patrick.net

There are over $400 Trillion in derivatives.

That is the total derivatives market, not the MBS and CDO derivatives. Many derivatives are stable and not worrisome. Many have liquid commodities or equities as underlyings.

Randy,

Any idea what percentage of the global derivatives trade is tied in some way to RE values? I have no idea, but I suspect it is probably still a huge number.

What will happen when a major counterparty fails? Anybody's guess. I doubt it will be the end of civilization as we know it, but it should create some great buying opportunities for savvy investors with sufficient liquidity. I predict that Warren Buffett will end up owning a big chunk of MBSs purchased at a significant discount to face value. Buffett wound up with some valuable utility assets after the Enron fiasco.

That is the total derivatives market, not the MBS and CDO derivatives. Many derivatives are stable and not worrisome. Many have liquid commodities or equities as underlyings.

But will they all become part of the chain reaction? Cascading Cross Default?

If/when there is a derivatives implosion, it would be hard to steer clear of it. Ironically, unleveraged real estate may turn out to be a pretty good store of value.

But will they all become part of the chain reaction? Cascading Cross Default?

If so, it could get scary. Is it just me, or does it occur to others that our federal government has recklessly guaranteed just about everything in our economy? Public and private pensions (PBGC), bank deposits (FDIC), mortgages ("implied" Fannie/Freddie guarantee), student loans (Guaranteed student loans), retirement (Social Security), medical care for the poor and elderly (Medicare), etc., etc...

Given the rapidly deteriorating federal finances, I suspect that the US gov't will need to repudiate at least some of this debt either explicitly (very politically unpopular and could worsen crisis) or implicitly (via inflation). My bet is on inflation.

There's no guarantee that RE would retain their nominal value (nevermind real value) outside of a hyperinflation scenario. High inflation would just push up the cost of things like food and gas, and seriously squeeze FBs stuck with ARMs. The high interest rates would also squeeze buyers out of the market.

Cash and commodities are probably the best place to be for the moment.

Not investment advice.

But will they all become part of the chain reaction? Cascading Cross Default?

Somewhat unlikely. At most I'd expect to see a lot of counterparty defaults resulting in increased settlements for virtual delivery of the underlyings, which would ultimately be settled in cash.

It could have the effect of chasing speculation out of the more esoteric derivatives for a long time to come.

More worrisome to me would be a cascade of failures of prime brokers triggered by hedge funds collapsing. If enough HFs fail, then unwinding their derivatives trades could crash those markets and leave prime brokers up a river and on the hook for settlements. But prime brokers have pretty deep pockets and a lot of Fed influence.

UK, AUS, USA - three very different RE markets, with different buying patterns, different financing structures, and different economies. The comparison is at best a distraction from the important considerations for evaluating our market.

In RE, Demography is Destiny...
How many people, at what ages, with what income distribution...

Everthing else is either temporary or a subtlety...

...and overpowered by demography.

UK, AUS, USA - three very different RE markets, with different buying patterns, different financing structures, and different economies.

And yet, all three experiencing historically unprecedented run-ups in RE prices vs. rents and incomes over the last decade, while simultaneously experiencing flat (UK, AUS) to moderate (US) population growth. And while the international credit markets (derivatives, CDOs/MBSs, Forex, credit swaps, etc.) become more interrelated and interdependent by the day.

Pure coincidence? Spurious pirates-vs.-global-warming correlation? I think not.

And yet, all three experiencing historically unprecedented run-ups in RE prices vs. rents and incomes over the last decade, while simultaneously experiencing flat (UK, AUS) to moderate (US) population growth.

Must be synchronicity.

Could that be the Police? Great album

Huh?

http://sfbay.craigslist.org/pen/rfs/200598266.html

It is quite close to 101. Is the area okay?

@Steve The Owner,

"Buyer protection" only for 6 month period. A huge improvement over no contingencies + feed the squirrels (typical 2005 terms), but hardly risk free in a slowly declining market that could keep falling for 5-10 years. Also does not say if they will buy it back for PRICE YOU PAID.

Coincidence or common cause?

What was the common cause that was also not also present in places with lesser price increases?

It is not principally credit, since the whole world experienced that (And the entire US experienced that) but many places saw no big price increases - even with the same credit conditions. Also, in the past we have had interest rates and prices sometimes move together and sometimes go in opposite directions. A long term study of interest rate movement and home price changes will show that the correlation is very very weak.

So what is it then? Population growth? Job growth and GDP growth varies by country and state. Is the variation in GDP growth correlated with the boom in prices? What is the proper time line to use as a base for analysis? Using only a few years one will reach dramatically different conclusions depending on which few years are used. For my investment analysis I use the last 40 years for careful analysis, and sometimes include the last 80 years for the more general observations. Looking forward I use a time horizon of 20 years.

Most people seem to look at the last downturn of the 1990s and draw their conclusions by comparison to that - often without understanding the boom that receded that bust. How many full cycles does one need to study to understand cycles? How many individual people does one need to study to be an expert on all people? Clearly more than one or two in both cases.

It is not principally credit, since the whole world experienced that (And the entire US experienced that) but many places saw no big price increases - even with the same credit conditions.

Credit is just an enabler or a trigger. Just like stars in the zodiac.

US births have been running running at about 4 million per year for a while now... Plus immigration...

Interestingly the number of children in school this year is a new all-time record high. More students than during the baby boom! (has been for a few years now).

In a few years these students will be young adults in the job market, and seeking apartments to rent.

‘Synchronicity’ was probably their best album.

Oh. I was talking about C G Jung's Synchronity, which is about coincidental but acausal events.

jeffolie Says:

"Our housing bust, collapsing MBSs, followed by derivatives overseas imploding will explode the world’s financial system well beyond the capabilities of central banks to control."
_____

I think you've mentioned deflation. Is it deflation then inflation?

Is cashing out of gold now a good idea, then, perhaps buying back after prices have collapsed the the inflationary wave hits?

I have wondered why prices did not fall in Australia and U.K. even though they had a bigger bubble than the U.S.

However comparing smaller regions, Sydney with San Francisco according to the link below

"Sydney has registered a 1.4 per cent increase after falls in seven of the previous nine quarters."

http://www.abc.net.au/news/newsitems/200608/s1723030.htm

However in Perth home (as ajh mentions above) prices went up 35% in one year. This hints at how to prevent a bubble from bursting with ill effects. Create another bubble. The mining areas of Australia benefited from the commodity bubble.

U.K. does not benefit as much from the increase in commodity prices but hedge funds in London are doing well because of money flowing in, some of it from the oil profits of the Arab world. Britain also benefits from the continued growth in the U.S. economy.

The U.S. is the big kahuna and if it slows down there is no other country large enough to bail it out. Could the Federal Reserve create another bubble? A boom in the prices of minerals would not benefit San Francisco. Another gold rush? The environmentalists will prevent that from happening.

Zephyr,

I thought we had long ago buried the "population growth is driving housing prices" myth, but...

Assuming that 4 million/yr, we're talking about 1.3% growth per year --in other words, about our long-term average growth rate over the last century. Add in a bit more for uninvited "guest workers" and you still don't have nearly enough to explain national prices nearly doubling nationally in less than a 10-year period, and tripling along the coasts and most major metro areas.

The current boom/bubble/pustule is simply not a consequence of population growth.

Population growth does drive real estate appreciation. Roughly: expected_long_term_RE_returns = popul_growth + inflation + 1% + local_premium + error

"local_premium" accounts for supply & demand fluctuations, long term area desirability (or lack thereof)

Since population growth is low, around 1~2%, we should see long-term RE returns at about 5%, lower in SouthEast Indiana, higher in Manhattan.

*** residential RE only; not commercial

What was the common cause that was also not also present in places with lesser price increases?

It is not principally credit, since the whole world experienced that (And the entire US experienced that) but many places saw no big price increases - even with the same credit conditions.

Wrong, wrong & wrong. It is precisely cheap credit in massive amounts that has fueled, nurtured and sustained the US/UK/AUS RE bubbles so long. That, plus the complete collapse in lending standards due to rise of international securitization of mortgage debt, increased government housing subsidies, relaxed oversight, etc.

Those nations that did NOT share the huge run-up in prices during the same period (Japan & Germany being good examples), either were in the crash/correction phase of a previous bubble --i.e., "out of sync" with the anglo-RE cycle-- or had far more restrictive credit/regulatory policies in place or both.

HARM,

Great thread. The continuation of UK and Aus bubble is one of the very few reasons for my self-doubt. I know, different societies, different laws, different mortgages and just about everything may be different.

So if they can achieve soft-landing, can US hope the same ? Very discomforting.

But even scarier is what you suggest. If these bubbles are related, they can collapse because of each other forming a vicious feedback loop. If so, I do not want them to be popped. For the sake of all of us, bulls and bears.

What about Asian RE markets ? Banglore, Dubai, Shanghai and so on. I read a news sometime ago proclaiming Dubai to be the biggest bubble of all. Are we going to experience a truly dark side of globalization ?

Sometimes I think Zephyr gets a kick out of playing devil's advocate with us, just for the heck of it.

I will bet anyone here there will be no macro deflation. I'll tell you what. You agree to pay me an agreeable inflation-index to the dollar if inflation is positive, and I'll agree to pay you that amount if inflation is negative. I'll enter into this contract from 6months to 2years, longer if it's a worthwhile amount.

Betting against central banks is best left to fools and hedge funds; which are at times one in the same.

Betting against central banks is best left to fools and hedge funds; which are at times one in the same.

Life is the journey of a fool anyway.

I think it was common cause:

1) historically low interest rates worldwide, largely brought about by US Fed keeping rates low post 9/11 (and post tech wreck?) with international flow-on effects

2) liberalised credit products from lenders -- international banks realised they could lend much more without increased risk of foreclosure, and offer more investor 'products' -- e.g. investor loans at the same interest rates as home buyers. here, they traded on the similarities between housing markets rather than differences.

possibly 3) get rich quick spruikers encouraging all and sundry to buy investment properties, 'plan for retirement', avail themselves of low interest rates, etc, etc. a la robert g. allen, carlton sheets, etc. booming prices seemed to really bring them out from the woodwork...

other effects noted here have been the increased participation of women in the workforce, particularly coming into the 1980s, thus creating a bidding war in housing in the best areas (best schools etc) of 2 incomes vs 1½ incomes vs 1 income, etc... plus a downsizing of families -- a downward secular trend from 3-4 children to 1-2 children... so increasing income and decreased expenses seems to get soaked up into housing bidding wars, whereas we expect the price of all other commodities to come DOWN over time, availability of raw materials not withstanding.

and lastly, the introduction of tax breaks, whether for investors or home buyers...

However, I now don’t think we’ll see a catastrophic bust here if US demand falls away (except perhaps in Perth). It’s far more likely that the $A would in that case retrace back to the levels of the late 90’s, even against a declining $US, so nominal house prices would only have a further mild decline. In fact, I wouldn’t be surprised to see a long period of flat nominal prices.

the only counter I would have to this is simply that the pool of wealth and available equity will become exhausted -- as noted elsewhere, the boom can be a little illusory as only a small % of properties are on the market during the boom years. since house prices are ultimately underwritten by wages and salaries, whether by tenants or home buyers, there is a natural 'cap' to prices, which is partly why politicians don't worry too much about housing booms, believing it it self-correcting, and therefore one less thing to worry about.

once the pool of wealth and equity and all that is exhausted, the next generation will potentially be able to get property at a discount -- unless they are prepared to spend, and are expected to spend, 60% of their net income on housing and live in an impoverished culture. i'm still concerned about the proportion of new mortgages that are for investment, though, as the alternative scenario is one of creating a two-tier society of landlords and renters. direct govt intervention may be required (the New Home Owners Act of 2007), or else the reality of high pricing with no capital gains in the foreseeable future may be enough to deter even the stupidest investors and cause a rout of the seminar hustlers...

and even 6) lowered commodity prices for cars, whitegoods, electronic equip etc due to offshoring also frees up more capital in the household budget for bidding wars in housing -- anything you saved buying a cheap DVD or steak knives is soaked up by housing in aforementioned bidding war. it's a very foolish loop indeed...

But even scarier is what you suggest. If these bubbles are related, they can collapse because of each other forming a vicious feedback loop. If so, I do not want them to be popped. For the sake of all of us, bulls and bears.

i really don't care what happens to materialistic, pointless capitalist societies, where the pursuit of 'happiness' is leaving us miserable and more stressed and overworked than ever, or wallowing in existential despair...

the vices have actually been elevated into virtues, just about all 7 of them: pride, envy, gluttony, lust, anger, greed, sloth... what's that about? and the virtues such as charity, kindness, and altruism have been denigrated as unworthy -- the poor should take care of themselves and deserve their lot, etc...

yeah, i talk to people around the world, and they always have exactly the same cold with the same symptoms at the same time, thanks to the joy of travel... ;)

could be. although we are learning more about microorganisms and coming up with new vaccines and cures every day. the advent of HIV meant that scientists had to study the 'life cycle' of viruses in great detail for the first time, and that study is flowing into new anti-virals. apart from vaccines for measles, etc. and we are on the threshhold of playing god with the human genome project, gene therapy, etc...

i think the price of oil and eventually running out is more of a threat to ongoing development... high oil prices in the present could lead to recession and house price deflation...

ajh,

The same year the Po-Po Police released Snychronicity Joe Walsh put out "You bought it, You name it" which was technically far superior than anything the Po Po ever put out. Sadly it was dismissed as eccentric and R+R was put into an irreversible nose dive from which it has never recovered. The Police put out pop tunes that were instantly recognizable and more importantly, instantly likeable. Kind of like peppermint schnapps. (To this day you can't even "wave the cap" under my nose without getting an involuntary reaction). On the other hand "You bought it" was ugly from track ONE and yet in time I grew to appreciate it and still listen to it today. Not one song made the FM radio.

You bought, You name it, pretty much sums up the housing bubble.

there was a study done by Treasury recently that suggested a nasty flu like HK flu or the one after WWI would cause economic problems, but that the survivors would 'benefit from the assets'. nice. glad someone is thinking these hypotheticals thru. i was so appalled by the reasoning i posted it on my blog...

Bird flu threatens misery for millions

Peter P,

What do you think of Warren Buffet getting married at his age? Who's the lucky gal? Anyone heard? Please tell me she was born in the same century as Warren B! This isn't one of those Marla Maples look-alike kind of deals is it?

Conor,

Those are big sky macro questions; and my opinion probably isn't worth much more than yours for answering very long term questions.

My opinion is that it all centers around real growth, mostly as defined by the Solow and related theories. In the very long run, real growth is only defined by productivity, which itself reduces to technology advancement. Population growth is offset in the long run with capital creation.

I don't necessarily agree that credit creation need be deflationary. So long as long term credit does not exceed long term real growth, then there is no net deflationary effect.

What I do agree with is that we've (collectively we, meaning anglo-style western market capitalism, which defines the global economy) committed ourselves to ever increasing growth. In the very long run this can only mean forever growing (but not necessarily accelerating) technological enhancements.

So in my mind, and ignoring obvious major reset events like global wars, it is a race between what the credit & capital enables: technology, and our ability to exploit that technology without wiping ourselves out.

In the very very long run, this will eventually lead to progressively expanded markets, resources, and growth opportunities. Mostly in the form of ocean and space territorial conquests.

For that matter, does a rapidly deteriorating housing & credit market here portend doom for these overseas markets?

I hope so :}

DinOR,

Buffett has been living with the same woman for decades. He had a very open marriage with his first wife and the three of them were allegedly on great terms with each other.

As for deadly influenza or a more communicable version of Ebola (Gawd that would be a messy way to die), the upside is that killing large populations this way is less traumatic on human civilization compared to war.

If humanity gets its act together, such a pandemic might shake humanity out of its bad old ways and result in a cultural/technological rebirth. (As with Europe and Black Death, which temporarily relieved the population pressure brought on the high Middle Ages + Little Ice Ages, lead to loosening of the manor-serf based system, and may have kick started the Renaissance.)

StuckInBA Says:

The continuation of UK and Aus bubble is one of the very few reasons for my self-doubt. I know, different societies, different laws, different mortgages and just about everything may be different.

On top of that, whatm0980 are the consumer savings rates in AU and UK, or the rest of Europe for that matter? I can't imagine them being nearly as bad as in the US. This would suggest that the average US homedebtor has no reserve when the $hit hits the fan. I'd argue this makes the US situation a potentially worse.

Minutes from the Fed Aug. 8 meeting:

http://www.federalreserve.gov/FOMC/minutes/20060808.htm

"All members agreed that the statement to be released after the meeting should convey that inflation risks remained dominant and that consequently keeping policy unchanged at this meeting did not necessarily mark the end of the tightening cycle. They concurred that an indication that economic growth had moderated was appropriate, and a consensus favored citing the same reasons for that moderation as in the June statement. Members also agreed that the statement should both mention factors contributing to the likely moderation of inflation pressures over time and reiterate the forces that were seen as having the potential to sustain inflation pressures."

Talk about fence-sitting!