patrick.net

brightc,

Not bad. Something tells me that the coming RE/finance meltdown is going to be inspiring *a lot* of sad Country-Western tunes.

How about "My broker screwed me, my wife left me, my hound dog died, and then the bank foreclosed" ?

"Then again, wait a bit longer till you’re dead, and then nothing matters anymore. The only thing that matters is how well you’ve lived your life, and I really can’t see a correlation between that and home ownership.
Especially these days." -- Girgl

WELL SPOKEN!!

San Diego County resale house prices tumbled last month by the biggest number in 18 years of record-keeping and contributed to the smallest year-to-year rise in overall prices in six years, DataQuick Information Systems reported Monday.

The median resale price for existing single-family homes dropped $15,000 from November to December to stand at $550,000, the largest month-to-month decline since DataQuick began keeping records in 1988.

I wonder if the McDebtors ate jalapenos for dinner, cuz they've got to be feeling the burn.

SV renter.
Well said about SF and I totally agree. The only reason to live in SF is because you want to be around gay people or maybe you are an indentured servant from china or a homeless crackhead looking for a monthly handout(does the city still give $300 bucks a month to homeless people?)

I'm partial to Mougins in Provence. That's France for those here from San Jose or Columbus, Ohio.

BA

Do not buy Gold.

I predict DEFLATION. Not just deflation but a deflationary DEPRESSION by the end of 2007. The era of ultra fast communications via first the internet, then radio programs and last the main street media will create an avalanche world wide. I look for real estate be down 80 percent from the peak, stocks down 85 percent, and mortgage backed bonds down 95 percent by the end of 2007.

The whole problem is when the collateral fails through foreclosures and bankruptcy pushing the houses (collateral) into the hands of the GSE's (Freddie and Fannie). This causes the mortgage backed bonds to fail or be seriously impaired. Borrowing against homes added $600 billion to consumers' spending power in 2004, according to research by Federal Reserve Chairman Alan Greenspan.

Banks will fail and cause commercial loans to medium or small businesses to disappear. Credit risk and credit ratings will fall slowing the "velocity" of money and the GDP. The hundreds of trillions world wide in derivatives based on mortgaged backed bonds will unwind destroying worldwide liquidity. The feds will step in to salvage and consolidate the surviving banks and thrifts after the collapse as the lender of last resort. The fed will be "pushing on a string", unable to stimulate the world’s economy.

People will not be able to buy major purchases. Many foreign manufacturers such as Honda, Toyota, Chinese, India, chips or computers and memory makers will fail as Americans fail to buy. Services such as insurance, tourism, entertainment will diminish proportionately. Democrats, aka “progressives” led by Hillary will sweep into power bringing crushing regulations and tariffs. Commodities, including gold and oil, will fall as people hoard what little money they have left.

My opinion is that commodity investing for producers, industrial consumers, professional specultators and investors and perhaps a very very tiny portion of individual investors. I've given my reasoning in previous threads. In short, regular folks almost always get killed in commodities, be it gold, silver, copper, molibdenium, pork bellies, or soy. Even if you bet in the right direction, you'll get destroyed by transaction costs and won't come out enough ahead of where you'd be with a much less risky investment. That is, unless you really know what you're doing (and your wardrobe includes yellow or red sport jackets).

Buy gold in the physical form at the bottom of the deflationary depression. All the central banks will reduce their "discount rates" to member banks to near zero. Liquidity(credit) and money will be created for as long as it takes to restart inflation. The central banks mostly likely will overdo the easy credit policy and start hypeinflation.

jeffolie,

Of course, time will tell. But I'd sell that bet on tradesports.com all day. The US generates between 76-78% of its GDP through internal economic activity. In fact, the US is by far the least dependent upon international capital flows as a GDP factor when compared to all other developed nations. The catylst for your scenario would need to be a catastrophic shock on a scale not seen in modern times. Otherwise, the existing levers will be sufficient to prevent depression. If your events unfold, I rather think we'd inflate our way out of trouble, causing long-run stagflation. Liquidity would be fine within the US, even if it dries up in terms of international capital flows. Europe and Japan would be a different story.

Just one point. You cannot buy physical gold either efficiently or effectively. Even in the very narrow circumstances in which you can take legal ownership over physical gold stock, you pay more in transaction fees and storage costs than your return. Or, go ahead and keep it in your basement. I'm sure no one will find out about it...at least I hope for your sake they don't.

Randy H

We agree to disagree.

I am predicting a catastrophic shock on a scale not seen in modern times. Derivatives based on mortgage backed bonds worth hundred of trillions will unwind as these bonds become "junk bonds". Derivatives are world wide to bonds as what program trading was to the US stock market.

Ha Ha
The best place to live in the bay area depends on many things. I think it depends on your income, whether you have children, your sexual orientation and your ethnicity. At lot of money is a cure all in my opinion, but let's face it, we're all not rich.
I have to believe that the best place for me is somewhere out of the bay area. I've been here for 36 years and lately I've been thinking about where else I want to live. I have property in Nothern Cali but it's too far to commute. If I completely quit the program, I'm thinking about the desert or northern or central coast beach towns.

How's that for a lousy answer

Unalloyed

The lenders that sell the mortgages they originate into the marketplace and do not keep them in their portfolio of assets are least likely to need a bailout.

Spread your deposits among many FDIC insured places so that this diversification will allow you to make withdrawls at each. In extreme times the feds may limit how much and how often you may withdraw from each place.

In my deflationary depression, banks will fail. During the Great Depression of the 1930's banks were closed for a "bank holiday". Keep enough cash safe (not in a bank that may go on "holiday") to buy food and gas.

Sunnyvale_Renter Says:

"To get real inflation figures, take George Ure’s advice and track prices of things YOU buy a year ago, and now. The items in the CPI are not very relevent any more..."

Very good observation. I'm at the point where I just look around at stuff with my own eyes, and do my own analysis. I cannot count on the media to put it all together for me. I think shit IS going up.

Salaries, my salary that is, is down in real terms. Not even stagnant, but down. Corporate profits are up. People doing the work of two and three people, legacy systems in use, etc. Greed!

And it's not even a salary, it's a wage minus benefits. I'm on contract at a Fortune 500 company through Manpower Professional.

I don't know how a lot of people are making it. A crackup's got to be in the cards...even if in slow mo.

Glad I'm not going to be in Cali when the wave hits...

It dropped 80% in an imaginary place called “Tokyo”.

Japan sufferred secular deflation. Their monetary policy was too tight, largely due to currency intervention. A country cannot manipulate currency and control money supply simultaneously. Japan had to do this because they are an export economy. The US is not an export economy. The US has a credit culture whereby Japan did/does not. Willingness to take on debt encumberance is essential to the fed interest rate lever. This works well in the US. It even worked well in the 30s during the depression. When the new fed policy reversed the "shake out the riff raf tightening" era, things started to become more liquid almost overnight.

The US is neither likely to suffer secular deflation nor hyperinflation (the definition of hyperinflation is 50% per month, which is over 1% per day, implying two orders of magnitude increase in prices per year). As to the depression hypothesis:

"Economists believe that the mistakes that led to the Great Depression are unlikely to be repeated. The Fed is unlikely to allow the money supply to drop by 25%. Further, the unecessarily long deflationary period of the early 1930s was directly responsible for the depth and length of the depression. A 'Depression' is not an economic state, but a sociopolitical state. Economic models do not support a prolonged deflationary period without a persistently falling money supply.

The fiscal-policy mistakes of hte Depression are also unlikely to be repeated. Fiscal policy in the 1930s not only failed to help but actually further depressed aggregate demand. Adherence to balanced budgets and debt controls worsened the deflation, a policy few economists would recommend today. [text goes on to invoke IS-LM models and econometrics supporting the validity of those models]"

--Macroeconomics, 5th Ed. (2003)

Welcome back, Randy H, glad to see u here again.

I predict we will have stagflation, 10% - 20% inflation a year on oil, food and anything that needs to be imported due to currency depreciation, no or minimal growth on wages. Any asset that is dependent on wage growth, i.e. houses, will actually see a pricing decline, while anything that has a much more inelastic demand, e.g. food, heating, healthcare, will see jumps in price.

DinOR

Orange County in California went bankrupt because it used derivatives based on bonds. The levage went against the OC when it guessed wrong on the direction of interest rates. Hundreds of trillions of derivatives will unwind bankrupting manifold holders. Todays liquidity in the mortgage backed GSE's (Fannie and Freddie) packaged bonds have produced the enormous, expodential funding of mortgages.

When bonds are downgraded to "junk" it usually means that the interest payout has been impaired by credit risk or actual reduction of the interest payments. Look at the OC bonds during the OC's bankruptcy, the OC suspended payments. The yield did not go through the roof (ie 698 % in your example), the yield went to 0 %.

Most pensions and institutions in the US hold lots of the mortgage backed bonds. A bond does not have to go into default to become junk. The US auto makers, GM and Ford, have junk status. I predict that deflation of houses will reduce or suspend the payouts via foreclosures and bankruptcies.

I am predicting a catastrophic shock on a scale not seen in modern times.

One can not refinance without equity. A drop of 20 percent wipes out the equity of the I/O’s and option ARM’s. The home buyers in San Diego and through out Southern California have taken out interest only or option ARM mortgages on 1/3 up to 1/2 of sales. Equity in conventionally mortgaged homes has been dropping severely for cars, vacations, education etc. Borrowing against homes added $600 billion to consumers’ spending power in 2004, according to research by Federal Reserve Chairman Alan Greenspan.

No home owner will escape by refinancing.

Refinancing will soon be dead

The California Department of Real Estate announced that the number of real estate agents approaches 500,000. Using the census, this works out to 1 real estate agent for every 75 Californians.

DinOR

The collapse has started:

"The Union Tribune has this breaking news. "San Diego County resale house prices tumbled last month by the biggest number in 18 years of record-keeping and contributed to the smallest year-to-year rise in overall prices in six years, DataQuick reported Monday. The median resale price for existing single-family homes dropped $15,000 from November to December to stand at $550,000, the largest month-to-month decline since DataQuick began keeping records in 1988."

With refinancing soon to be dead even the rich will suffer greatly:

"A coastal strip of Newport Beach (in Orange County, Californai) gained the distinction of being the only local area where everyone who bought a home last year used an adjustable-rate loan (ARM).

The 92662 ZIP code is also the county's priciest, with the median price of a home at $2.26 million, according to DataQuick Information Systems.

Adjustable mortgages, which start with a low interest rate and then track market rates after a set period, were also widely used in Santa Ana and Anaheim.

ZIP codes in those cities accounted for seven of the top 10 ranked by ARM usage. In four Santa Ana ZIPs, about 86 percent to 88 percent of purchasers used an ARM. The median price in those areas ranged from $525,000 to $560,000."

Orange County in California went bankrupt because it used derivatives based on bonds.

CORRECTION: OC went bankrupt because of *over exposure* to a specific asset class: debt derivatives. Simple diversification strategies would have prevented it. The same thing has happened recently in Ohio. That's the problem when you allow governments to make investment policy.

Derivatives in and of themselves represent no more of a particular "evil" or "flaw" with the capital market system than do any other type of leveraged trade, including equities, commodities, forex, und so weiter.

The MBS industry--a focus of a lot of fretting in this blog--is not nearly as financially exposed as it seems. Through the use of debt tranching, the risk has been diversified broadly. There will be a lot of pain, no question, but it will not cause domino-effect bank collapses. It may take out the "toxic waste tranches" entirely, but the owners of these are either speculators or have them as a very small portion of a diversified portfolio.

And the Orange County Register. " The number of delinquent property tax payments has reached the highest level in a decade. This worrisome trend may be evidence that high purchase prices and burgeoning payments on popular adjustable mortgages as interest rates rise may finally be taking a toll on the budgets of local property homeowners."

"Orange County's tax collector reports that: Almost 46,000 property owners had not paid as of Jan. 7, a group that's grown 15 percent from the same time a year ago. It's also the largest count since the December 1995 bill."

John Moorlach, the Orange County’s treasurer and tax collector, wasn't totally surprised by the increase in late bills. Moorlach is troubled by what he called a 'remarkable' $21 million jump in delinquent payments. If you recall, Moorlach shouted warnings about the county's high-risk, idiotic investment schemes. Nobody listened and the county government ended up in bankruptcy court."

The deflationary collapse in housing because of excess supply will overwhelm us: There were 503,000 unsold new homes in November 2005

From Inman News. "One sign of slowing is the level of unsold new homes. There are now nearly 200,000 more unsold new homes under construction than there were just five years ago. Rapidly rising sales have masked the surge in construction."

"Most analysts focus on the months of new-home supply. Since hitting a low of 3.5 months of supply in the summer of 2003, this number has gradually increased to its current value of 4.9 months, its highest value since December 1996. If sales slow even a little, the months of supply figure will surge, as it did in 1990. There were 503,000 unsold new homes in November 2005, compared with 305,000 in November 2000."

Uptoolae

The birth rate definitely has an impact on demand. If the immigrants (legalr or illegal) barely qualify for an apartment, vast numbers of immigrants will not save the housing market.

Look at Europe's immigration policy of importing Muslims. Vast numbers created slums and social unrest. If mere numbers of people were the force to support a liquidity driven housing market, then the over a million foreclosures in Shanghai, China would not have happened in 2005.

Immigrants will not save the deflationary depression in housing.

Randy H,

Does that mean I can come out of my bunker now, and get rid of my hoardes of canned food, guns and ammo, and gold coins, and start breathing again?

In more seriousness, your post is somewhat comforting, as it suggests that should there be a very sharp correction and concommitant defaults, that generally only those who most deserve it, will get burned. Let's all hope so, because the alternative is truly depressing.

DinOR

High risk mortgages will provide less mortgages and slower sales. Refinancing will soon be dead:

From the LA Daily News:

'Mortgage lenders in California are more critically scrutinizing loan applications now because of higher default risk resulting from a shift in sales patterns as the real estate market nears the end of its boom cycle, an industry tracker said Monday.'

'During the second half of 2005, risk levels for new mortgages statewide increased 28.6 percent across California from the prior six months'

'Stepped-up scrutiny means lenders could be asking for more financial information from borrowers and seeking more detailed appraisals of property.'

Refinancing will soon be dead: Refis fell 35-45%

Steve Roach of Morgan Stanley recently (January 14th) coined what I think is a center piece observation:

Long lacking in income support, the spending-addicted American consumer has turned to equity extraction from asset holdings in order to support the habit. According to Federal Reserve estimates, the current pace of home equity extraction was around $600 billion in 2005 -- more than enough to compensate for the $335 billion shortfall of real labor income generation noted above. But if the housing market softens and financing costs rise -- both quite likely, in my view -- equity extraction will fade and over-extended American consumers will then have little choice other than to bring spending and saving back into more prudent alignment with income.

We now have evidence that equity extraction in the fourth quarter and into the new year, is running at much lower levels. A recent Citicorp report on the financial sector gives us an idea of just how much. Their blended calculation of FNM, FRE, MBAA data estimates 4th quarter mortgage originations decreased 18%, qt over qt. Refis fell 35-45%, so still robust purchases kept it in the ball park. A section entitled "refinanceable mortgage debt outstanding", estimates that right now only 10% of the total mortgage universe would benefit from a refi into a 30 year fixed, and 16% would benefit into an 5/1 ARM. If rates dropped 25 bp, this would kick up to 13%, and 25% respectively, so rates do still matter. 25 bp higher, it's all gone, 5% and 11%, so we are pretty much at "cry uncle" time on refi activity.

Further we have data on home equity loans (HELOCs) revealing the same pattern.

Why the death of refinancing alone will cause a deflationary depression:

An estimated $400 billion in mortgages will reset in 2006, and another giant wave of $ one trillion in 2007.

Borrowing against homes added $600 billion to consumers’ spending power in 2004, according to research by Federal Reserve Chairman Alan Greenspan.

Deflating housing will raise interest rates:

In a falling housing market, the mortgage backed bonds will cause higher interest rates to attract investors. A vicious cycle of higher mortgage rates will result in ever increasing foreclosures and deflation

I'm not trying to only pick on you, jeffolie. I am quite convinced that a sharp correction is emminent. However, I feel obligated to offset talk of another Great Depression.

Why the death of refinancing alone will cause a deflationary depression:

Borrowing against homes added $600 billion to consumers’ spending power in 2004, according to research by Federal Reserve Chairman Alan Greenspan.

Only a small percentage of those scarry numbers will directly result in decreasing aggregate demand. While I agree that $600bn from "ATMing one's house" is cause for serious concern, removing even 100% of that from the economy does not portend deflation or depression. Aggregate demand could easily be stimulated to an offsetting degree by monetary or fiscal action (or both, more likely). The government can deficit spend an offsetting amount in a millisecond. This will still be painful, but it won't be a depression.

Deflating housing will raise interest rates

Not necessarily. Why wouldn't such a dynamic simply shift use of credit from consumption into investment (C being all personal consumption and I being all business investment). This is already happening, in fact; it has been for the past 3 quarters. You aren't suggesting the Fed will contract the money supply within a deflationary environment, are you? Just that mortgage lenders will raise their rates. Finally, what percentage of mortgages are fixed rates? (rhetorical, the proportion is very high as a % of total mortgage debt). This dynamic would tend to increase aggregate demand from those holding fixed mortgages, offsetting part of the imbalance.

I use M-1 data to gauge consumer "daily life" funds and activity. Given his great dependence on equity extraction as opposed to wage or personal income growth, this would be manifested by greater up and down fluctuations intra-month. This is the case, because Joe Six, is constantly drawing on fresh borrowings, just to meet basic expenses and debt service. The drop mid month is when his mortgage payment clears. The present M-1 chart looks very stressed. It's flat, and showing more signs of defibrillation. Starting in January 2005 M-1 has been hitting a ceiling of 1400 billion.

http://research.stlouisfed.org/fred2/series/M1/25

Yeah, I lived through that bubble too! Excellent analogy and a great way of explaining why we are where we are. Many homedebtors don’t seem to want to realize that even if you are in the midst of a “great neighborhood” or “hot” area and extracting equity in wheel barrows living the life that doesn’t mean you are not out on a limb.

Equity extraction is pretty much the same as putting debt on a credit card. In this case, increasing home value similar to getting an ever higher credit limit. The only difference is that one charges 7% interest while the other charges 25%.

In fact it might be more accurate to say it’s like making a credit card payment with a credit card.

Yes, that is very true.

I use M-1 data to gauge consumer “daily life” funds and activity.

The distinction between M1 and M2 is increasingly difficult to quantify. Demand deposits can in fact be used as cash, through debit cards, which constitute a great portion of consumption. Also, the definition of demand deposits is difficult given the integration of personal investments with electronic banking and personal debt.

Most economists, for this reason, do not base forecasts upon M1 volatility. Also, this phenomenon is the reason for the rapidly increasing velocity of money that has occured over the past 10 years.

Deflation in Michigan lowers wages and wealth:

The Detroit News has a report that shows what a declining housing market looks like in a poor economy. "Southeast Michigan's housing market took a sharp dive at the end of a weak 2005. Statistics released Monday showed median sale prices fell 4.3 percent in December, the biggest monthly drop in 2005, and most sellers were waiting at least 3 months to find a buyer."

"According to the Census Bureau, Michigan was one of only eight states that have seen household income decline in recent years. The trend of falling income is worsened by the decline in the values of homes, where most wage earners still have most of their wealth tied up."

"Layoffs and pay cuts have kept many families from committing to a new home, forcing desperate sellers to reduce their asking price in the hopes of luring a buyer. Many have had to move out before a buyer materialized, forcing them to make two mortgage payments in the interim. Some homes listed on the Internet have multiple ads, one picturing the home with leafy trees and another showing a blanket of snow, an indication of the many months they languished with a for-sale sign in the yard."

"The only difference is that one charges 7% interest while the other charges 25%"

I've heard of people paying off their CC debt with a HELOC. Isn't that like converting short-term debt to your mortgage term? What are the implications?

"The government can deficit spend an offsetting amount in a millisecond. This will still be painful, but it won’t be a depression."

This, along with real interest rates below zero, didn't readily help Japan with deflation. I wonder what the Fed would/could do differently.

The HELOC (Home Equity Line Of Credit) does not convert short-term debt to your mortgage term. HELOC's provide a credit card type of loan secured against your ownership of your house as a lesser security than your first mortgage. Usually HELOC's have variable rates of interest tied to an index.

Unlike a credit card, you may get foreclosed. Like a credit card, you can get various amounts of money upto your limit.

This, along with real interest rates below zero, didn’t readily help Japan with deflation. I wonder what the Fed would/could do differently.

As I've said, it is not possible to simultaneously manage money supply and intervene in exchange rate. The Central Bank's only mechanism for managing exchange rate is by shifting money supply to offset capital inflows/outflows. Japan was effectively restricting money supply by allocating a huge portion of it towards the end of keeping the JPY/USD rate within a band.

If the US started trying to prop up the dollar, then I'd buy these arguments. I'm not going to hold my breath.

Randy, this comic is for you!
http://www.penny-arcade.com/comic/2002/07/12

LOL! Thanks. (I grew up in Ohio, btw, so I have creds when it comes to diss'n it)

"What are the implications?" -- KurtS

Well, for one, HELOC debt is "secured debt" while credit card debt is unsecured. Meaning that you can lose your house if you don't pay off your HELOC. You can't have your house seized if you cannot pay your credit card bill. Of course the HELOC generally has a lower interest rate than CC debt, so anyone paying of CC debt with HELOC is taking the upside of lower debt servicing costs with the downside of losing their home if they are unable to make the HELOC payments in the future.