Posts filed under “Credit”
One of the things I have consistently pointed out was that the so-called Housing Bubble was in reality two bubbles: Credit and Interest Rate.
We can define a bubble as a “trade in high volumes at prices that are considerably at variance from intrinsic values." By that definition, I’m not so sure Housing was a true bubble — the run up in prices, a doubling over the course of about 7 years, was actually a rational market response to interest rates being dropped to generational (46 year) lows. Trading volumes moved up, but proportionately so. Compare that with the Nasdaq, which doubled from October 1999 to March 2000 on a dynamic of a new paradigm. Trading volumes skyrocketed. When it was over, the Nazz had plummeted 78%.
House prices normally fluctuate in response to interest rate changes due t how they are financed. An example I used a few years ago: The first house I owned had a $300,000 mortgage. Back when interest rates were over 9%, the monthly payment would equal $2,632.71 (30 year fixed 10% mortgage). When mortgage rates plummeted, a buyer could finance a $500,000 purchase with a 6% fixed mortgage for a monthly payment of $2,997.75.
That example has the home price appreciating ~67%, but the monthly mortgage payments up only 14% (Source: Don’t Buy Housing Bubble Propaganda, 5/26/2005).
But this only explains some of the pricing run up from 2001-04. It does not explain the next phase of price increases. To do that, we have to understand how everyone in the lending community got so drunk on securitization they simply abandoned their traditional risk metrics and repayment concerns.
This drop in lending standards and absurdly easy credit is where things truly went awry: Despite the incredibly accommodative interest rates, lenders simply stopped being concerned about the borrowers’ ability to repay loans. My favorite example: California strawberry picker Alberto
Ramirez, who despite earning just $14,000 a year, was able to obtain a mortgage to buy a home for $720,000.
The assumption appeared to be that lenders could simply sell the mortgages to Wall Street to be securitized, without worries about delinquencies, defaults and foreclosures.
Since that abandonement of nearly all lending criteria, 173 major U.S. lending operations have "imploded."
You can see the decrease in lending standards over time: With each subsequent year of mortgage issuance, more and more homes began defaulting earlier in their ownership/repayment cycle. Have a look at the nearby chart — it shows the delinquencies in the non-sub-prime loans. These were supposed to be higher quality loans. Apparently, these loans also succumbed to a lack of traditional lending metrics.
The results speak volumes to where the bubble was.
Indeed, the destruction of mortgage lenders and capital is much more akin to the result of a bubble popping than the relatively mild decrease in Housing Prices so far. Credit was where the speculative mania was, and that is where the pain is being felt most acutely today.
We can also look at the Home Builders’ stocks as a speculative bubble; their share prices are now down nearly as much from their 2005 peaks as the Nasdaq was from 2000-02. They will not "bottom" until they clear out excess inventory, and see improvements in their cancellation rates.
Strangely, Houses themselves are more of an extended asset class than a true bubble. As we noted back in 2005:
are bubbles in debt, credit and interest rates. There is the oil
bubble, the import bubble, the China bubble and the current account
deficit bubble. In short, we have a veritable bubble in bubbles.
Indeed, it is astonishing how many people who failed to either
acknowledge the tech bubble in the 90s — or at least failed to act on
it — now have no hesitation to declare real estate to be a bubble.
This despite their lack of expertise or past track record in spotting
bubbles on a timely fashion.
The bubble du jour though is the
housing bubble. From Greenspan’s testimony to CNBC’s Housing special to
(uh-oh) this month’s Fortune magazine cover, it seems to be all anyone
wants to talk about.
My position is that housing is not in a
bubble — yet. But it is an increasingly extended asset class that may
be subject to a significant correction in the future. But a 25%-35%
retracement is a very different situation than a bubble (recall that
the Nasdaq dropped 80%), primarily because there are very different
consequences for both homeowners and investors."
That thesis has been borne out by subsequent events.
How is this likely to play out over the next few years?
The well regarded Jeremy Grantham — the "G" in GMO — points out in his quarterly letter to
that home prices are trading several standard deviations
above their "fair value." Grantham notes that the 2000 tech bubble
was statistically a 3-standard deviation, 100-year event. As his nearby
chart shows, House prices are also at 3 standard deviations from their
intrinsic values. In order to return to more appropriate levels,
prices need to drop 25% — or just stay flat for 5 years.
Why "only" a 25% correction, versus the nearly 80% whackage of technology stocks?
The main difference is intrinsic value. Outside of Love Canal or Detroit, house prices simply do not go to zero. You can always live in or rent out a house. Compare that with certain internet stocks whose only asset was a sock puppet.
Some people have complained that I am splitting hairs in distinguishing between home prices versus rates and credit as where the bubble lies.
But this is a distinction with a significant difference. A 25% correction in home prices would ultimately be tremendously Bullish for home builders, for lenders, and for the overall economy. As we have seen, price decreases generate real buying interest. It clears out the huge amounts of excess inventory (i.e., overhead supply). And it would kick off a virtuous cycle of economic activity . . .
GMO, October 2007
Median Price Chart Source:
National Association of Realtors, U.S. Census Bureau, GMO
Don’t Buy Housing Bubble Propaganda
RealMoney.com, 5/26/2005 2:04 PM EDT http://www.thestreet.com/p/rmoney/barryritholtz/10225437.html
Minorities Hit Hard by Foreclosure Crunch
May 3, 2007
Fascinating front page WSJ article today, titled More Debtors Use Bankruptcy To Keep Homes. It seems that Chapter 13 filings are gaining in popularity. Why? Because they halt foreclosure proceedings: “Last month, as the nation’s housing slump continued, consumer bankruptcy filings increased almost 23% from a year earlier – representing nearly 69,000 people — according…Read More
Yesterday, Traders embraced the release of the FOMC minutes. Indices were flat up until just before the 2:00pm release, and then took off, with the Dow gaining near 1%.
The thinking behind the Fed action was clearly revealed in that release. The emphasis was on the subsequent impact of credit on the entire system. The WSJ reported:
"Federal Reserve officials worried that credit-market
turmoil could reinforce slower growth at a time of "particularly high
uncertainty," leading to their half-point interest-rate cut last month,
minutes from the meeting show.
Without a cut, there was concern that "tightening
credit conditions and an intensifying housing correction would lead to
significant broader weakness in output and employment," the
rate-setting Federal Open Market Committee said. The minutes, released
yesterday, also showed members worried that market turmoil "might
persist for some time or possibly worsen."
They offered no clues about
the direction or timing of the Fed’s next move."
That last sentence is quite intriguing. Understanding whether or not a rate cut is forthcoming impacts yields, stocks prices, etc.
Given the significance of the Fed’s action, one would suppose that the markets which trade the Fed Futures would be, if not prescient, than at least telling about their future price action. One of the more fascinating aspects about this, however, has been the way the Fed Fund Futures have functioned over this time. They have been wildly wrong, forecasting an imminent rate cut since January 2006. I thought it might be instructive to look at why this maybe so, and what it might mean . . .
Yesterday, we discussed the potential impact of the ongoing weakening of the US dollar.
Today, we look at a few
printing press Money Supply issues. Our focus: The spread between the Fed liquidity action (a/k/a Repos) and the M2 money supply measures.
This is simply a measure of how much cash the Fed is injecting into the system.
The following Bloomberg chart shows the spread between the two of these monetary measures. It is quite instructive:
Speaking of surges: As you can clearly see above (bottom left chart), the amount of MZM (repos) versus M2 during 2007 is enormous.
This means that the Fed is "inflating" at a rate faster today than it did right after 9/11, or during the deflationary scare of 2003.
As we asked Wednesday night, "What did the Fed Chair and the FOMC see that spooked them into a half point (over) reaction?" I am not sure what is was (and we’ve discussed many of the potential issues over the past 2 years), but the Fed is obviously scared witless.
Why? One way to think about it is supply and demand. Print ALOT more dollars and each one is worth a little less.
Or, consider it this way: Extracting Oil or Gold from the earth ain’t easy: We have to explore for Oil, determine where it is, how deep, what quality, etc. Then we have to use lots of heavy machinery to extract it, ship it to where it gets processed, refined, used in chemical manufacturing. Some of it gets refined into gasoline, and it is then transported to a network of gasoline stations, and it gets pumped into your car — all for less per gallon than diet Coke or peach Snapple!
For gold, the process is not all that dissimilar.
Just crank up the printing press: Its cheap and easy. But why should us gold and oil producers exchange our hard won commodities (its hard work) for pieces of paper you people are simply cranking out for free? Either give us something of real value — or instead, we will insist on more of your crappy ittle pieces of green paper.
Thus, the inflationary repercussions of a "free money" policy. In fact, every commodity that is priced in dollars can potentially see much higher prices: Gold, Oil, Wheat, Soybeans, Copper, Timber, Corn, etc.
Its easy to understand why inflation has been called The Cruelest Tax.
BTW, for those of you without a pricey Bloomberg terminal on their desks, a good source for (free) data of this kind is the Federal Reserve Bank of St. Louis’ publication, Monetary Trends. There are always a solid collection of charts showing money supply, economic conditions, etc. Not to get too wonky on you, but this is simply pornography for econ geeks.
There are a few charts after the jump worth reviewing. For the less visual of you, they show that Money Supply continues to grow at a rapid pace, that bank borrowings are increasing.
Federal Reserve Bank of St. Louis’
Where Crude Goes Now May Depend on Dollar
Futures Close Near $82
WSJ, September 20, 2007; Page C1
Inflation Fears Send Gold to 27-Year High
Weakening Dollar Also an Influence; Metal Hits $732.40
WSJ, September 21, 2007; Page C6