Chapter 1
(Housing Crash-Part II)
"Great news for the housing market gave equities a boost after a week of up and downs. Sales of Existing Homes in July soared by 7.2% in the month, pushing the annualized pace of sales to 5.420 million, the highest rate in almost two years and the first time past the 5 million mark in nine months."
"July marks the fourth straight month of increases for Existing Home Sales, including a 3.6% gain in June. Markets were only looking for a 2.5% advance in July. Compared to last year, total sales are up 5% ? the first annual gain in 43 months."
"Single-family home sales climbed 6.5% in the month, while condo sales jumped 12.5%."
"Nearly a third of sales were from distressed homes, a similar share to sales in June."
These are B.S. headlines found in news articles and television reports last month. Very little attention has been given to exactly how and why these housing improvements have come about. Well, I'm about to spill the beans. Much like the artificial, government created, "cash for clunkers" incentive gave the auto industry a small bump in car sales. The state and federal government tax credits, for first-time home buyers, are largely responsible for the bump in the housing markets. “Let's credit the tax credit for doing what it was supposed to do . . . give a strong incentive to allow buyers to cross the threshold to home ownership,” It's just as well deserved as the blame for the inevitable flat line or decline to come after the tax credits expire at the end of November. Fact is, even after this, government designed, housing market bubble. The inventory of existing homes on the market remains roughly twice as large as it was at the end of 2002, although it is down nearly 11% from its peak in July of 2008. Inventories remain at a still-high 9.4 months, meaning it would take 9.4 months at the current sales pace to clear overhang. A healthy-market ratio is 6 months. Now, with prices down 23% from their peak, sales are expected, by many, to continue at a brisk pace, at least until the government tax credit for first-time home buyers expires at the end of November. Like taxes, incentive programs, once implemented, are extremely difficult to rescind without negative consequences. Just as governments get used to rolling in our hard-earned tax dollars, consumers will simply stop buying again when no longer offered huge, honking tax credits. The secret to a successful incentive program, then, is much the same as the alcohol-sodden keggers we all attended at college. It’s all right to party hard all weekend, but come Monday morning, you need to have the discipline to pull yourself up from the stupor, and deal with the inevitable pain.
Now, while keeping a key interest rate near zero, the Fed is spending $1.75 trillion to buy government securities in a bid to keep mortgage and other loan rates artificially low. On top of these reports that housing prices are at "steal of a deal" levels, now may look to be a good time to jump into the housing market. Unless the forecast by Karen Weaver, global head of Deutsche Bank's securitization research division is correct. She is predicting that 48% of U.S. mortgages, 25 million Americans, will be "underwater" by 2011. Currently 27%, or 14 million U.S. homeowners with a mortgage, already owe more than their home is worth, and are "underwater". If she is correct, you new home purchasers better hope that tax credit is equal to 14% of your mortgage, because that's how much further down the worth of your home will go. That's right! In an effort to temporarily help the housing markets, the government handed out a great incentive for you to loose money on your investment.
While the housing markets have seen some improvements, the wave of foreclosures has not, by any means, abated. The rate of serious delinquency has been rising rapidly and continues to rise, almost paralleled to the unemployment rate. As long as you have serious delinquencies going up, probably for the next year and a half, a large portion of those are going to turn into foreclosures. Of sub-prime and Alt-A (Alternative A-paper) borrowers, about 33% of those borrowers are seriously delinquent. If you look at prime jumbo, the highest quality mortgages, 6.2% are seriously delinquent. That sounds like a low number. But two years ago that number was 1%. It's a very straight trajectory from September 2007, also pretty closely mimicking the rise in unemployment. If a borrower has equity, and they can't maintain their mortgage, that borrower is going to sell rather than default. This speaks to the inherent credit worthiness of mortgages and why they're always considered to be a low-risk investment. But, once you get to the point where negative equity is significant, 25% or more, there have been studies that suggest you get more strategic defaults. If Deutsche Banks forecast is correct and 25 million borrowers fall underwater, many will try to keep their mortgage current, but to expect defaults to be as low as 7% this time, is wishful thinking at best. People say, "I bought my house for $500,000, it's now worth $250,000, and there are 10 others for sale on my block that are not selling. It makes no economic sense to spend the rest of my life trying to pay off a $500,000 debt when there's no reasonable likelihood to expect this house will ever get back to $500,000."
(See chart above)
From the beginning of 2007 through September of 2008, sub-prime loans (the gray bars above) were resetting like crazy. Those are the ones people were walking away from, sending a shock wave of defaults and foreclosures into the financial and investment markets, devastating our economy.
The ARM market got very quiet between December 2008 and March 2009, hitting a low that won't be seen again until November of 2011. Since June, resets began to tail off a little, and are going to be basically flat for the next eight months. It’s not until May of 2010 that the next wave really hits. From there to October of 2011, the resets will be coming fast and furious. That's 18 months of further turmoil in the housing market.
Alt-A's (the white bars above) are loans to the folks who are a small step up from sub-prime. Unsecuritized loans (blue bars) are a 50-50 proposition; either the borrowers were good enough that they weren’t thrown into the CDS pool, or they were so risky no one would insure them. Option ARMs (green bars) are the real black sheep, loans with choices on how large a payment the borrower will make. The options include interest only or, worse, a minimum payment that is less than the interest, leading to "negative amortization"(a loan principal that continually gets larger).
In this next housing and financial market collapse, the biggest deterioration could take place, not is sub-prime markets, but in the prime quality mortgages. Right now about 16% of those borrowers are underwater. If the Duetsche Bank's home price forecast is correct, we could have 41% of borrowers underwater in the prime mortgage market alone. If home prices do fall another 14%, and being underwater translates to further defaults and foreclosures, we are sure to see a second housing market crash resulting in further stress to our financial and credit markets.
Once the carnage begins, will it be as bad as the sub-prime crisis? Well, we're fresh out of a severe recession and unemployment is high, which wasn't the case when the sub-prime crisis started. More people will be unable to meet payments. And the housing market has continued to decline, pressuring both marginal homeowners and banks that can’t sell foreclosed properties. Make no mistake about it, the second crash is coming. It can’t be prevented, no matter what desperate measures Obama and his hapless financial advisers come up with. All we can hope for is that, with a little luck, it won’t be as severe as the first one. But it will last longer. We aren't even in the middle of the woods yet, much less on the way out.
It's hard to see how the economy can get going if people and businesses can't borrow money. The economy, over the past decade or two, has been very much driven by the consumer. Consumer spending equates to nearly 3/4 of all economic activity. Not from gains in their incomes. But from easy credit and rising home values. When their home price was rising they could borrow against it, through home equity lines or loans or refinancing. With homes increasingly becoming a liability, this will no longer be possible.
Chapter 2
(It ain't over, till it's over)
It's my understanding that we got into this terrible financial mess because we spent money we didn’t have, on things we couldn’t afford. Now, the cure for this greatest of recessions has been to spend even more money we don’t have, on even more things we still can’t afford. While I know enough history to understand that the Great Depression was exacerbated by governments’ inaction on the fiscal front, the notion of spending a bunch of money to end a crisis caused by spending too much money reminds me of the famed Vietnam-era protest chant "fighting for peace is like f*cking for virginity".
Most economists, including Federal Reserve Chairman Ben Bernanke, predict a slow and gradual upturn. To be sure, the telltale recovery signals have been flashing green of late. Factory output and new orders grew last month at the fastest pace in two years. With inventories of stores and manufacturers depleted, factories must soon ratchet up production just to restock. But some experts say the recovery will be muted, largely because consumers are in no mood to open their wallets. They've lost a massive $13,000,000,000,000 of wealth in the recession's housing and stock market crashes and appear determined to sock away any extra cash they have for future hard times. The savings rate jumped to 5.2% in the second quarter from a low of 1% before the crisis.
This downturn’s origins signal a weak recovery or a double-dip. Unlike typical post-war recessions this slump was spawned by a financial bust, not high interest rates, and when overindebted borrowers need to rebuild their balance-sheets, and financial systems need time to repair, growth can be weak and easily derailed for years. Japan’s 1990s banking crisis left the economy stagnant for a decade, and an ill thought out tax increase in 1997 plunged it back into recession.(sound familiar) Typically, sharp downturns, like the current one, yield equally rapid, or V-shaped, upswings. But the worst recession since the Great Depression has been anything but typical, with housing and credit markets devastated. In a USA TODAY survey, 63% of economists said the recovery will be U-shaped: A sharp downturn followed by a slow and gradual rebound. In the short term, the shape of our economic recovery could look beguilingly like a “V”, as stimulus kicks in and the inventory cycle turns. Government support, especially employment programs and incentives to buy houses or new cars, has artificially cushioned weak demand. But, as home-buyers’ tax-credit ends, high unemployment takes further toll, and home foreclosures continue to rise, America’s housing market will inevitably lurch down again and pull our economy down with it. Even if and when the housing markets stabilize, consumer spending will stay weak as households pay down debt, rebuild nest eggs and create emergency funds. In America and other post-bubble economies, a real V-shaped bounce-back seems unlikely, but it could happen if private investment capital and vigorous private domestic demand picks up the baton from the stop-gap, deficit causing, government stimulus. This because, only through private sector investment matched by increased consumer spending, not government spending, can real and sustainable economic growth be created. Until that shift takes place, the global recovery will be fragile and probably quite feeble. Most predict a gloomy U-shaped recovery with a long flat bottom of weak growth, driven only by higher-income households and businesses that don't need credit or are, somehow, still able to get credit.
I see a complex and drawn out recovery. "V" shaped at first, followed by a "U". I know what your thinking... "Doesn't he mean a "W" shaped, double-dip recovery". No, I don't. I see a recovery occurring right now, weak as it is, due to mild private sector gains and government spending. And it may even last a few quarters. But I see a second recession caused by the ending of stimulus spending projects and the tax increases required to pay for them. Obama did not cure anything, he just delayed the slow, but inevitable, real recovery. The cause of the "V" upside recovery, is also the cause of the "U" downside recession. I believe the economy will grow at a respectable 2.0-2.5% in the third and fourth quarter as manufacturers boost output to replenish stocks and consumers, who have been putting off purchases of everything from cars to appliances, address the pent-up demand. But, it will likely hit a wall into the fourth quarter, with little sustained customer demand to keep production up very long. The economy will slow to about a 1.0-1.5% crawl in the first quarter, then a tepid 1-2% recovery as most of the economic stimulus money is doled out throughout the remainder of the year. Also in 2010, due to the massive liquidity injections, plus rising commodity prices, inflation will increase. The central bank will be slow to raise interest rates, as needed to stave off inflation, because doing so would tamp down the weak economic recovery during an election year. The Fed, after waiting too long, will then be forced to raise interest rates sharply. Perhaps early in 2011. Right in the middle of another wave of adjustable rate mortgage resets, sending the economy right back into recession. That's what happened in the early 1980s when the economy soared the first few months of 1981 following a recession, before the Federal Reserve raised interest rates to head off inflation. That put the brakes on the recovery, resulting in another, more severe downturn.
Tax increases will precipitate another shock to the economy that may be more protracted than what we have already experienced. Given the budget situation at the federal, state, and municipal levels, harsh tax increases are inevitable. At least 48 states addressed or are facing shortfalls in their budgets for the upcoming year totaling $166 billion or 24 percent of state budgets. New data show a majority of states expect shortfalls in 2011 as well. Aggregate gaps through 2011 likely will exceed $350 billion. Some states will go further into debt, but a number of them, by law, are not allowed to run deficits. Given the power of state employees (and their unions) over state legislators and governors, these budget shortfalls will not result in cuts alone. States will instead focus on tax increases. Given the escalating state budget crisis, tax increases will continue for some time to come. Now, add the federal tax increase we all know is coming (whether it's health care, carbon tax, etc.) and we have what economists sometimes call an "exogenous shock" to our economy. A famous paper by Christina and David Romer (Berkeley - 2007) analyzes the impact of tax shock to our system and found a deeply disturbing result. Christina Romer, economic advisor to President Obama, who I have in the past called one of the dumbest economists on the planet, is a fine economic historian.(pretty much anybody can look backwards) The paper finds a tax multiplier of roughly 3: each dollar of tax increase will translate into 3 dollars lost from GDP. There is of course a delay before the tax shock translates into GDP decline, but the connection is there ... and the conclusion is clear. All attempts to pay for a recovery, with taxpayer dollars and government spending, will only exacerbate the problem. Now, I don't know if you remember this from an earlier blog. But, Christina Romer was also the economic historian that studied the New Deal of the Great Depression and concluded that government spending made the depression deeper and prolonged it for years, and never really did much for recovery.
(thank god WWII came along)
At no time in history has tax increases for government spending ever spurred lasting economic growth. In fact, it deepens and prolongs the pain and suffering for much longer than need be. This is why I truly see Romer as a severely retarded economist ....she can't learn from her own studies! ....or their conclusions!
Over the past few months, deflation has occurred. This means that prices have gone down and money can buy more stuff. Deflation is considered to be very dangerous, as it has occurred both in the Great Depression and in the Japanese economic disaster of the 1990's. Consequently, the Federal Reserve is trying to halt deflation by printing money. Theoretically, more money in existence lessens the worth of all money. Based on the principles of supply and demand, your money would then buy less and prices would be pushed back up, bringing deflation to a halt. The problem is that it is very difficult to measure when enough money has been added to stop deflation and not over-do-it causing us to go into hyperinflation. Before the recession, the primary goal of the Federal Reserve was to stop inflation; now we are trying to create it. The Federal Reserve will, likely, continue pumping money into the American economy until it see signs of it working to counter deflation. There is the possibility that this signal could come too late and cause a delayed reaction, resulting in hyperinflation. This means the FED has to balance a very fine line, like a tight rope walker. And the room for error is just as small. If hyperinflation occurs, it's very possible that we will be even worse off than we ever were. I understand, we are in a recession, and people are demanding some action be taken to address it. The fact is, recession is a natural part of a capitalist economy. Recessions are certainly not enjoyable, but they are unavoidable, necessary and, at least up till now, always do come to an end. However, hyperinflation, if it were to occur, is very difficult to end. The Weimar Republic of Germany suffered hyperinflation and ultimately resulted in the collapse of the German economy and the rise of Hitler. Currently, Zimbabwe is a complete economic disaster because of hyperinflation. And there appears to be no end in sight. We must be very careful not to overreact in what we do during times of economic crisis. Although this new money may help us in the short term, if the fed screws this up, we could be facing very long term consequences.
Chapter 3
(Holey Sh*t!!.... what do we do now!)
So, what needs to be done to address of this next great economic calamity?
Well, as a start, the Obama administration need's to abandon it's plan to remake our economy with it's Recovery Act. They need to scrap it and use the money for more traditional stimulus and forget about the tax increases that would be needed to pay for it. They need to scrap the poorly thought through budget mess they have created that now projects a 9 trillion dollar add-on to our national debt over the next ten years. (up from $7T just a few moths ago) They need to face facts that the economy has shrunk, taking government revenues right along with it. Everyone else is pulling back to basic essentials, government needs to do the same. Not the programs designed to help people through tough times, not national security or defense necessities, but everything else needs to be pared back or eliminated to ensure yearly deficits are as small as possible.
The problems are plentiful. Slow economic growth, high unemployment and another housing disaster on the horizon. It's the second coming of the housing collapse that poses the most serious harm. And it doesn't seem to be on anyone's radar screen. Any stimulus created needs to address the glut of empty houses that has resulted in the reduced the worth of all houses. The more we can get owned, the more they all will be worth, keeping more Americans "above water" and out of trouble. Boosting employment means giving employers incentives to hire. And, boosting the pace of new hires is directly related to the rate of consumer spending.
They implemented a housing tax credit plan that, much like "cash for clunkers", seems to have had fairly good success stimulating demand over the last few months. It, however, was a good idea not fully realized. Why only 1st time home buyers? Why only home buyers, and not refinancing of distressed home mortgages? And why new homes when the problem seems to be too many existing homes?
- Give a tax credit for 10% of all "existing home", 30 year fixed mortgages financed through 2010, with a maximum credit of $25,000. (Refinancing credits would require proof of distress and need)
- Give all employers a 12 month payroll tax holiday on all new hires.
- Increase the Obama tax cut to $25 a week through 2010, and assure the American citizenry that tax increases are not in their future.
Any plan right now that explodes the debt, or increases taxes, is bound to have negative effects later down the road. But addressing the oncoming crash now will be dramatically less costly, and less painful, than waiting for it to occur. Any adjustments made now will not be time enough to solve the future housing crisis. But a glancing blow is much better than a head-on collision. Sure, my stimulus plan will undoubtedly create debt. But it's quicker, more effective, and actually addresses the cause of our economic downturn. And, probably at much less cost than their pie in the sky, green to the extreme, environmentalist fluff that has been untried and unproven to do anything positive for our economy as a whole.
GOD HELP US IN 2012"!"
6 MONTHS IN, AND WE ALREADY NEED CHANGE AGAIN"!"
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