21 replies to this topic

[OEXCHAOS]

I posted this on a thread that aged off the front page, so I thought I'd offer it out there for those who might have missed it. The thread was all about how those with subprimes were almost assured of going teats up on these loans shortly. Here's my response: Yanno, I always worry about a confident call by a lot of folks. Let me play D.A. here for a mo. I'm confident that a lot of inappropriate mortgages were sold to people who didn't understand them. I know that many of these "variable rates" were really nasty teaser rates that folks didn't understand. OK, fine. But... What if a lot of these loans are also in the hands of folks who could afford that rate and could afford to pay their debts in a timely fashion for 3 years. Let's say that their credit scores go up from the high 5's to the high 6's over that time. Also, let's assume that someone at the fed realizes that we might be in more trouble than they thought. The long bond suggests that. What if the Fed starts cutting again or what if the long bond runs up higher than anyone thought because big money is worried about a massive recession? Suddenly, there are some low 30 year rates for some of these folks to roll into. And, maybe, just maybe, those who can't, reset only a tad higher. And, as for a 10% rate? Well, if it's fixed and one can make the payment, then one can make the payment. Most wouldn't take it if they didn't think they could make it. I'd say it's less than assured that these folks are all going to walk on those loans. In fact, I'll bet that most don't and quite possibly many convert them into much more affordable loans. Assuming the Fed doesn't dawdle too long. I'm not saying that we don't have a problem here that's not over. It is going to get worse. BUT, there are a lot of things are GOING to happen if and as it gets worse and those things have bullish implications. Think like an economist. Cripes, I said that LAST summer as we were making the June or July lows! Mark

[selecto]

As there is no saving, to the extent that resets increase payments, consumer spending declines, whereas abandonments arguably have an opposite effect as rents are dropping. I muse that this sub prime business started as an attempt to socially engineer everybody and their darn brother into home ownership. It was the American dream, but nobody set out the shark nets.

[OEXCHAOS]

As there is no saving, to the extent that resets increase payments, consumer spending declines, whereas abandonments arguably have an opposite effect as rents are dropping.

I muse that this sub prime business started as an attempt to socially engineer everybody and their darn brother into home ownership.
It was the American dream, but nobody set out the shark nets.

I strongly agree, Mike.

I wonder, too, if there won't be legislation to provide some sort of relief to some of the folks who were mislead. That might makes for a more orderly correction, too, in addition to getting a bunch of pandering politicians re-elected...

Mark

[zedor]

Mark Usually you are quite astute in your comments but I find this too be dream land wishful thinking. 1. Since the market rela estate market is down to at best flat, and credit standards are going up the refi option is closed since the appraisal wont match the requirements that tougher standards are requiring for equity that will be refied. 2. You assume those that bought the house with credit scores in the high 5s would have led an examplary credit life. Reality is most folks understimate the true cost of owing a home vs rental. (porperty taxes, repairs, more utilities, insurance, lawn care etc) thus not only do they start off with a larger place then they should they have unplaned for recurring expenses. Then after being house poor for a year they start buying things for this house on credit. These people will then most likely have also missed or been late on a few credit card payments and thus seen 5 and 6 % cards get yanked to 19% taking away a few extra hundred dollars a month from available money plus lowering, not raising their credit score. So what you write sounds nice but not the way the real world works in my experience of what I see others doing.

Edited by zedor, 05 August 2007 - 12:08 PM.

[libertas]

Think like an economist.


Mark

OK.

So let's do a little "supply and demand".

1. There is a very large inventory of properties listed for sale, both new and used, in the housing market. Many of these are vacant, up to half by some estimates. That means that there are fewer "butts" than "seats". Inventory is increasing.

2. Builders are up to their armpits in land inventory and are still building like crazy in order to dump the land, adding to said inventory problem. See the decent (for the WSJ) article in Saturday's WSJ concerning this problem.

That leads me to believe that the market clearing price for property is much lower than where we are, and that builders are going to have to essentially stop building for about two years to clear the unsold inventory from where we are today. Or operate at much reduced levels for a much longer period. This in itself is a major financial problem.

The so-called "subprime" problem is a decoy. If it were just subprime, it would be a serious issue, but survivable by a reasonable amount of re-negotation and so forth. And so if you describe it as a "subprime" problem, or even a housing or property problem, you diminish the problem.

It is a credit bubble, of which housing is the most recent symptom. Central banks, notably the BoJ and the US Fed, have flooded the world with cheap money and allowed an unregulated and undercapitalized credit industry to come into existence, bypassing the traditional banking system. In response to the banking industry's complaints that it couldn't compete with the unregulated lenders, the Fed the de-regulated the banks and removed their reserve requirements so that the whole system became effectively unrestrained.

Any monetary site will show M3 or its analogs growing rapidly, far faster than the central bank's balance sheet or M1. This is a credit system gone off the rails, where debt generates money and money generates debt in a violent positive feedback loop. This works, and everything looks fine, until the debt grows so large that it can't be serviced anymore.

Of course, this shows up first with the most marginal borrowers - your subprime folks, but it is really a systematic problem because the credit market operates, like any market, at the margin. But that is enough to reverse the feedback loop, because as soon as defaults start at any significant level, they start to destroy liquidity instead of create it. It is essentially the same mechanism as a Ponzi scheme (except there is no guiding individual beneficiary like poor old Chuck).

The Fed and the BoJ kicked off and abetted the creation of the credit bubble, but they are not in control. It is an autonomous process that will operate as it will. I think it is unlikely that any rate effect by the Fed will restore confidence to the extent needed for the bubble to continue inflating. I think many participants knew it was a Ponzi and were counting on getting out ahead of everyone else. We will see which are actually successful.

[OEXCHAOS]

Let's DO be realistic. Are massive defaults inflationary or deflationary? Do rates go up in a deflationary environment or down? I'm just saying that there will be countervailing forces--there always are. They will be Bullish. That's just simple economic fact--it's not open to legitimate debate. Now, will those forces be Bullish enough? That's the $64000 question. They might not be. But they shouldn't be dismissed. Just remember, there's always "another hand" when you're talking about an economy, particularly a dynamic one like ours. Here are some clues. You detectives theorize what they might mean. Fact one: Fed Chair has talked like an inflation hawk for months and months now, and acted like one too. Fact two: The RE slowdown has been well advertised for nearly 2 years now. Fact three: The sub-prime problem has been well understood by bankers and the Fed for some time now. Fact four: There has been an explosion of short and leveraged ETF's coming to market and becoming established over the past two years. Fact five: The Uptick rule has been eliminated--a huge change to the dynamics of our stock market with little or no public debate. Fact six: The stock market has entered a sharp and dramatic correction. How might all these facts relate to each other? If you're not going to think like an economist, think like a criminal. Mark

[JAP]

Think like an economist.


Mark

OK.

So let's do a little "supply and demand".

1. There is a very large inventory of properties listed for sale, both new and used, in the housing market. Many of these are vacant, up to half by some estimates. That means that there are fewer "butts" than "seats". Inventory is increasing.

2. Builders are up to their armpits in land inventory and are still building like crazy in order to dump the land, adding to said inventory problem. See the decent (for the WSJ) article in Saturday's WSJ concerning this problem.

That leads me to believe that the market clearing price for property is much lower than where we are, and that builders are going to have to essentially stop building for about two years to clear the unsold inventory from where we are today. Or operate at much reduced levels for a much longer period. This in itself is a major financial problem.

The so-called "subprime" problem is a decoy. If it were just subprime, it would be a serious issue, but survivable by a reasonable amount of re-negotation and so forth. And so if you describe it as a "subprime" problem, or even a housing or property problem, you diminish the problem.

It is a credit bubble, of which housing is the most recent symptom. Central banks, notably the BoJ and the US Fed, have flooded the world with cheap money and allowed an unregulated and undercapitalized credit industry to come into existence, bypassing the traditional banking system. In response to the banking industry's complaints that it couldn't compete with the unregulated lenders, the Fed the de-regulated the banks and removed their reserve requirements so that the whole system became effectively unrestrained.

Any monetary site will show M3 or its analogs growing rapidly, far faster than the central bank's balance sheet or M1. This is a credit system gone off the rails, where debt generates money and money generates debt in a violent positive feedback loop. This works, and everything looks fine, until the debt grows so large that it can't be serviced anymore.

Of course, this shows up first with the most marginal borrowers - your subprime folks, but it is really a systematic problem because the credit market operates, like any market, at the margin. But that is enough to reverse the feedback loop, because as soon as defaults start at any significant level, they start to destroy liquidity instead of create it. It is essentially the same mechanism as a Ponzi scheme (except there is no guiding individual beneficiary like poor old Chuck).

The Fed and the BoJ kicked off and abetted the creation of the credit bubble, but they are not in control. It is an autonomous process that will operate as it will. I think it is unlikely that any rate effect by the Fed will restore confidence to the extent needed for the bubble to continue inflating. I think many participants knew it was a Ponzi and were counting on getting out ahead of everyone else. We will see which are actually successful.

Very well said.

I've always thought this mess will eventually go beyond subprime. This post has helped bolster my thoughts on that. Even Big Ben himself has recently admitted the subprimes are systemic.

[beta]

The so-called "subprime" problem is a decoy. If it were just subprime, it would be a serious issue, but survivable by a reasonable amount of re-negotation and so forth. And so if you describe it as a "subprime" problem, or even a housing or property problem, you diminish the problem.

It is a credit bubble, of which housing is the most recent symptom. Central banks, notably the BoJ and the US Fed, have flooded the world with cheap money and allowed an unregulated and undercapitalized credit industry to come into existence, bypassing the traditional banking system. In response to the banking industry's complaints that it couldn't compete with the unregulated lenders, the Fed the de-regulated the banks and removed their reserve requirements so that the whole system became effectively unrestrained.

Any monetary site will show M3 or its analogs growing rapidly, far faster than the central bank's balance sheet or M1. This is a credit system gone off the rails, where debt generates money and money generates debt in a violent positive feedback loop. This works, and everything looks fine, until the debt grows so large that it can't be serviced anymore.

Of course, this shows up first with the most marginal borrowers - your subprime folks, but it is really a systematic problem because the credit market operates, like any market, at the margin. But that is enough to reverse the feedback loop, because as soon as defaults start at any significant level, they start to destroy liquidity instead of create it. It is essentially the same mechanism as a Ponzi scheme (except there is no guiding individual beneficiary like poor old Chuck).

Agree, Libertas, this is not just about subprime defaults but system-wide risk.

You write as well as Doug Noland !

Speaking of whom, Kaiser posted this link below of Noland's latest weekly update, an especially compelling read on the subject of growing risks in the credit markets:

http://www.prudentbe...icles/show/2081

Edited by beta, 05 August 2007 - 12:44 PM.

[libertas]

Let's DO be realistic.

Are massive defaults inflationary or deflationary?

Do rates go up in a deflationary environment or down?

<snip>

If you're not going to think like an economist, think like a criminal.

Mark

Well that does work. But going back to the economist bit, declining rates are not necessarily bullish. The question is, what happens to real rates? In a deflationary environment, you just have to look at the Japanese example to see that real rates can increase while nominal rates decrease. In fact, per said example, you can have positive real rates even when nominal rates are at zero. The credit bubble works so long as real real rates (when nominal rates are deflated by changes in asset prices, not incomes) are negative. As soon as they turn positive, it's over, because the carry is gone.

This is what has flummoxed the BoJ and the Fed, in turn. Central banks must look at asset prices, not just the national income accounts.

Edited by libertas, 05 August 2007 - 12:45 PM.

[ed rader]

I posted this on a thread that aged off the front page, so I thought I'd offer it out there for those who might have missed it. The thread was all about how those with subprimes were almost assured of going teats up on these loans shortly.

Here's my response:

Yanno, I always worry about a confident call by a lot of folks. Let me play D.A. here for a mo.

I'm confident that a lot of inappropriate mortgages were sold to people who didn't understand them. I know that many of these "variable rates" were really nasty teaser rates that folks didn't understand. OK, fine.

But...

What if a lot of these loans are also in the hands of folks who could afford that rate and could afford to pay their debts in a timely fashion for 3 years. Let's say that their credit scores go up from the high 5's to the high 6's over that time.

Also, let's assume that someone at the fed realizes that we might be in more trouble than they thought. The long bond suggests that. What if the Fed starts cutting again or what if the long bond runs up higher than anyone thought because big money is worried about a massive recession? Suddenly, there are some low 30 year rates for some of these folks to roll into. And, maybe, just maybe, those who can't, reset only a tad higher.

And, as for a 10% rate? Well, if it's fixed and one can make the payment, then one can make the payment. Most wouldn't take it if they didn't think they could make it. I'd say it's less than assured that these folks are all going to walk on those loans. In fact, I'll bet that most don't and quite possibly many convert them into much more affordable loans. Assuming the Fed doesn't dawdle too long.

I'm not saying that we don't have a problem here that's not over. It is going to get worse. BUT, there are a lot of things are GOING to happen if and as it gets worse and those things have bullish implications.

Think like an economist.

Cripes, I said that LAST summer as we were making the June or July lows!


Mark

if you couldn't (wouldn't, didn't) lock in a sub 6% loan i think you probably couldn't afford the house.

the question is can you now afford the home at higher interest rates?

the disparity between rents and mortgages here is huge.

i think the problem will get nightmarishly worse .

ed rader