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March 18, 2007

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I’ve been saying for 3 years now it’s coming… I have one friend (with a swing loan) trying to sell who I have been trying to convince to reduce his price and just basically bail.

I think this could be really bad (i.e. “dot com” bad).

OCSteve: I think it could be worse. Like I said, though, I'm a pessimist when it comes to the economy. (I started predicting the dot-com bubble in 1997. I now just assume that there's some mystical force, sort of like whatever it is that lets Wile E. Coyote keep on running after he's over the cliff, that keeps markets and economies perking happily along long after it seems to me that they should be falling like a rock.

What will be the difference between, on the one hand, the coming meltdown when these underqualified borrowers stop being able to pay back their risky lenders, and, on the other hand, the situation that would have obtained if the risky lenders hadn't made the risky loans in the first place? (This is not meant to be sarcastic. There is, I'm sure, a big difference, but I don't understand what it is.)

Cardinal Fang, I think the answer to your question is "a whole lot of jobs and production that wouldn't have happened without those new homeowners."

Well I am no expert Cardinal Fang but I will give it a shot. It seems to me that the basic problem is that the economy has now expanded on the basis of this borrowed money. Business have grown and expanded, hired more people, branched out with investment. I live in two cities currently, Las Vegas and Miami, where the effects of this sort of expansion are quite visually apparent with new construction and shiny new towers popping out of the ground on a weekly basis. Now that it turns out that the money doesn't really exist, all of that inflation is now becoming deflation. Vegas will be alright for obvious reasons. In Miami however, where lots and lots of people were buying homes that they felt that they would be selling within a year or two for profit, are finding out that that will not be happening and they will either have to sit on their investment or take a loss. Deflating economies means closing businesses and many lost jobs.

Well, the homeowners now in danger would still be wherever they'd been living before.

On a more macro scale, the housing market would have been less active, probably, and since the housing and refinancing booms were driving the economy, there would have been fewer jobs and less economic growth generally.

There's no way of telling how much less, though. The problem with building an economy on debt is that it's difficult - probably impossible - to determine how much the economy 'needs' large scale speculation to grow versus how stable it would be without all that risky speculation.

That's also a big problem for an economy based on endless growth: it constantly needs new and bigger markets. It constantly has to sell people more, bigger, fancier, more expensive stuff. If people actually did what prudence dictates - live within your means, save money, etc. - the economy would grind to a halt.

Cardinal Fang: Well, the people who got the mortgages paid a bunch of money and will end up evicted and with their credit ratings trashed, instead of having rented all the while; the mortgage lenders would probably have done less well, but would not now be bankrupt, and their employees would probably still be employed; the people who bought the securitized mortgages would probably have made slightly less during the last few years, but would probably not have lost as much as they now will.

Moreover, housing prices would probably not have gone up nearly as much during the past few years. This would have meant that some people didn't have as much equity to tap into, which might have prevented them from doing some stupid spending. It would also have meant that new homeowners didn't have to accumulate nearly as much debt, debt which they will still owe when this is all done.

Also, housing prices would not now tank, which means that a lot of people who will now find themselves underwater and unable to sell would not have.

All in all, just think of all the things people did as a result of all this easy credit being available -- assuming debt, investing, spending, etc. -- and think: all those actions and choices have consequences. Bubbles distort economic choices, and when they burst, those choices have to be unwound in ways that are often painful for all concerned. It's generally a lot better for assets to go up less and then come down less than it is for them to skyrocket and then crash.

It's also better for companies and individuals not to go bankrupt.

This is hitting folks pretty hard here in Orlando, where "flip your house" nearly became a religion.

I tend to look at that sort of thing this way: by the time word is out, and people are rushing to buy in to whatever is the trend, it's far too late to make any money. And the likelihood is it's you (and lots of others) who'll be left standing when the music stops.

Me? 20-year fixed, with a 2nd folded into it. Our current valuation is such that we still have less than the original sales value owed, although we do plan to pour as much as we can into it for the next few years to drive it down further. We're at about 50% of valuation right now, but I expect that number to go up a bit as the market bottoms. Maybe it's bottomed already; maybe it won't do it for a year or two. I've got no plans to move, though, so it's all good.

Very good, you have done some work. Roubini has lost some credibility, he has predicted one too many recessions for my tastes. Speaking of credibility or lack of it, Stirling Newberry has recently written another Summary. Long of course, and challenging, I like to think that Newberry is the Zizek or Baudrillard of monetary thinkers. He can do better than I.

It may be crazy to say:"It is all connected," but China and Saudi Arabia are buying many of those mortgage instruments. China etc buys dollar instruments to keep interest rates low feeding the housing bubble and consumer spending which buys Chinese manufactured goods. SA gets high oil prices and continued demand which supports air-conditioned McMansions 50 miles from work.

Both finance Bush's War in Iraq, tax cuts, Keynesian stimulus with pressure on the welfare state. The "GWoT" is directly connected to the housing bubble. How could it not be?

Paranoia can be true perception when trillions are in play.

Slarti: we think as one on this point. My theory has always been (a) what you said -- by the time I hear about it, it's almost certainly too late, and (b) there are a lot of smart people out there trying to make money in (pick asset of your choice -- stocks, houses, whatever), and if I want to speculate, I can't expect to outdo them unless I am prepared to commit about as much time and effort as they are. Do I want to do that? Hell no.

Thus, I do not speculate. Though I do, occasionally, regret that back in -- 2002? 2003? -- when Apple was selling for $12-15 and I knew it was way undervalued, I didn't buy some for kicks. (It's pushing 90 now.)

Incidentally or not, Newberry certainly isn't the first by a long shot to view money and prices as information. But if there are others, besides Uncle Milty himself, to apply post-structuralist theories of discourse and communication to economics I would love to have them linked for me. Even some good information theory. But no rational expectations please, especially about inflation. Good post at Thoma's about why rational expectations will only work for those with adequate information, i.e,. the elite and rich.

And of course the number-crunching neo-liberals and neo-classicists don't respect pomo Stirling.

Cardinal Fang, the key difference (I think) is that had lending policies been sane all along, overall growth would have been slower, but the gains people made would have been more sustainable. The problem with the current situation is that having something and losing it is much more disruptive than never having it, particularly when we talk about something as big and fundamental as a home. Everything dependent on the prospect of future resources now dissolved is at risk. In addition, there's a lot more fear and uncertainty, more pain, more anger - all passions ripe for exploitation by scoundrels and demogogues.

People made a lot of stupid choices in recent years. But the experts told them it was smart! Starting with the Chairman of the Federal Reserve Board, one of the most genuinely respected figures in American politics, let us not forget. Now the victims are prone to a mixture of inward directed loathing and outward directed skepticism and anger. They were set up, adn even though we all bear ultimate responsibility for our folly, I don't think people should have to bear the burden of figuring out that the entire fiscal apparatus of their country is feeding them crap for stupid reasons.

And a policy of sensible credit throughout would have forestalled that social situation.

"And a policy of sensible credit throughout would have forestalled that social situation."

"Another way to look at it is as an enormous gamble on the proposition that property values will continue to rise." ...hilzoy

This is inflation. Asset inflation. It is a global phenomenom, and a product of globalization.

Okay, two insights of Friedman's that most economists I read seem to accept are:

1) Inflation is always a monetary phenomenon.
2) What is important is the expectations of future inflation.

1a) Inflation as monetary phenomenon means that the Fed has enabled or supplied both the tech and housing bubble with easy money or lack of brakes. M3 has been in double digits for a decade. Cheap and crazy credit instruments don't just happen; they happen because there is a lot of money floating around with insufficient productive places to invest it. Now maybe the Fed doesn't deserve direct blame, globalization has simply accelerated the velocity and increased M3 and there is nothing the Fed can do about it. I could say it was a consequence of China coming online, but inflation is a monetary phenomenon.

2a) But we are in our third inflationary bubble. The first was in the mid-eighties with the rise in the Stock Markets, then tech, now housing. Larry Kudlow is still saying Dow 36k. I have no reason to believe that expectations of asset inflation will not be fed by the powers that be, here and overseas. The Far East markets fell more than domestic, they ate some of our sins.

China cannot afford an American recession, and Saudi Arabia does not want the crash in oil prices that a recession would create. The last time (?) oil prices crashed Iraq went to horrible war with Iran, followed by Kuwait. Over oil, and oil money.

OCSteve: I think this could be really bad (i.e. “dot com” bad).

The trouble, from my perspective, is that a) it looks like it's going to be bigger than the dotcom bust, and b) there are parts of the country -- e.g. here in Wisconsin -- that haven't actually recovered from the dotcom bust in the first place.

If the bubble is in tulip bulbs, that happens when people get rid of all the tulip bulbs they couldn't really afford anyways, and things go back to normal.

Hmmmmm..... going back to normal was not as easy as you make it sound though.

Heh. My wife and I were one of those with the two mortgages, no down payment loan types. But we did have a 30 year fixed rate; we would have gone with a 20, but just too much in the DC Metro area.

Yeah, they tried to get us into an ARM, but both of us told 'em to go fly a kite.

But yeah, the housing market needs a correction. I have friends who recently bought and probably bought poorly admittedly, but to get a home they had to go to a 40-year mortgage.

Not because they were ready to buy a home, but the house they were renting was going to be sold, and they couldn't find any place with a rent cheaper then what they are currently paying on the mortgage.

And that's 50 miles from DC.

Echoes of New England late 80's, early 90's:

US Rep. St. Germaine leads passage of the doubling of FDIC deposit insurance. S&L's get into (clueless/Midas) commercial lending. Construction boom, everybody into the pool!!: Mixed-use office, residential, marina-slips included, projects in beautiful downtown Fall River. Deals done, zero due diligence. Outruns the absorption rate by 200%. S&L's start bleeding. Bank of NE (2nd largest regional) crashes, takes fifty smaller banks with it. FDIC/Resolution Trust returns, holding the paper at a dime on the dollar. Foreclosures and Fire Sales!!

as someone who works in the development business here in not-so-sunny So. Cal., I am extremely worried. There is some evidence that our entire economy is much more a house-of-cards than meets the eye.

There is a lot of data to suggest that the housing bubble is enormous (make that ENORMOUS!). (Look at, for example, the sale of stock by Mr. Toll in his own company.)

The usual response to a tanking economy is to ease credit and run deficits. But we are already running huge deficits and the US has already de-industrialized to a large extent due to globalization. In order to get our fiscal house in order, we may need to see a big drop in the dollar so that exports can become competitive again.

This could hurt, a lot.

It's worth emphasizing that, in the option ARM tutorial that you linked to, the folks at Calculated Risk mention at least one instance in which a loan officer had a deep misunderstanding about how the mortgages that he was offering worked. Evidently it wasn't only borrowers who were clueless and delusional.

The financial page of the New Yorker about two months ago had a great article on the housing bubble. The basic upshot is this:
Once you adjust for inflation and the increase in average house size and amenities (air conditioning and central heating being the biggies) over the 20th century (roughly speaking; I think the numbers started in 1910 or 1920, not at the very beginning of the century), there was actually almost no change in home values throughout the century.
CaseyL raised the big point earlier -- economies based on endless growth don't, uhm, work. Because it's impossible for everyone to keep getting more and more money out of the same basic resources, whether that's oil reserves or a house or an old-growth forest. And the belief in endless growth is what fuels bubbles. Oops.

Decided Fencesitter, I just moved out of the DC area after 7 years, so I feel your -- and your friends' -- pain. I moved back to Cleveland, and got a 30-year FRM with 11% down, paying an extra quarter-percent in interest so that I don't have to pay PMI. I got a deal, in my opinion, and I'm glad I got it now.

economies based on endless growth don't, uhm, work.

They do work.

The US economy, and those of other modern countries have been growing probably since at least the Industrial Revolution, maybe much longer. Without growth you have a problem - population grows, the economy doesn't grow, per capita income falls, etc. This is the sort of thing Malthus talked about.

Even if population is constant there's still a problem. Without growth any increase in anyone's income comes at someone else's expense. You want a raise? OK. Whose pay should we cut to give you one?

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Regions and cities which never enjoyed the boom are now relishing in the stability. Yes, there may be a 5-10% drop due to spillover, but modest home values will keep the local economies nearly immune as compared with hot markets. Buffalo is looking balmy,

Why Banks are going Out of Business?

Since late 2006, 288 banks closed their doors, while other major banks are in the process of bankruptcy. Indy mac, countrywide, washington mutual, chase wholesale and lately on the verge of a merge wells fargo and wachovia, just to mention some. People are terrified to loose all their savings, so they’re saving money in their homes instead. That is a scary situation for america and the whole world. Which leads me to this question: What is happening to the world?

Remember 5 years ago?
We used to spend money on real estate investments, luxury cars, vacations and we still had some money left, money wasn’t an issue. Back then some people looked at all these spending as a temporary ride, while others thought this dream will last forever. The problem was that 90% of us thought this dream will last forever, unfortunately the banks were part of this category and that’s where the economy crisis started.

We can blame each other or we can blame ourselves, but looking for faults will not fix anything. Many people are completely innocents, they just wanted to have a more comfortable lifestyle, but others (banks, mortgage brokers, loan officers, real estate professionals, etc) wanted to get rich from these innocent people. Why innocent people need to pay the price? Unfortunately that is how the system works in america; rich people’s money always will play a roll over the ones that don’t have as much.

We’ve trusted banks with our money, our investments and our homes. If you think about it for a second you don’t trust anybody in this world like that, so why do we trust banks? No one can understand really why, but many will blame the false advertisement and promises that banks kept on delivering to us through television, radio, newspapers, internet and other sources of advertisements. Banks are a multi billion dollar organizations that run the world, but today it’s a little different.

It’s hard for us to accept changes in life, but this change topped every other small change that we were afraid from. No body ever expects something like this to happen in the year 2008, but we have to learn how to live with this change. Many people have predicted this change to last for about 5 years or more, some say it will last for 2 or 3 years, but no body really knows.

Some of the questions that you’re probably asking your self today are:
Who will tell us what to do with our money?
Who will tell us what is the right investment for our money?
Who will tell us how much money we have?
Who will loan us money when we need it?
Who will help us sleep well at night?
Who will help us finance our homes?
Who will help us build businesses?

We have so many questions and no ones to talk to, because now these banks are fighting for existence. There are some organizations that operate by the government and they can help you with your money, but don’t ever forget that you are the master of your own mind and use it to your benefit. More important you need to learn how to live with this change and make the best of it.

good job

how should central bank position in managing economic meltdown

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