Real Estate Market / Inflation / Recession / Depression (mortgage, credit, loan)

[jazzlover]

Originally Posted by hello-world

LOL re the torpedo analogy.

otherwise, do you think that the scenario you envision can be helped by buoyed consumer confidence? (continued spending, e.g.) i imagine one contention you might harbor could be "well, look at how overextended people are regarding credit - credit cards, auto loan credit, etc., so there's only so much credit overextended people/markets can grab, and we're at the end of the rope". but are we at the end of the rope, in your view? are there other "buoys", in your view? increases in exports and tourism due to weak dollar, e.g.?

Among some less important differences between the Great Depression and now, there is one MAJOR difference, and it is not one that works in favor of the US. In 1929, the United States was essentially self-sufficient in just about every single natural resource category, and had a manufacturing base to produce just about every product it needed for self-sufficiency. Today, the US is not self-sufficient in either of those critical areas. People suffered greatly in the Great Depression because they lacked the financial means to purchase many basic necessities. In the coming crisis, they may not only have that problem, but may face the reality that many things they absolutely need for survival will be controlled by countries and enterprises outside of the US who are absolutely our sworn enemies. When that happens, we may look an awful lot like Germany and Japan during World War II. Will we stoop to the same vicious and inhumane behavior that they did when that happens?

[hello-world]

Originally Posted by jazzlover

Among some less important differences between the Great Depression and now, there is one MAJOR difference, and it is not one that works in favor of the US. In 1929, the United States was essentially self-sufficient in just about every single natural resource category, and had a manufacturing base to produce just about every product it needed for self-sufficiency. Today, the US is not self-sufficient in either of those critical areas. People suffered greatly in the Great Depression because they lacked the financial means to purchase many basic necessities. In the coming crisis, they may not only have that problem, but may face the reality that many things they absolutely need for survival will be controlled by countries and enterprises outside of the US who are absolutely our sworn enemies. When that happens, we may look an awful lot like Germany and Japan during World War II. Will we stoop to the same vicious and inhumane behavior that they did when that happens?

great points.

in a way, other countries are dependent on us for our consumption of their goods and services these days, too. so, i wonder how perceptions of climate change (and consumptive influences on it) might come into play with some of this, and in terms of fallout in the real estate market (and vice versa). in that vein, carbon markets are also ramping up (don't know how long they may be around, but...). could be another factor to contemplate...

[Bob from down south]

Originally Posted by hello-world

LOL re the torpedo analogy.

otherwise, do you think that the scenario you envision can be helped by buoyed consumer confidence? (continued spending, e.g.) i imagine one contention you might harbor could be "well, look at how overextended people are regarding credit - credit cards, auto loan credit, etc., so there's only so much credit overextended people/markets can grab, and we're at the end of the rope". but are we at the end of the rope, in your view? are there other "buoys", in your view? increases in exports and tourism due to weak dollar, e.g.?

No, I don't think it's possible to spend our way out of this...especially with OPM (Other People's Money). One thing I learned in business school is that leveraging works two ways...those who have near 100% loan-to-value loans on expensive houses they never really could afford by traditional standards, are about to learn this lesson the hard way.

It's one thing to take $300,000 of OPM to control an asset that appreciates 33% in three years...that $100K is yours and the result of a "smart" decision to buy, even with risky debt up to your gills. Right.

But the opposite scenario...the one that the mortgage brokers and realtors never mention, is that taking $300,000 of someone else's money to control an asset that loses 33% in three years leaves you with a $200,000 house and a $100,000 bill you're still expected to pay to the other guy that loaned you his money. That's the result of a "predatory lender," not a dumb decision on the buyer's part. The real fear in the mortgage industry today is that many buyers in this situation will end up opting to send a "jingle mail" (keys in an envelope) to their lender and walk away, rather than pay what they owe. It's analogous to the margin calls that destroyed the speculators in the 1929 crash leading to the Great Depression.

If housing prices drop 30% from their 2006 peak, something like 40% of the home "owners" in the US will be upside down in their mortgages. "Jingle...jingle...jingle."

So...the mortgage industry has rapidly throttled down lending to prevent more exposure to borrowers who could be leveraging themselves in a down market right into walking from their debt. That means down payments will be in vogue, income ratios will be enforced again, and credit for those who are less than stellar risks will be virtually nonexistent.

That, in turn, means much of the population that was buying $200,000 entry-level houses last year can no longer qualify for a loan to buy a $200K house, if they can qualify for a loan at all. Without those buyers, the people in those entry-level houses can't sell in order to move up, even assuming they could qualify for a more expensive house under the traditional guidelines. It also means that many who entered into loans with known future rate resets or at high rates (due to credit problems in the past) that counted on a refinancing to get things under control after a few years are now stuck in a loan they can't continue to pay, because they no longer qualify to refi since they owe more already than the home is worth.

It's bad, bad juju, until prices fall back to affordability, or wages are inflated up to affordability, or a combo of the two. Either scenario--asset deflation, or massive inflation--is a train wreck for the general economy. Not the end of the world, but a life-changing event for millions. This had to happen...again, my investments professor in business school (thank you Dr Dickler, wherever you are!) taught me to step back, look at the macro trend, and ask myself if it really makes sense. For housing to have continued much longer on its 2002-2006 course, only people making a seven-figure annual income could have legitimately bought a house in SoCal by 2010. It had to stop, and the bigger the bubble, the more damaging the collapse will be. Note that the NASDAQ is still more than 50% off it's dot.com bubble high nine years later. Same analysis worked well there, as well. That bubble deflated more than 90% off its highs at one point.

The LA Times article sugar coated it a bit, but the point is valid...throwing sand bags in cannot stop this mess from playing out, but might mitigate the carnage. But from a macro view, I see no way out of a pretty terrific economic earthquake. And not 2 years from now. As Bill Paxton said while looking up at the sky in Twister, "it's not coming...it's already here!"

Bob

[hello-world]

bob

thanks for the post.

as i see it, you're saying that people will no longer have equity to borrow against, and lending standards have changed so others with iffy credit to begin with won't have any way of refinancing.

so more waves of housing depreciation to come.

and less capability for consumer spending, which largely will become impossible for a huge chunk of the population.

a bit of a 1929 economic scenario, or 2001 nasdaq scenario?

my ridiculously lay-understanding (that may very well be way too oversimplified or wrong) is that the 1930's had a bit to do with
- the climate/ag crisis in the midwest falling on top of the following;
- inflation due to money supply from the fed and lenders (through the 20s), but a devaluation of worth in the end as people stopped buying things and the fed neglected to prime the pump with an injection of cash (through the early 30s);
- consequential "underconsumption" (inequity of wealth resulted in too many have-nots unable to keep pace, and falling flat when credit ran out, e.g.) - wealth had concentrated under the free market - and under low tax rates for the rich - to something too unsustainable for the economy at large (MOST couldn't buy what the super rich had to sell them);
- some bank runs, while banks could no longer collect on debt from those that had nothing or were too overextended credit wise, and so failed themselves;
- late/inadequate federal action to stem it, and federal actions that angered other countries;
- (and some retaliatory international action against import tariffs, so reduced international trade);
- while some of this was towards inflating the value of gold around the world (diminishing the availability of the monetary backing, for example) and, especially for the UK - which was trying to roll back over to a gold standard - by importing more gold as a backing to credit and buying up the gold from within the US;
- and some of these factors were not mutually exclusive, and actually resulted in strong feedbacks.

i wonder how you see today, relatively.

and what might happen to banks as people can not or will not pay the bills today? do you see a similar scenario?

what might happen to hiring as people can no longer spend as much on goods and services (n o need to hire for production of what noone can afford), or as tax revenue diminishes (so less cash for government backed infrastructural work, e.g.)? can the fed "borrow" any more from other countries, or against other "backing", e.g.?

what might happen to the value of the dollar as more $ is pumped into the system to stave off the storm that's "already here", in your view?

how else might the american economy be buoyed against some of this?

it seems to me that some of globalization might act as a bit of a safety net rather than as a danger. for example, freer trade, and the undesirability of any large economy going down as it might have even more dire impacts globally now?

yes, good to keep the macro in sight!

[Bob from down south]

Originally Posted by hello-world

as i see it, you're saying that people will no longer have equity to nborrow against, and lending standards have changed so others with iffy credit to begin with won't have any way of refinancing.

That's already happening now.

Originally Posted by hello-world

so more waves of housing depreciation to come.

Yes, or one really big wave. More likely it'll ratchet down over the course of 3-5 years. Housing suffers from poor capital mobility, meaning capital can't move in/out/around the market quickly.

Originally Posted by hello-world

and less capability for consumer spending, which largely will become impossible for a huge chunk of the population.

I think the second-order effects on the job market will drive a downward spiral in consumer spending as this picks up steam.

Originally Posted by hello-world

and what might happen to banks as these people can not or will not pay the bills, any longer?

We'll get a hint at that in the next week or so as giants like Merrill and CitiGroup report for Q4/07. Rumors are $15 billion writedown for Merrill (to put it in perspective, that's over 30% of their current market cap), and possibly $24 billion for Citi. That's butt-ugly, and it's really only the beginning.

Originally Posted by hello-world

what might happen to hiring as people can no longer spend as much on goods and services, or as tax revenue diminishes?

I think that one answers itself...

Originally Posted by hello-world

what might happen to the value of the dollar as more $ is pumped into the system to stave off the storm that's "already here", in your view?

Hard to say, as the US doesn't have the only vote in currency exchange rates. But the Fed doesn't really pump $$ into the economy...it basically loans banks cash in exchange for securities the banks hold like treasuries. It "injects liquidity" by making sure the banks have cash on hand (but all of it backed up by bank-held securities). But there are finite limits to how much of that the Fed can do...their real power lies in the magic people think they can do, which isn't nearly as omniscient and omnipresent as lots of folks would like to believe.

Originally Posted by hello-world

how else might the american economy be buoyed against some of this?

I think half of the economics PhDs on the planet are trying to figure that one out right now.

I hope they find a way out of this, really I do. But I expect it's going to result in some rather large and unfair redistributions of wealth on a global scale, and not necessarily to the USA's benefit. And some of those redistributions, as Jazzlover points out, may indeed occur on a battlefield.

Bob

[hello-world]

Originally Posted by Bob from down south

I hope they find a way out of this, really I do. But I expect it's going to result in some rather large and unfair redistributions of wealth on a global scale, and not necessarily to the USA's benefit. And some of those redistributions, as Jazzlover points out, may indeed occur on a battlefield.

Bob

or be occurring? figuratively and literally?

what are the odds that oil prices and inflation are not being steered, in part, by some of the literal and figurative "battlefield" (or responses to it)?

and seemingly so about production and consumption... hm.

[Bob from down south]

Originally Posted by hello-world

a bit of a 1929 economic scenario, or 2001 nasdaq scenario?

my ridiculously lay-understanding (that may very well be way too oversimplified or wrong) is that the 1930's had a bit to do with
- the climate/ag crisis in the midwest falling on top of the following;
- inflation due to money supply from the fed and lenders (through the 20s), but a devaluation of worth in the end as people stopped buying things and the fed neglected to prime the pump with an injection of cash (through the early 30s);
- consequential "underconsumption" (inequity of wealth resulted in too many have-nots unable to keep pace, and falling flat when credit ran out, e.g.) - wealth had concentrated under the free market - and under low tax rates for the rich - to something too unsustainable for the economy at large (MOST couldn't buy what the super rich had to sell them);
- some bank runs, while banks could no longer collect on debt from those that had nothing or were too overextended credit wise, and so failed themselves;
- late/inadequate federal action to stem it, and federal actions that angered other countries;
- (and some retaliatory international action against import tariffs, so reduced international trade);
- while some of this was towards inflating the value of gold around the world (diminishing the availability of the monetary backing, for example) and, especially for the UK - which was trying to roll back over to a gold standard - by importing more gold as a backing to credit and buying up the gold from within the US;
- and some of these factors were not mutually exclusive, and actually resulted in strong feedbacks.

i wonder how you see today, relatively.

Well, there's probably a bit of both NASDAQ and 1929 in here, and some factors that haven't been seen before.

The NASDAQ scenario involved electronic exchange mechanisms and a lot of leveraging and shaky derivative action like those used to trade the CDOs/SIVs etc, and I think the rating services were pretty suspect in that collapse...The ratings services (S&P, Moodys, Fitch etc) were so completely asleep at the wheel for this one I don't think they will be trusted like they were for decades if ever again.

The 1929 scenario has a lot of parallels...the land speculation and "flipping" behavior was essentially the same manifestation of greed that we found on such wonderful entertainment venues as "Flip This House." The limited capital mobility, or "stickiness" of house price changes resulted in the mortgage collapse taking over 2 years in 1930-31, and the same prolonging effects are likely to be seen here.

Clearly, the masking of real risk in the securitization process is something new and ominous with this current crisis. Thousands of mortgages of unknown quality were packaged together and then layered into different groups of securities, and widespread fraud and corruption underlies many of those loans (stated-income "liar" loans, multiple artificial constructs designed to avoid PMI despite no mitigation of risk i.e. 80/10/10 loans, various artificial justifications for ignoring income ratios, etc). And hedging, through credit-default swaps and other derivatives, presents an illusion of security that is likely to fail, revealing the real magnitude of the losses here. Some of the hedges are magnificently undercapitalized because the real risk was hidden, and probably because the markets got carried away with second and third level derivatives that few understood.

What we won't see is massive bank runs, due to FDIC/FSLIC etc. But sooooo much private investment is sitting outside of the protection of the banking system it's not funny. If the average U.S. recession produces an average 30% peak-trough delta in stock equities, I have to wonder where the stock equity-invested 401Ks of most middle-aged Americans might end up if this really plays all the way through. We've already seen major financial stocks take 50% and larger hits in 2007...some of these are companies that until this train wreck never ever in decades of operation lost money. To see this much blue blood in the streets should be cause for concern.

OK, enough propheteering for the evening. I'm gonna go find a nice Belgian Ale and dream about moving to Colorado Springs.

Bob

[Mike from back east]

Originally Posted by Bob from down south

....OK, enough propheteering for the evening. I'm gonna go find a nice Belgian Ale and dream about moving to Colorado Springs. Bob

When you get here, we'll have a nice house waiting for you, at a nicely discounted price....

[hello-world]

Originally Posted by Bob from down south

The 1929 scenario has a lot of parallels...the land speculation and "flipping" behavior was essentially the same manifestation of greed that we found on such wonderful entertainment venues as "Flip This House." The limited capital mobility, or "stickiness" of house price changes resulted in the mortgage collapse taking over 2 years in 1930-31, and the same prolonging effects are likely to be seen here.

so, you're saying that the slow pace of home value appreciation (or depreciation) is resulting in a delay in the fallout as, for example, people "slowly" have to come to terms with the terms of their loans, or with the fact that they cannot refinance or borrow against their home equity any more?

Clearly, the masking of real risk in the securitization process is something new and ominous with this current crisis. Thousands of mortgages of unknown quality were packaged together and then layered into different groups of securities, and widespread fraud and corruption underlies many of those loans (stated-income "liar" loans, multiple artificial constructs designed to avoid PMI despite no mitigation of risk i.e. 80/10/10 loans, various artificial justifications for ignoring income ratios, etc). And hedging, through credit-default swaps and other derivatives, presents an illusion of security that is likely to fail, revealing the real magnitude of the losses here. Some of the hedges are magnificently undercapitalized because the real risk was hidden, and probably because the markets got carried away with second and third level derivatives that few understood.

i.e. more "shaky derivative action" as was the case you pointed to concerning the NASDAQ collapse, or in other words, in this case bad loans hidden in instruments banks and the rich exchange are going to take still more time, while still more big banks and firms wind up having to write down losses due to them?

What we won't see is massive bank runs, due to FDIC/FSLIC etc. But sooooo much private investment is sitting outside of the protection of the banking system it's not funny. If the average U.S. recession produces an average 30% peak-trough delta in stock equities, I have to wonder where the stock equity-invested 401Ks of most middle-aged Americans might end up if this really plays all the way through. We've already seen major financial stocks take 50% and larger hits in 2007...some of these are companies that until this train wreck never ever in decades of operation lost money. To see this much blue blood in the streets should be cause for concern.

yeah, i guess that some of those "shaky instruments" are rolled into some individual retirement investments that are evaporating with the values of some of the firms and banks people had in their retirement portfolios, as well as the repercussions through the rest of the stock market that reflect confidence (or lack thereof) or even real value that may fall? interesting point (if i got that right). and though i guess banks won't fold as they did around 1930 (though it almost seems like you're assuming that people understand what FDIC is and that they don't have to grab their cash out of worry of bad news from citibank or whatever), i guess having to write so much debt down comes out almost like a fold for people invested in them. and couldn't the backing of FDIC conceivably falter as well? i don't know, the finance world is not my world, so i ask here.

happy sipping. thanks for your insights.

as for Mike FBE, i love the icons! too funny.

[jazzlover]

Here's my take on a possible scenario:

The Fed will lower interest rates again and inject liquidity into the banking system to stave off a near-collapse in the real estate market. What they can do will be fairly limited without unleashing a wave of inflation. This is complicated by the fact that general commodity prices are already inflating, not because of the mortgage meltdown, but by growing scarcity of basic commodities, most notably oil. This inflation, along with the US trade imbalance, is already causing serious problems for the dollar. That, among other things raises the prices of all nature of imported goods, to which the US is now heavily addicted. If the fed "over-liquefies" the banking system, that will further the debasing of the the dollar, cause more inflation in oil prices and imports and unleash inflation as bad or worse as what was seen in the late 1970's.

High inflation will fuel an inflationary recession--that, in turn, will send tax receipts downward at the same time that entitlement payments are rising because of unemployment--ballooning the already bloated federal deficit. As a result, the government will have to borrow massive amounts of money to finance a ballooning debt. There will be a lot of bank failures, too, and the fed will have to make good on the FDIC insurance pledges to individual account holders (to the tune of up to $100K each), which will balloon federal spending some more. Whether the fed likes it or not, that will cause market interest rates to start rising. They already may be going up by then, because astute investors will have already realized that inflation will have eroded the real interest rate on money to 0% or below (3% "real" interest is considered the normal "risk-free" interest rate--that is, the nominal interest rate minus inflation). Gold will go crazy in price, as people look for an inflation hedge. Meanwhile, banks will essentially stop lending to anything other than the most credit-worthy and recession-proof customers--especially when financial institutions and investors who actually have cash can buy federal securities hemorrhaging from the fed to finance the burgeoning deficits. While all of this is happening, the further collapse of real estate prices, stock prices, and the ravaging of fixed income securities will lay waste to many pension funds, IRA's, 401K's and the like. For the average American, there will be no refuge. (This is where the retirement strategies of a lot of Baby Boomers may change suddenly.)

Just as happened in the early 1980's, only much more drastically, the fed will eventually have to raise interest rates and curtail federal spending in order to control inflation and restore order to credit markets and confidence in the dollar. The result will be a gut-wrenching recession/depression that will likely leave no one unscathed (if what already had transpired wasn't bad enough). Unlike the early 1980's, though, where all of the pain of expunging inflation also led to stabilization in energy costs, and the ascendancy of high-tech and a stronger economy (and, eventually, the fall of the Communist bloc), the nagging problem of America's dwindling domestic natural resources, mis-investment in automobile-centric suburbia, and exportation of its manufacturing base will remain a semi-permanent major drag on the American economy and American citizens for many years--possibly even decades--afterward.

If that all sounds bleak, it is, but not nearly as bleak as it could be if the whole economic destabilization that events trigger causes some country to decide to start World War III over it. Then all bets are off.

For Colorado, the only thing that will be going for it will be the energy industry and Colorado's poor stepchild agriculture industry, but that can't prop up the rest of the state's economy so heavily invested in real estate, construction, and high-end recreation. All of that is likely to be pretty much history. Even a lot of those precious federal government and military jobs on the Front Range will likely disappear as the government tries desperately to balance its spending against collapsing revenues.

A "doomsday" prophecy? Maybe. But I think we are tiptoeing very dangerously close to the brink. A couple of decades of "let the good times roll" with little thought to the future are about to end and the piper is going to have to paid.