March 13, 2007
New Century Financial Corporation, formerly one of the nation's biggest subprime mortgage lenders, has had a spectacular trip up and even more spectacular trip down.
Companies like New Century initiate mortgages and then resell them to other investors, often with promises to repurchase the loans. New Century had quadrupled its loan originations over the last three years producing $56 billion in new loans in 2005:
But that's all over now. The company announced last week that it has stopped making loans, and reported Monday that it may be asked to repurchase $8.4 billion of the loans it had originally sold, which would force it into bankruptcy.
I share Arnold Kling's concern that one of the most troubling aspects of this story is the apparent contribution of fraud. The Wall Street Journal reported that in December, borrowers failed to make even the first payment on 2.5% of New Century's loans.
Others will follow, and there will be two implications for the housing market. First, as loans are no longer extended to potential homebuyers with higher credit risk, that will reduce the demand for new and existing homes. Calculated Risk (your one-stop-shop for all housing news) notes the estimate from Dale Westhoff, Bear Stearns' head of mortgage-backed research, that tighter lending standards could mean 1.1 million fewer home buyers. Second, as some of the previously issued weak mortgages go into default, the homes will come back on the market under foreclosure resale, further depressing the market. Again from CR, rising mortgage defaults by subprime borrowers may mean an additional 500,000 homes for sale, according to CreditSights Inc.
And to that I say, !
Posted by James Hamilton at March 13, 2007 08:18 AMdigg this | reddit
James, I hate (but have to) ask this question: what were you thinking back a few months ago, calling for "soft landing" in housing? This whole subprime mess was so obvious, it was only a question of time before the sticky substance was going to hit the ventilating appliance. You sincerely didn't realize THIS was going to happen?
Small Investor Chronicles
Posted by: Alex Khenkin at March 13, 2007 08:42 AM
Economists have no tools to model non-linear, multiple-feedback effects. So generally, they don't think about them.
That's not quite true; some have embraced simulation; but emphasis on the "some".
Posted by: Aaron Krowne at March 13, 2007 10:08 AM
In his classic, Manias, Panics, and Crashes, Charles Kindleberger noted the tendency for frauds and swindles to emerge during the manic phase of the cycle. My all-time favorite has long been the stock that was offered for sale during the British South Sea Bubble of 1720 for "an undertaking which shall in due time be revealed." It had takers, but the undertaking never was revealed...
Posted by: Barkley Rosser at March 13, 2007 10:17 AM
The party is over for housing. The tightening of credit standards will lead to a huge leg down in housing prices which will lead the subprime fallout to spread to all other parts of the market. This will lead to credit defaults in other segments of the economy and further tightening of lending standards. Consumer spending will be seriously crushed and personal bankruptcies will rise exponentially. Very few economists are even ready to accept the possibility of a recession period let alone the possibility of a VERY SEVERE recession or DEPRESSION that could result from this lending collapse.
Posted by: Ryan at March 13, 2007 10:18 AM
So who become the losers in the sub-prime melt down? The subprime borrowers probably put down a few thousand dollars in loan fees for a home they will occupy for less than a year which will wipe out whatever nest egg they once had. And New Century shareholders, obviously. But who else? Freddie and Fannie? Mutual fund buyers of mortgage backed securities? The government? Who's going to end up eating the billions in losses?
Posted by: Joseph at March 13, 2007 10:29 AM
"So who become the losers in the sub-prime melt down?"
We simply don't know yet. It's only the beginning, the tentacles will spread far and wide.
Small Investor Chronicles
Posted by: Alex Khenkin at March 13, 2007 10:52 AM
From WSJ 3/13/07 a frightening article on HSBC's unsuccessful attempts to recapture subprime loan losses.
"Led by HSBC Holdings PLC, banks and others are trying to force small mortgage lenders to buy back some of the same loans the banks eagerly bought in 2005 and 2006, by enforcing what the industry calls repurchase agreements. Squeezed by the onslaught of defaults, many originators are saying they can't afford to buy back their loans or are pursuing bankruptcy protection."
I think this is the order it will play out.
small lenders -> Banks -> US govt. -> taxpayers.
Posted by: CB at March 13, 2007 11:26 AM
So... Roubini was right...
For some strange reason, I want to laught...
Posted by: João Carlos at March 13, 2007 11:31 AM
The talk at "Wall & Broad" this afternoon can be summarized as, "Looks like this thing is going to go systemic."
When the health of the system rides on the back of what some in the industry call "leafblower loans" (half-million to million dollar loans made to folks who earn their livings walking up and down driveways with leafblowers strapped to their backs) one should not be caught looking the wrong way at the inflection point.
Posted by: esb at March 13, 2007 11:34 AM
Or to put it a little differently...would any of you be willing to lend a half-million or a million dollars to your gardener? No? Well, collectively, we did...over and over and over again.
Posted by: esb at March 13, 2007 11:46 AM
I too am curious about your view of current events given your aversion to bubble explanations. I can't see any other explanation for the last few years of lending and borrowing other than people making decisions which only made sense under the assumption that housing prices would always continue to go up, which is pretty much the definition of a bubble.
Flippers, subprime loans, credit derivatives. The form is new, but really there is nothing that would have surprised Galbraith in the least:
"The more obvious features of the speculative episode are manifestly clear to anyone open to understanding. Some artifact or some development, seemingly new and desirable -- tulips in Holland, gold in Louisiana, real estate in Florida, the superb economic designs of Ronald Reagan -- captures the financial mind or perhaps, more accurately, what so passes. The price of the object of speculation goes up. Securities, land, objets d'art, and other property, when bought today, are worth more tomorrow. This increase and the prospect attract new buyers; the new buyers assure a further increase. Yet more are attracted; yet more buy; the increase continues. The speculation building on itself provides its own momentum.
"This process once it is recognized, is clearly evident, and especially so after the fact. So also, if more subjectively, are the basic attitudes of the participants. These take two forms. There are those who are persuaded that some new price-enhancing circumstance is in control, and they expect the market to stay up and go up, perhaps indefinitely. It is adjusting to a new situation, a new world of greatly, even infinitely increasing returns and resulting values. Then there are those, superficially more astute and generally fewer in number, who perceive or believe themselves to perceive the speculative mood of the moment. They are in to ride the upward wave; their particular genius, they are convinced, will allow them to get out before the speculation runs its course. They will get the maximum reward from the increase as it continues; they will be out before the eventual fall.
"For built into this situation is the eventual and inevitable fall. Built in also is the circumstance that it cannot come gently or gradually. When it comes, it bears the grim face of disaster. That is because both of the groups of participans in the speculative situation are programmed for sudden efforts at escape. Something, it matter little what -- although it will always be much debated -- triggers the ultimate reversal. Those who had been riding the upward wave decide now is the time to get out. Those who thought the increase would be forever find their illusion destroyed abruptly, and they, also, respond to the newly revealed reality by selling or trying to sell. Thus the collapse. And thus the rule, supported by the experience of centuries: the speculative episode always ends not with a whimper but with a bang. Here will be occcasion to see this rule frequently repeated."
Posted by: Stuart Staniford at March 13, 2007 12:03 PM
Alex, I do not know that I have used the expression "soft landing" to describe the current or prospective outlook for housing. I have used the expression "soft landing" several times to describe 1994-95, and on October 3 to refer to a scenario of slow but positive real GDP growth. But in that post, what I said in particular about housing was "the housing slowdown is significant, real, and upon us now, but this is as bad as it's going to get".
As for why I thought the number of new home sales would not deteriorate further from the autumn levels, I saw high interest rates as the primary cause of the housing downturn and the drop in interest rates since last July as a favorable fundamental.
It is certainly true that I have become more pessimistic about both GDP and housing over the last month. Part of that is because I'm seeing more indications that the slowdown has spread beyond housing, and, to the extent that happens, it's a big negative for housing as well. Part of my growing pessimism is the acknowledgement that any stimulus from last summer's drop in mortgage rates has worn off by now. And part of my growing pessimism comes from the recognition that I did indeed underestimate the nature of mortgage problem, as I will be discussing further in future posts.
Posted by: JDH at March 13, 2007 12:07 PM
JDH wrote a famous paper arguing that one cannot econometrically identify a fundamental in a price time series, ergo, one cannot identify a bubble. This is known as the "misspecified bubble" problem.
However, there is an asset for which one can do so: closed-end funds. For these there is an underlying asset value that tends to differ from the fund's value. Most funds have values somewhat below their underlying asset values because of tax and management costs. But if such a fund develops a premium, especially one that rises sharply, then one really is observing an honest-to-gosh, econometrically specifiable bubble. We have seen quite a few of these over time.
However, regarding the real estate market, I am unaware of any closed-end funds in real estate securities that we can use to measure this. Does anybody out there know of any?
Posted by: Barkley Rosser at March 13, 2007 12:08 PM
Ah, I can't resist setting off that Galbraith quote with this one Barry Ritholtz unearthed from Alan Greenspan the other day:
"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. . . . With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . .
Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending . . . fostering constructive innovation that is both responsive to market demand and beneficial to consumers." (emphasis added)
-Remarks by Chairman Alan Greenspan on Consumer Finance
At the Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8, 2005
Posted by: Stuart Staniford at March 13, 2007 12:10 PM
Joseph, The WSJ reports that
The largest debt listed by New Century, owed to Morgan Stanley, was $2.5 billion. New Century said that after Citigroup Inc. demanded additional collateral of $80.3 million to cover a "margin deficit" on some of the company's debt last Tuesday, Goldman Sachs Group Inc. filed a default notice on Wednesday, seeking repayment of roughly $100 million. In a filing yesterday, New Century also listed outstanding debts of about $900 million to Credit Suisse Group Inc., $800 million to IXIS Real Estate Capital Inc. and $600 million to Bank of America Corp.
Of course, there's a whole lot more out there somewhere.
Posted by: JDH at March 13, 2007 12:12 PM
Stuart, I hope to revisit this issue in later posts.
Posted by: JDH at March 13, 2007 12:13 PM
Joseph, Menzie also calls my attention to this neat interactive graphic from the WSJ
Posted by: JDH at March 13, 2007 12:18 PM
James, I used "soft landing" not as a direct quote, but as a description of your stance toward the hosing market, as recently as:
January 27, 2007
The housing market and the Federal Reserve
More evidence that the housing market has stabilized, consistent with the recent policy stance of the Federal Reserve.
Didn't you know at the time that there existed a huge number of loans ready to go belly-up as their initial teaser rates were jacked up, the 30-year mortgage rates notwithstanding? I knew this, and I'm just an amateur trying to keep above water. I regard monthly numbers as just so much noise, little shrubs obscuring a massive forest. Wasn't it very unlikely that a dislocation, once started, would just play itself out in a few months?
I don't mean to pile on you here, just trying to understand the logic...
Small Investor Chronicles
Posted by: Alex Khenkin at March 13, 2007 12:32 PM
I did see it pointed out that there is one major difference between the current housing problems and the housing crunches of the past. In the past, the recessions caused people to lose jobs, which caused the defaults on the mortgage loans, and then things snowballed. However, we aren't seeing that happen this time. Unemployment is low. People may lose their house due to not being able to make the payment, but they probably still have a job.
I think that's the main reason most economists aren't expecting a massive recession out of this housing mess. I expect we'll see a recession, especially on both coasts where the housing markets were hot. However, so long as companies keep their employees, the economy will survive.
Posted by: kdp at March 13, 2007 12:34 PM
But when consumer spending plunges from the housing and credit problems, how are the companies going to keep their employees? The job market was great in Japan before their real estate crash too.
Posted by: Ryan at March 13, 2007 12:51 PM
Thanks. The psychologists have a concept of emotional contagion - the tendency for humans to express the same emotion as those they interact with. The neuroscientists have confirmed the existence of specific mechanisms for this - mirror neurons which fire when an animal observes another doing the same action as itself. Since the act of forming a judgement in the human brain centrally relies on emotions, it seems overwhelmingly likely that markets made up of (slightly suped up) primates will be swept by waves of emotional contagion, which indeed is what investors anecdotally report.
Has anyone made any formal attempt to study emotional contagion dynamics during market events? (Eg via videotapes of trading floors? Simple questionnaires?) I agree the price history itself doesn't seem the easiest place to go looking for evidence of the bubble, since the fundamental price isn't easily observed (indeed in a lot of cases doesn't have any meaning outside of what humans give to it with their emotional neolithic brains)
Posted by: Stuart Staniford at March 13, 2007 01:02 PM
Stuart, I believe they have done some pychological experiments where they operate a fake 'market'. I seem to recell that bubbles tended to form each time. Human psychology tended towards irrational exuberance.
vorpal (umass1993 on theoildrum.com)
You could probably find this article if you really searched the net.
Posted by: vorpal at March 13, 2007 01:26 PM
Vorpal: Thanks, there seems to be some discussion of this literature in this paper (which looks pretty interesting in its own right).
Posted by: Stuart Staniford at March 13, 2007 01:38 PM
Stuart, Jeremy Grantham of GMO has made an investment career of studying bubbles. He uses 2-sigma deviation from the trend to identify one, and haven't found a single one (among more than two dozen) that did not revert back to the trend, and usually far below it.
Small Investor Chronicles
Posted by: Alex Khenkin at March 13, 2007 01:41 PM
stu, I downloaded that article. It sounds llike the one I read about.
I also remember reading about 'greed.' They did an experiment where they had one group where they brought up money repeatedly, and then watched to see how charitable they were later. The group which hadn't discussed money was more charitable.
When you are participating in a market, money is the central subject, so perhaps price bubbles are an expression of this 'greed' phenomena.
Just a thought.
BTW: I would still like to see a plot of your gaussion fit on URR, start date 1935 and end dates 1945 to 2005. (URR vs. EndDate instead of (StartDate vs EndDate) More in my second response on TOD.
Posted by: vorpal at March 13, 2007 02:13 PM
When I read news like this I'm quite relieved that I went fixed-rate.
As of tomorrow, it's three years to go and counting.
Posted by: Martin at March 13, 2007 02:30 PM
Thanks, JDH and Menzie for the WSJ link. It provides a nice picture of the major players and ripple effects.
Posted by: Joseph at March 13, 2007 03:46 PM
Off-topic, but Mr. Rosser, I give you CRF.
I'm short, but it has not been a good trade, despite the obvious and eventual denouement.
Famous (infamous?) hedge-fund geniuses Renaissance are long.
Perhaps rationality is overrated.
Posted by: wcw at March 13, 2007 04:19 PM
Is there a lag between *the saying* here:
And to that I say, 8(
and the illustrating on the opening page depicting the recession chances
with that emoticon and that number?
I found the Bloomberg article on the role that CDOs play in this market
Posted by: calmo at March 13, 2007 08:03 PM
If you are inquiring about the dating of shifts in the official Econbrowser Emoticon Index, Calmo, I believe that the current face turned sad with this post and was moved to the front page with this one. Today I just added an exclamation mark. I gave some thought to updating the front page with an exclamation mark as well, but then thought it perhaps runs a bit counter to the whole philosophy of pretending to be able to summarize everything with one silly face.
Posted by: JDH at March 13, 2007 08:51 PM
Professor, it's going to be a long, ugly downturn. Even in La Jolla.
Time to short the market, then get back into gold and gold mining stocks.
Posted by: jg at March 13, 2007 09:20 PM
It's all a matter of perspective when talking about how consumer spending will plunge. Having just gone through one bubble with tech, I see this housing bubble as being pretty similar. A lot of financial companies will see money evaporate - easy come, easy go. A lot of marginal homebuyers will get foreclosed upon and have to move back to renting. Not fun, but not the end of the world.
I expect consumer spending to dip, but not plunge. There will be some lost jobs, but that happened when the tech bubble burst, too. It hurt, but mostly a lot of money evaporated and a few people lost their jobs and had to move on. Similar thing here - this is a financial bubble caused by people making dumb decisions with excess cash flow.
Most companies are still going to be in great shape fiscally; plenty of cash on hand and still low interest rates for borrowing. I don't see companies panicking much outside of the housing industry. Even in housing, everyone has been prepping for years for a burst bubble. Basically the banks end up taking the losses, if I'm reading the money flows correctly. They'll report reduced earnings for a while and tighten credit standards back to more reasonable levels.
The way the economy looks right now, I'm just not seeing massive layoffs. I do see reduced earnings and some belt tightening, which will include some layoffs. Probably no worse than the Tech bubble crash, though.
Posted by: kdp at March 14, 2007 11:43 AM
The idea that a loan can be considered as prime at the time it is lent for 100% of a property value seems just silly. Surely that is a sub/below prime or high risk loan until the property has appreciated in value by around 30%? Without a margin of error in a loan the lender is taking a massive risk.
I believe that this was all known but the idea here was not to produce good credit but rather to inflate the bubble to avoid what is likely to happen anyway, maybe because it was believed that the bankers were clever enuf to avoid the failures of those who came before or perhaps they were just plain desparate?
Nothing changes! The first lesson of history is that the lessons of history are not learnt
Posted by: Anonymous at March 14, 2007 01:09 PM
It ain't neccessarily so that a closed end fund trading above book value means is proof of bubble. It can simply be an indication that the market price is rising faster than the valuer can keep track of it. Particularly for real estate funds that can happen quite easily.
I doubt that house prices will take major hits from a USA national average perspective for a bunch of reasons.
1. Mostly round the rest of the world we don't see this. Typically a long period of stagnation in nominal prices is far more typical. That's just what we've seen in Australia the past five years and there are plenty of other examples.
2. Housing is procyclical and there is little evidence of a recession in the USA. A slow down to be sure, but nothing like a recession right now. Bond rates have range traded over the past 12 months, the next move in the fed funds will be down.
3. The flow on to the rest of the economy will be in two parts. Wealth effects, and the direct slow down in GDP growth caused by a reduction in building construction, since residential building construction is presumably less than 5% of GDP, that impact will only be modest.
Posted by: David Leitch at March 14, 2007 04:03 PM
You might want to take a look at these graphs at Calculated Risk. In four of the last five recessions, housing sales were a leading indicator. Employment and the stock market are generally coincident indicators of recessions.
Posted by: Stuart Staniford at March 14, 2007 08:27 PM
Echoing Alex Khenkin above, Professor, I think you owe a more complete explanation about your record regarding housing/mortgages.
December 27, 2006:
"When I suggested two months ago that we'd seen the worst for home sales, many or our readers responded with derisive skepticism. But so far, my analysis seems to be holding up. . . . To recap, the basis for my assessment was the belief that low interest rates had been the primary factor driving the housing boom, that higher interest rates had been the primary cause of the downturn, and that the fall in mortgage rates since this summer would begin to make a positive contribution to home sales by November."
Jan 1, 2007:
"For the equities of homebuilders in particular, the Dow Jones Construction Index continues to reflect a market consensus that the worst is behind us:"
Jan 27, 2007:
"More evidence that the housing market has stabilized, consistent with the recent policy stance of the Federal Reserve."
Now (3/13/2007) you write:
“And part of my growing pessimism comes from the recognition that I did indeed underestimate the nature of mortgage problem, as I will be discussing further in future posts.”
So, I come back to Alex’s question: You sincerely didn't realize THIS was going to happen?
Did you not see that THIS was a mania? Were you unaware that fraud was taking place on a massive scale? Did you know that people were making loans at 1 to 2 % teaser interest rates, requiring little or no documentation, pushing debt-to-income ratios to 50% and higher, and selling these loans as fast as they could? Did you truly think THIS could be explained primarily by interest rates fluctuations (yes, I agree, unbelievably low interest rates were a big factor, but there are forests and there are trees).
“But so far, my analysis seems to be holding up.” Are you going to own up to that little snib of hubris?
Oh yes, and please, before you modify your analysis to a “more pessimistic” shade, can you at least be man enough to tip your hat to the “derisive skeptics” who saw this cesspool for what it was?
Posted by: Anonymous at March 14, 2007 09:49 PM
Peoples memories are short....around 3 score years and 10 plus a few more for better health care
2007 - 75 = 1932
I actually can remember the UK price fall in the late 80's and early 90's, where previously the UK did not even have price falls in WW2 but it was bad......really as bad as it could be. 40% and more devaluations.
How good is prime really?
Posted by: Worried at March 15, 2007 03:30 AM
The professor was quoted as saying:
"For the equities of homebuilders in particular, the Dow Jones Construction Index continues to reflect a market consensus that the worst is behind us:"
I learnt recently what seems to be an open secret in that the 'working' group set up by President Reagan ensures that pivotal stocks are supported thereby distorting the markets "intelligence". This group is dubbed the "Plunge Protection Team" and some financial newsletters earnestly have charts showing PPT strength and weakness to inform readers when it is a good time to short or not short the market.
Similarly back in the 1980's i would hear in london that the "old lady" is intervening right now.
Who actually really believes markets are efficient? who actually says they are the most?
Posted by: Worried at March 15, 2007 03:59 AM
Anonymous, I will write more on this, though I have the feeling from the tone of your comments that you're not going to like what I will say.
The short answer to your question is that I regarded the level of interest rates to be more important than you did. But I believe I also have been stressing all along the possible risks of default feedbacks. For example, here is what I went on to say in the paragraphs that followed each of the three quotes you provided above:
December 27, 2006:
Let me also recap what could still go wrong from here. Although the latest data nudge the inventory of unsold new homes down slightly, there remains a significant overhang that needs to be worked off.... I expect to see a drop in construction employment, and that could itself generate other problems for the economy.... And I continue to be concerned about whether the housing downturn could lead to widespread bankruptcies or default. Calculated Risk notes one assessment that 1 in 5 of the subprime mortgages originated in the last two years will end in foreclosure. It is difficult for me to be quantitative in predictions about these dynamics, other than to recognize the possibility of some nasty negative feedbacks setting in.
January 1, 2007:
If we do see widespread defaults sending housing into a freefall from here, then I certainly would expect the Fed to start cutting rates, though at that point it would be too late to do much good. But in my opinion, such a prospect, while a tangible possibility, is not the most likely outcome.
January 27, 2007:
the autumn monetary policy stimulus will have evaporated by February 2, after which the apparent decision of the Fed to hold the rate steady at 5.25% through the first half of 2007 will start to make a net negative contribution.
Posted by: JDH at March 15, 2007 06:18 AM
Just to be clear here, you offered an opinion which you said had some risks associated with it and that opinion was met with derisive comments, but in fact your opinion now is that the risks were more important than your opinion at the time?
Did i get that right?
Or are you saying that you think A but on the other hand you might also think B so to know what you are saying we need to evaluate A and B and decide for ourselves because you dont actually know what your opinion is?
And by the way i am not Anonymous but i thought i would offer my opinion here:-)
I wonder if you will smile at my comments? or maybe you wont smile at them. I imagine you might not really like what i am saying here, but there are some risks associated with that opinion because you might yet have a sense of humour!
Posted by: Anonymous at March 15, 2007 06:50 AM
To the One Who Claims not to Be Anonymous, perhaps you know the future, but I don't. What I offer instead is a probability assessment-- there's some chance that A will happen, and some chance of B. So I lay out both, and say which I think is more likely.
Posted by: JDH at March 15, 2007 06:58 AM
In my view, reasonable people do not question your intelligence, expertise or integrity.
I think the crux of what’s going on here is 1) owning up to your record, and 2) recognizing that what’s going on here is a housing/mortgage/liquidity bubble (or mania). Please hear me out. I’m not attacking you personally. I’m trying to explain where the anger in some of the above posts comes from.
When you write “. . . I did indeed underestimate the nature of mortgage problem . . .”, that sounds a bit too much to me like a “mistakes were made” or “if my comments caused offense” less than complete mea culpa. Did you “underestimate” or did you “miss” the significance of the mortgage problem? More broadly, you’ve more or less been calling a bottom for new home sales, and, to my reading, dismissing the more dire predictions of the “derisive pessimists”. The recent mess in subprime mortgage shops seems to corroborate the views and predictions of the pessimists, the bubble believers, the mania Cassandras (I count myself as one), so what they would like to see, in my opinion, is a straight-up “I missed this, you were right (so far) on this count.” Future data and events may support your position.
Sure, we’re in the middle of this game; We don’t know how it will end. Perhaps your views and predictions will turn out to be correct. But you didn’t predict this subprime mess, others did, and I think they would like you to acknowledge that fact clearly.
The upside for you is that you actually gain credibility by admitting error when it is warranted. No one bats 1000. And I give you credit for modifying your views.
Posted by: MTHood at March 15, 2007 08:48 AM
I am sorry that i anonymously announced i was not Anonymous
I think the issue here is that when you offer probabilities of events, you also seem to be offering an opinion of which event is most likely.
So when you say:
"When I suggested two months ago that we'd seen the worst for home sales, many or our readers responded with derisive skepticism. But so far, my analysis seems to be holding up."
from that it is hard not to read that you are wanting to confirm to yourself that your analysis is correct and that others are just wrong.
Maybe i rushed into this having nothing better to do and i am sorry for that but even so i felt the anonymous guy had a point worth exploring with you.
I come to this blog because i have marked you as a Bull whereas most of my bloggs are in the bear camp. I like to see both points of view.
I would honestly like to see that your more sober view of this situation is correct because the alternative does frighten me but so far all that i read about that seemed bad seems to be coming home even quicker than thought possible by those tracking the arm resets and so forth which suggest a later than now problem.
I would like to see a way out of this if there is one
Posted by: Worried at March 15, 2007 11:53 AM
Toll Says Spring Was `A Bust,' Can't Predict Recovery
March 15 (Bloomberg) -- Toll Brothers Inc. Chief Executive Officer Robert Toll said the start of the spring selling season was ``pretty much a bust'' and he can't predict when the housing recovery will begin.
``When will the market rebound?,'' Toll said at a conference in Las Vegas today. ``Who knows? The Shadow knows. I have no idea. I would've thought that it would've rebounded by now and I would've been dead wrong, and I was.''
Posted by: Anonymous at March 15, 2007 12:46 PM
Housing prices, and housing activity are well known as leading indicators. I guess this time around though I see housing as being out of sync and the housing price/starts boom falling over of its own accord rather than being pushed down by higher interest rates.
In respect of housing prices, I guess it is true that if we look long enough you can find examples where in post ww2 economies house prices do fall materially. Hong Kong was another example around 1998 from memory. Generally speaking though the impacts don't turn out to be that severe outside of the housing sector because only a relatively small number of marginal buyers purchase at the top of the market so that the average householder is only looking at an opportunity loss.
Personally I am quite negative on the outlook for housing starts. That's based on household formation rates compared to actual starts rather than a view that we will see significant house price deflation, leading to wide spread economic weakness. The transmission impact of the latter would have to show up via reduced household consumption and why should it?
Posted by: David Leitch at March 15, 2007 05:29 PM
>>Personally I am quite negative on the outlook for housing starts. That's based on household formation rates compared to actual starts rather than a view that we will see significant house price deflation, leading to wide spread economic weakness. The transmission impact of the latter would have to show up via reduced household consumption and why should it?
This former/latter phrase always confuses me.
Are you saying that house price deflation created by a decrease in household consumption is unlikely to happen? And that you see no method whereby household consumption is likely to decrease?
If you are saying that then the method is well established by the bears and is the very reason they have forcast the currently occuring cycle.
In a nutshell the bears case is that people have used the stock market and their home as an ATM machine. And since 70% of the economy is based on consumer spending the feel good factor or the apparant wealth factor created by rising assett prices has enabled more consumption and greater rises in assett prices. However the problem the bears argue is that there is insufficient productivity in the economy and the economy is overly reliant on the creation of more and more debt to fund consumption.
More and more commentators from a wide number of sources were saying about 18 months ago that the consumer was 'tapped out'. Therefore no more money could be borrowed until wages rose, Mew would decline etc etc etc. The bears then said the cycle was ending, the results were unavoidable no matter how many devices were created to enable more borrowing to be created by those not already borrowing.
Then again maybe i have entirely misunderstood what you meant so sorry for that if that is the case!
Posted by: Worried at March 16, 2007 01:44 AM
>>Housing prices, and housing activity are well known as leading indicators. I guess this time around though I see housing as being out of sync and the housing price/starts boom falling over of its own accord rather than being pushed down by higher interest rates.
I am sorry, but i cannot even begin to understand how you can say that rising interest rates and the housing price boom ending are not related?
Is that what you are saying? I think it must be.
How many monthly rate rises were there? 17? Why were the rates raised? To tame inflation? Where did some of that inflation come from? Was it not in part due to the rapidly increasing consumer borrowing and MEW and so forth etc etc etc.
Something about this conversation is disturbing me. It is like i am in a time warp discussing what is likely to happen last year with somebody who sees no evidence of it happening.
Posted by: Worried at March 16, 2007 02:32 AM
If we enter a recession (or worse) interest rates will crash. Mortgage rates will crash. I will then refinance my house at lower rates. Subprime owners will suddenly be solvent at lower interest rates, and can afford their dwellings by refinancing (thus holding off foreclosures and holding up housing prices). Perhaps I will upgrade to a bigger house. Perhaps I would rent out my current one as many people would wait for "the bottom" to buy, thus increasing rents.
If stagflation resurfaces, hey, got my house, and my 5.5% mortgage...groovy!
If everything stays the same, my calculations for living remain the same. I pay my mortgage and enjoy a comfortable life.
The bottom line...up,down, each is only opportunity. As long as Bernanke has pump priming abilities I see little long term concerns.
Posted by: outsider at March 17, 2007 02:15 AM
If a recession arrives or deepens from where we are at now then:
Subprime owners will have to access market rates as people with poor credit in recessionary times **caused** by collapsing consumer confidence because house prices have declined. Most will have negative equity. Without some kind of government gaurantee they will not be able to refinance. Rates might go to zero for banks but banks will only lend out to them at say 4% or something. Seems many chose subprime as a way of going no document to leverage their borrowing possibilities as if they were playing the forex market......they will be destroyed even if they have good jobs.
Stagflation is a recession with inflation or growth with excess inflation depending on how you look at it. Some argue we are already there. Rates could go up. 5.25 seems cheap because most have forgotten about double digit rates. Since the economy is now reliant on growth and assett appreciation a deepening recession is likely to create job losses as all those employed in services that service the bubble get laid off and all those involved in house parts manufacturer go too. Stagflation is unlikely to last because it is kind of stable.
To my surprise dispite his helecopter ben reputation Ben has written two books where he says that rate cuts are not possible until housing bites into the wider economy so that it too is heading into recession. In any case the amount the fed can do to pump is limited by the ability of the system to suck. In a recession after an assett price bubble people with wealth protect it by withdrawing faster than any borrower and they then head to the sidelines and wait for things to reach bottom. The fed cannot pump if nobody sucks. The alternative then becomes helicopter money but then you have hyperinflation.
Hyperinflation has its attractions. Hard to
go bankrupt as debt is devalued for example. But the experience of those that tried it was not pretty or it would be first choice solution rather than last.
The hyperinflation route is the basis of the current world money system but it is done on the basis that it will never run out of control and can be managed safely while simultaneously in effect wanting to devalue government debt as quickly as possible. Historically it has proven to end in tears each and every time.
Posted by: Worried at March 17, 2007 05:06 AM
Thanks for your clear insights.
Posted by: outsider at March 17, 2007 11:39 PM
Have been out of country. Sorry slow to reply.
There is a huge literature now on emotional contagion and markets. Dome of it is experimental, some of it is surveys, such as one done by John Pound right after the 1987 crash of participants. An early paper on bubble markets in labs was by Vernon Smith and coauthors in Econometrica in 1988. A lot of these papers can be found at the ICES website, with David Porter a coauthor on many of them.
That looks like a pretty long bubble, but it is a bubble. Usually closed end funds run discounts. John Ritter pubbed a paper in one of the fin journals back in the 90s showing one could beat the S&P 500 by buying and holding deeply discounted closed end funds and lose money buying steeply premium ones, suggesting you should still come out ahead, although we know that markets learn about yesterday's anomalies.
It is not a matter of valuers. The NAV is a market basket and should respond quickly. Anyway, one should not be moving in the sort of time horizon where there would be such a lag.
On the bigger issue, although I do not think there are any housing closed end funds, the fundamentals should be driven by rents, incomes,and interest rates. Robert Shiller has shown in the second edition of his Irrational Exuberance that the housing price to rent and price to income ratios reached all time highs in the US by 2005, although interest rates were low and some observers have claimed they were low enough to still justify some of the housing market prices observed, although probably not in all markets.
Posted by: Barkley Rosser at March 20, 2007 12:14 PM