Asset deflation has a long way to go, inflation or no.
Members of the Stockhouse macroeconomics group peppered their discussion with analyses of the bad-and-getting-worse U.S. housing market – with prognostications for England’s real estate sector also sounding grim – throughout the length of the week-long event.
Below are a few of the comments made by group members along the way.
Please add your comments at the bottom of the page, and enjoy!
[Editor’s note: Posts have been edited for punctuation, spelling, grammar and length.]
littleguy123: I see the U.S. economy as a house of cards in a wind-storm - with nothing protecting it/holding it up except for a thin veil of propaganda which surrounds it. How long can the house of cards resist the wind?
arnoldj: So where do we go from here. Continued asset deflation seems inevitable yet it seems a conspiracy of hope exists that somehow the deterioration of real estate is near a bottom. Terrific insight and analysis from blogs such as Calculated Risk or Nouriel Roubini's RGE monitor, Wall Street Examiner, Barry Ritholtz's Big Picture suggest far from it. In fact, typical valuation methods such as 3x median income would suggest a further 25% decline in many markets.
With bank-owned inventory of unsold homes from auctions skyrocketing (not included in inventory stats from the NAR by the way), it seems reasonable residential real estate values will continue to depreciate and the banks balance sheets will continue to erode. I find it foolhardy bottom-callers such as Dick Bovine claiming banks are a generational buy when we're no where near able to accurately value their balance sheets.
From my earlier post, with rates rising last week due to a flood of debt issuances, homes become even less affordable, and the downturn in residential real estate values quickens. My expectation is for rates, particularly longer term, to rise due to a mountain of treasury supply hitting the markets. The only uncertainty is the rapidity of their rise. Much of the past several posts have touched upon moral hazard issues and the abdication of accountability and propensity for deceit and fraud rather than implementation of tangible measures.
I expect to see a skyrocketing of examples further highlighting this theme over the coming months as we cannot expect those who were at the helm of the wreckage to take ownership and plead mea culpa when all their actions to date speak otherwise. I place this theme as an enveloping contextual backdrop to the ultimate problem for the banks: Asset deflation.
Rob prompted the discussion with the inflation topic. I would add asset deflation as another dominant theme. The U.S. is an asset-based economy, in fact a highly leveraged asset-based economy. It takes over $6 of debt to create $1 GDP. In this environment, asset deflation is simply not tolerated as debt becomes unsupportable and this is exactly what is unfolding as home values deteriorate. Consequences are born by holders of the debt. Straightforward.
This is the tale of the U.S. economy right now and the implications to the Federal fiscal deficit are enormous. And that's what we see, the deficit is exploding. State deficits are exploding as well. There's a mountain of evidence all showing this trend. This ties in to the other post I did. Government raises revenues from three sources: Tax collection, borrowing, and actual money creation. With tax collection deeply deteriorating, heavy lifting has come from borrowing abroad. If that fails, one is faced with two choices: Default on debt obligations or create your own money. This is the full circle, all starting with asset deflation as synthetic financial products, all tied to real estate values under the illusion that real estate always appreciates, explode on the books of the holders.
We've heard the acronyms, CDOs, CDS, RMBS and a dozen others. Fictitious capital is eroding and the forced unwinding is forcing the Fed to come to the rescue at a time when the Treasury department needs more funding than ever before. I cannot think of a worse inflection point for poor Ben. With the erosion of capital, banks are forced to restrict lending due to capital requirements. For a leveraged economy based on credit this is severely restricting to GDP and I think we clearly see this today.
Assets artificially inflated must revert to the fundamental supply levels. A new equilibrium needs to be established between supply and demand with price moving to that point, and it’s lower than where it is now, hence the holders of those products will see continued erosion of their balance sheets, continued pressure on earnings and capital requirements and continued deceit and deliberate attempts to hide their financial stress.
Banks falsifying their LIBOR reporting is a prime example of this. Outright lies.
(1) Continued asset inflation = (2) continued contraction of credit = (3) continued contraction of economy = (4) continued reduction in tax revenues = (5) worsening fiscal budgets = (6) continued dependency on borrowing funds (FCBs) - ties into my crowding-out comment of earlier post = (7) continued risk of debt default or impending need to print money with moral hazard issues weaved throughout the entire chain. Throw in peak oil debate and a helluva summer and fall await, but other than expecting to see a continuance of much of #1 thru #6 with plenty of cover-up and obfuscation by those guilty, I don't know what comes next, except that something has to give and I don't believe it will be beneficial for Joe taxpayer or the US dollar in the long run.
littleguy123: Through an Economist article, I discovered there is a housing database to compare the current meltdown with the collapse in U.S. real estate during the Great Depression. The numbers are nothing less than appalling. The current meltdown has already resulted in a year-over-year decline in values (in real dollars) more than twice as bad as any year in the Great Depression - and the U.S. housing sector is just beginning to get ugly. Commercial real estate has also just begun a melt-down of its own.
gabrielgray: BTW, there was a lot of good stuff in the Washington Post article linked earlier, but a lot of drivel, too. For example:
"Brokers and bank officers often didn't bother to tell borrowers that providing income and job verification would lower the loan's cost considerably. In fact, a majority of subprime customers -- 61 percent in 2006, by one count -- could have qualified for less expensive conventional loans."
That's because if the majority of subprime customers had provided honest income and job verification, they wouldn't have qualified for the loan. Mortgage lenders called them "liar's loans" because they found, on verification, that over 80% of applicants misrepresented their household income. By a big margin.
Everybody was guilty of collusion in that swindle - banks, brokers, appraisers and borrowers. Everybody.
The Post believes the mass of sheeple are just innocent children hoodwinked by the big bad con men. Everybody was in on the con, including the sheeple.
And this: “‘Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it sometime,’ Greenspan said recently. He has a point.”
No, he doesn't. The point is that holding the target rate at 1% all those months was what created the bubble in the first place. It should never have happened. And no one said he had to raise rates incrementally - Paul Volcker drove the prime rate from 6% to 16% - in five months. I watched him do it. And of course, it caused a recession, but that was an unfortunate necessity. The beast had to be slain.
If Greenspan had been willing to, he could have directed Open Market ops to drive the funds rate to 6% and killed the bubble in its tracks overnight. But he couldn't face the howls of dismay from his buddies in Wall Street or in government. He was a pleaser, and he gets a pleaser's reward.
There's more, but I have to go eat my filet mignon.
frontline_jason: Forget about buying a home in London... I wrote a report on U.K. real estate back in January and sure enough, it's going down the toilet. The RICS survey keeps getting worse on all fronts (record low home price expectations, elevated sales-to-stock ratios), mortgage lending is collapsing (-40% YoY), and the finance community in London is shrinking by the day. The problem in the U.K. housing market could be even worse than in the U.S. due to ridiculous valuations (all of my readings suggested a 40% overvaluation). Couple that with heavily leverage for first-time buyers (7x income in London and 90% LTV) and you have the perfect recipe for disaster.
Property in Germany on the other hand...
In the U.K., there is no actual figure available for the actual size of housing inventory (checked CML, BoE, and others), but in my report I made a proxy for it by multiplying the RICS inventory of houses per agent by real estate employment. The result is interesting as it shows a doubling in supply since the pause in the housing market in '99, and is currently at a high for the current expansion (it is notable that before the big bust in housing in '90/'91 my housing inventory was higher).
In Canada I'm just surfing the CMHC website, which has some neat charts... They keep tabs on inventories of homes, although I have yet to find the right link to access the raw data (I think a paid subscription is required). It should come as no surprise that home price appreciation has moderated in most parts of the country while it continues to skyrocket in the Prairies. Construction seems to have shifted from Calgary and Edmonton to the rest of the West, which should keep prices well-supported there. I'm just waiting for the day when Montreal gets to be part of the bubble and I can sell my 3-bedroom townhouse in suburbia for $700k.
gabrielgray: The curtain is being pulled back on this. Just as multiple parties took out credit-default swaps on the same CDOs (like 50 people taking out life insurance policies on Evil Knieval), it turned out that multiple banks ended up owning the same mortgages, but none with full rights of possession.
So when Deutsche Bank went to foreclose on the Jeffersons in Toledo, the judge said, “Show me the mortgage.”
“Huh?” said DB. “The mortgage,” said the judge. “You can't foreclose unless you're the mortgage holder.”
“Well....we hold the mortgages indirectly because we're the owner of the mortgage bond,” said DB.
“I don't understand that crap,” said the judge. “Just show the mortgage contract, or get out of here.”
DB's lawyers retired in confusion. The fun is just beginning.
This group discussion was conducted with members of the Stockhouse community.
Next: Members tackle the question of currency valuations in the wake of the US dollar’s continued decline.
Archive
Investor groups launch with macroeconomics discussion
Inflation and money supply, part I: Treasuries crowd bonds
Inflation and money supply, part II: Buyer’s remorse
Inflation and money supply, part III: Indeflationists unite
Inflation and money supply, part IV: Measuring money
Inflation and money supply, part V: Derivative “Death Star”
Oil supply, oil demand: Is oil in a bubble?
Spin-offs
Inflation debate stirs investors
Oil speculation theory taken to the woodshed
Oil prices: A critique
