger than the rebate checks sent out earlier in 2008.

In addition, heating-oil and natural-gas prices are down since the summer. So the coming winter should prove to be less onerous than was feared when crude oil shot past $140 per barrel.

The holiday shopping season has also brought a ton of bargains for consumers. Although door-busters and 20%-off coupons are the kiss of death for retail profits, consumers looking for flat-screen television sets, cashmere sweaters, or toys, are benefiting greatly.

Finally, there are trends that cut both ways across the consumer sector.

Extremely low interest rates, for instance, are great for borrowers. Homeowners in good financial shape and with equity in their homes have rushed to refinance their mortgages now that rates have fallen close to 5% for a 30-year loan.

But low rates are a drag for savers. Data from the Federal Reserve show that households — spooked by the stock markets — have boosted their holdings of interest-bearing accounts by about $250 billion so far this year. But interest income has fallen by $25 billion over the same time, hurting retirees and others on fixed incomes.

Interest earnings will fall further in 2009, now that the Fed has cut its lending rate to near zero.

Falling home prices are a boon for house-hunters; but a bane for sellers and for homeowners who have seen their home values plummet. Dropping stock prices, meanwhile, are good for those newly enrolled in 401k plans; but they have been a disaster for people in or near retirement.

What may be the biggest plus for the U.S. consumer sector is its ability to look forward. A survey by the Investment Company Institute in October showed that despite market volatility, investors remain committed to saving for retirement. Only 3% of participants have stopped making contributions this year.

And consumers are hopeful about the coming stimulus plan. A survey by the Center for American Progress indicates 70% of Americans think government spending on infrastructure is “the right thing” to do given current economic circumstances. Infrastructure spending will go a long way to create jobs in 2009.

Many households also should benefit from the other stimulus ideas being bandied about. A middle-class tax cut, aid to state and local governments, and investment in education should be pluses for the consumer sector in 2009. –Kathleen Madigan

A roundup of economic news from around the Web.

Compiled by Phil Izzo

The White House released a fact sheet of the G-20 summit. The full text follows:

Summit On Financial Markets And The World Economy

President Bush And World Leaders Agree On The Washington Declaration to Address Current Financial Crisis

Today, President Bush and world leaders gathered for the first in a series of meetings to discuss efforts to strengthen economic growth, deal with the financial crisis, and to lay the foundation for reform to help to ensure that a similar crisis does not happen again. Since the outbreak of this crisis, the world’s leading nations have coordinated actions more closely than ever before. Thanks in large part to these decisive measures, once frozen global credit markets are beginning to thaw and businesses around the world are gaining access to essential short-term financing. This problem did not develop overnight, and it will not be solved overnight. No single nation will be able to fix this crisis, but with continued cooperation and determination, it will be solved as long as we are steadfast in our commitment to reforming our financial sectors and maintaining free and open markets.

Today’s Summit achieved five key objectives. The leaders:

The leaders agreed that immediate steps could be taken or considered to restore growth and support emerging market economies by:

The Leaders Agreed On Common Principles To Guide Financial Market Reform:

Strengthening transparency and accountability by enhancing required disclosure on complex financial products; ensuring complete and accurate disclosure by firms of their financial condition; and aligning incentives to avoid excessive risk-taking.

Enhancing sound regulation by ensuring strong oversight of credit rating agencies; prudent risk management; and oversight or regulation of all financial markets, products, and participants as appropriate to their circumstances.

Promoting integrity in financial markets by preventing market manipulation and fraud, helping avoid conflicts of interest, and protecting against use of the financial system to support terrorism, drug trafficking, or other illegal activities.

Reinforcing international cooperation by making national laws and regulations more consistent and encouraging regulators to enhance their coordination and cooperation across all segments of financial markets.

Reforming international financial institutions (IFIs) by modernizing their governance and membership so that emerging market economies and developing countries have greater voice and representation, by working together to better identify vulnerabilities and anticipate stresses, and by acting swiftly to play a key role in crisis response.

Our Nations Will Continue To Take The Right Steps To Get Through This Crisis

The leaders approved an Action Plan that sets forth a comprehensive work plan to implement these principles, and asked finance ministers to work to ensure that the Action Plan is fully and vigorously implemented. The Plan includes immediate actions to:

The leaders instructed finance ministers to make specific recommendations in the following areas:

The leaders agreed that needed reforms will be successful only if they are grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively-regulated financial systems. The leaders further agreed to: