Real Estate Market / Inflation / Recession / Depression (Denver: mortgage, environment, credit)

[hello-world]

thanks for that, jazzlover.

is oil truly becoming scarce? or is it more a matter of dollar value relative to the world's "valuation" of oil, where a region that is not totally happy with the western world is nudging prices?

do i have it right by interpreting your comment on federal spending -> higher interest rates as the fed will have to raise interest rates to make up for federal debt (i.e., to help pay down that debt)?

how do astute investors impact the market interest rates with the realization that inflation has eroded any "gains" on their money (as "market interest rates" are shaped by federal funds interest rates rather than investment activity, aren't they?)? would you say this could occur via people pulling money out of the banking system and putting it elsewhere, thus reducing the number of dollars in banks, and so raising the risk for banks of hitting a wall, so interest rates would have to raise to hedge that risk? or something like that?

i guess federal spending puts more money into the system, making it easier for folks to purchase (a bit like credit does) so drives inflation, in your view?

are you thinking that the fall of the Communist bloc opened markets to drive trade, thus bolstering the economy?

and how does investment in automobile centered suburbia impact the economy? are you thinking of the "need" for petroleum which is growing more expensive for americans is an issue, by that line of thinking?

do you know of any security in debt owed to the US? though, i suppose the debt owed BY the US outstrips that substantially, and the debt owed might be insecure (by developing countries that might have some difficulties of their own, e.g.). just wondering what the international safety net might be.

finance is not one of my areas, so, thanks for the education...

[MySkreenName01]

I really like reading all of your posts. Colorado seems great. My husband visited last summer, because we were thinking of moving there. Still are. Reading these posts just make me want to move there more.

[Bob from down south]

Originally Posted by 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.

Realistically, the Fed has limited control over interest rates. They control the federal funds "target" rate...basically they add or remove cash (by swapping for collateral) to the banking system to modulate overnight interbank lending rates. But if the need for overnight dollars rises or falls too strongly for the Fed to defend the rate within its limited window of control via the target rate, it essentially recognizes that it's been trumped by market forces and capitulates with a rate change. The Fed is, albeit to a lesser degree, a passenger on the same train along with the rest of us. The Fed cannot save the day if the wave is big enough.

Normally, banks borrow and loan each other money fairly freely to redistribute cash around the banking system. But we have something really troubling going on now...banks have suddenly become very wary of loaning each other cash on an overnight basis. Lowering the target rate wasn't enough...the Fed had to set up these quasi-anonymous market auctions so that banks could sneak over to the Fed and borrow cash without letting on to their peers. What does it mean when our banks can no long trust each other? My belief is that is a telling indicator that those closest to the problem see real troubles--big enough to cause defaults in the banking system itself.

Liquidity injections will not fix the real estate problem. Banks have cash to lend, but they are suddenly very choosy on who to lend it to. They no longer have the option of making any old loan, rolling it together with a bunch of others, and then selling it to the next greater fool on the now-dead secondary market in the form of a CDO. They have to keep it on their books, and deal with any defaults that might arise. So long-term mortgage rates (which are largely unaffected by swings in the overnight funds rate) are falling as loan qualification barriers throttle demand for the the money already available for mortgages. Finding a buyer isn't the only problem in the real estate market. Finding a qualified buyer that can swing a loan is the challenge of the day. A couple of my realtor buds are telling me that in the last six months their agencies are losing between a quarter and a third of their sales contracts due to inability of the buyer to find financing--and there haven't been that many offers to begin with. Some banks are even backing out on prequalified buyers as standards tighten up.

At some point the Fed is going to realize that they can't fix housing with monetary policy--that it isn't interest rates that are holding the market underwater (it's unsustainable high prices)--and they're going to have to deal with inflation. That means rate increases, which will put further pressure on employment and production in the general economy, and will eventually raise mortgage rates, accelerating RE price declines.

Originally Posted by jazzlover

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.

What he said. And I think it's going to be a major drag on the world economy as well.

Originally Posted by jazzlover

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.

Any student of history should be worried about this one. Desperation breeds destruction.

Bob

[jazzlover]

Originally Posted by hello-world

thanks for that, jazzlover.

is oil truly becoming scarce? or is it more a matter of dollar value relative to the world's "valuation" of oil, where a region that is not totally happy with the western world is nudging prices?

do i have it right by interpreting your comment on federal spending -> higher interest rates as the fed will have to raise interest rates to make up for federal debt (i.e., to help pay down that debt)?

how do astute investors impact the market interest rates with the realization that inflation has eroded any "gains" on their money (as "market interest rates" are shaped by federal funds interest rates rather than investment activity, aren't they?)? would you say this could occur via people pulling money out of the banking system and putting it elsewhere, thus reducing the number of dollars in banks, and so raising the risk for banks of hitting a wall, so interest rates would have to raise to hedge that risk? or something like that?

i guess federal spending puts more money into the system, making it easier for folks to purchase (a bit like credit does) so drives inflation, in your view?

are you thinking that the fall of the Communist bloc opened markets to drive trade, thus bolstering the economy?

and how does investment in automobile centered suburbia impact the economy? are you thinking of the "need" for petroleum which is growing more expensive for americans is an issue, by that line of thinking?

do you know of any security in debt owed to the US? though, i suppose the debt owed BY the US outstrips that substantially, and the debt owed might be insecure (by developing countries that might have some difficulties of their own, e.g.). just wondering what the international safety net might be.

finance is not one of my areas, so, thanks for the education...

I spent years in college studying all of this stuff, so writing a one-paragraph answer is impossible. The inflation/interest rate behavior is pretty easy, though. Imagine you own an interest bearing security paying 5% interest right now. The interest being paid to you is your payment foregoing the use of that money yourself (giving up liquidity) and for the risk you bear to let someone else use it--the more risk you take of not getting it back--the more interest you should charge. The "risk-free" rate charged--where the lender sees little if any risk in not being repaid--has historically been about 3%. So, if inflation is zero, 5% is a pretty good return on a low risk investment.

Now, imagine, inflation is 3%. 5%-3% = a 2% "real" return on the money you have lent--that is less than the "risk-free" return. If inflation exceeds 5%, the money you have lent is actually losing value. (By the way, I'm not even counting the fact here that you are probably paying income tax on that interest.)

So, if inflation goes to 5%, or whatever, eventually astute investors will demand an interest rate that covers the "inflation-risk" of their investment. With inflation at 5%, it might look like 3% risk-free return + 5% inflation risk premium = 8% interest. That is exactly what happened when inflation went crazy in the late 1970's and early 1980's. Interest rates went to double-digits. If the federal government is having to borrow scads of money to finance the national debt, increasing interest rates will make the feds interest costs skyrocket. That is why the Fed tightened credit in the early 1980's--bringing on a recession--because they knew if inflation was not controlled, eventually interest payments on the national debt would eventually take up nearly all of the federal budget.

Bob-from-down-south is right. The fed has very little wiggle room here, and is quickly running out of tools in the tool box to manage what lies ahead.

As to the oil situation, I posted a link earlier to a presentation by Matthew Simmons, a leading investment banker to the oil industry, about the coming problems of oil depletion worldwide ("peak oil"). That is one sobering presentation and I think his research and conclusions are pretty irrefutable. I will repost the link here: http://www.simmonsco-intl.com/files/...%20Conf-BW.pdf

[Bob from down south]

I heard it said somewhere else that in the next few years, return of investment is going to be more important to many people that return on investment.

The whole concept of risk is something new to those who have not seen a powerful downturn in the economy. The recessions of 1991 and 2001, and maybe even the twin recessions of 1980-81 are what I believe most think of when the subject comes up on MSNBC. I am thinking more in terms of 1973, or even 1933. Pain on a whole different scale. When you look at the sheer magnitude of the losses that have been piling up on the cutting room floor, it's hard to see otherwise.

Bob

[jazzlover]

Originally Posted by Bob from down south

I heard it said somewhere else that in the next few years, return of investment is going to be more important to many people that return on investment.

The whole concept of risk is something new to those who have not seen a powerful downturn in the economy. The recessions of 1991 and 2001, and maybe even the twin recessions of 1980-81 are what I believe most think of when the subject comes up on MSNBC. I am thinking more in terms of 1973, or even 1933. Pain on a whole different scale. When you look at the sheer magnitude of the losses that have been piling up on the cutting room floor, it's hard to see otherwise.

Bob

Looking at the Dow Jones Industrial Average (at 12,749 a few minutes ago), prior to the 1929 crash, it peaked at 381.17 in the mid-1920's. During the Depression, it dropped as low as 41.22. That was an 89.2% drop! If today's DJIA dropped by the same percentage today, the DJIA would be 1,378.69. That's only 11,370 points! If a home valued at $300,000 dropped by the same percentage, it would be worth $32,442.

How far does the bubble have to deflate? Probably not as far as in the Great Depression, but if it even went half that far, the US--and most of its citizens--would be would lying on the ground twitching with financial death rattles.

Both of my parents became adults near the beginning of the Great Depression. I was just talking to my elderly Mom about it. Pretty darned interesting survival stories--and survival, not much more, was exactly what it was about.

[hello-world]

Originally Posted by jazzlover

I spent years in college studying all of this stuff, so writing a one-paragraph answer is impossible. The inflation/interest rate behavior is pretty easy, though. Imagine you own an interest bearing security paying 5% interest right now. The interest being paid to you is your payment foregoing the use of that money yourself (giving up liquidity) and for the risk you bear to let someone else use it--the more risk you take of not getting it back--the more interest you should charge. The "risk-free" rate charged--where the lender sees little if any risk in not being repaid--has historically been about 3%. So, if inflation is zero, 5% is a pretty good return on a low risk investment.

Now, imagine, inflation is 3%. 5%-3% = a 2% "real" return on the money you have lent--that is less than the "risk-free" return. If inflation exceeds 5%, the money you have lent is actually losing value. (By the way, I'm not even counting the fact here that you are probably paying income tax on that interest.)

So, if inflation goes to 5%, or whatever, eventually astute investors will demand an interest rate that covers the "inflation-risk" of their investment. With inflation at 5%, it might look like 3% risk-free return + 5% inflation risk premium = 8% interest. That is exactly what happened when inflation went crazy in the late 1970's and early 1980's. Interest rates went to double-digits. If the federal government is having to borrow scads of money to finance the national debt, increasing interest rates will make the feds interest costs skyrocket. That is why the Fed tightened credit in the early 1980's--bringing on a recession--because they knew if inflation was not controlled, eventually interest payments on the national debt would eventually take up nearly all of the federal budget.

Bob-from-down-south is right. The fed has very little wiggle room here, and is quickly running out of tools in the tool box to manage what lies ahead.

As to the oil situation, I posted a link earlier to a presentation by Matthew Simmons, a leading investment banker to the oil industry, about the coming problems of oil depletion worldwide ("peak oil"). That is one sobering presentation and I think his research and conclusions are pretty irrefutable. I will repost the link here: http://www.simmonsco-intl.com/files/...%20Conf-BW.pdf

thanks. yeah, i at least understand inflation/risk/interest rates and the fed's balance of inflation against depletion of "money supply", so tuning of interest rates to steer the availability and desirability of "money" (or what it can buy with borrowing). return on money (or investments) relative to inflation (so a 2 or 3% return on a home, e.g., is basically a loss). not exactly an economist, though! i was just curious about clarification about some of your more specific points. e.g., how do individual investors impact market interest rates? my imagination is that the flow of cash (securities) has an impact on banks' "risk" (not much buffer against it if the $'s gone, e.g.). or, movement of investments can directly impact inflation with "supply and demand" changes. thanks for the insights.

and i can definitely see how "oil" might tie into the resource draw down of suburban growth, e.g., and so the demand for a waning resource driving that resource's price up, thus making much of everything pricier (as much of everything is transported with petroleum fuel, made with petroleum (plastics, e.g.), etc.. but wasn't sure if that was your point. thanks for that link.

the survival part of a significant downturn is pretty scary for most of us, for sure!

[sterlinggirl]

Originally Posted by jazzlover

If a home valued at $300,000 dropped by the same percentage, it would be worth $32,442.

The fed doesn't have the guts to let property prices drop as far as they need to go. I'm guessing they'll keep pushing to keep those prices inflated by debasing the dollar.

Try to look at the bright side....when it takes a wheelbarrow full of dollars to buy a loaf of bread, paying off the trillions that we owe China won't seem so bad

[Bob from down south]

Originally Posted by sterlinggirl

The fed doesn't have the guts to let property prices drop as far as they need to go. I'm guessing they'll keep pushing to keep those prices inflated by debasing the dollar.

My belief is that the Fed doesn't have the ability to stop the inevitable asset deflation. It isn't so much that they're out of guts (they are), as it is that they're out of Schlitz. Japan took interest rates to zero percent almost a decade ago and is still caught in the jaws of its deflationary horror story.

Originally Posted by sterlinggirl

Try to look at the bright side....when it takes a wheelbarrow full of dollars to buy a loaf of bread, paying off the trillions that we owe China won't seem so bad

But then we'll end up paying a quadrillion dollars for Chinese wheelbarrows to take to the store...

Bob

[hello-world]

Originally Posted by Bob from down south

My belief is that the Fed doesn't have the ability to stop the inevitable asset deflation. It isn't so much that they're out of guts (they are), as it is that they're out of Schlitz. Japan took interest rates to zero percent almost a decade ago and is still caught in the jaws of its deflationary horror story.



But then we'll end up paying a quadrillion dollars for Chinese wheelbarrows to take to the store...

Bob

or for the money-printing press with parts "made in China" to fill the barrows.