The wreckage in the housing market just keeps piling up. Sales of
existing homes in October dipped 23.5% from last year. Prices on new homes
dropped 13% year over year. Third quarter foreclosures skyrocketed to 635,000,
a 94% increase over last October and an all-time high on the Misery-Meter. The
real estate market is in free-fall and the real trouble hasn't even begun yet.
California, Nevada, Arizona and Florida are mired in a full-blown
housing depression. Inventory is off-the-chart. Presently, there's a 10.8
month backlog and the numbers are steadily rising. If foreclosures continue at
the current pace, by the end of 2008, there'll be a 14 month inventory. That
means that every builder in the country could take off his tool-belt right now
and stop working FOR MORE THAN A YEAR before the market would clear.
Contractors would be filling out job-applications at Red Lobster or looking
for an empty street-corner with a tin cup.
We're now entering the crisis phase of the biggest housing bust in
US history; Greenspan's remake of Three Mile Island; only this time the whole
country will be vaporised by a subprime-radioactive cloud.
As bad as the housing market is now; it's going to get a whole lot
worse. Judith Levy sums it up in her article ?ARM Resets to Hit Fan in 2008?:
? In 2008 interest rates will be reset upward on $362 billion worth of
adjustable-rate subprime mortgages [ARMs] ....The 'real crest of the reset
wave' has yet to take place, which promises more pain for borrowers, lenders
and Wall Street.... In addition to the $362 billion of subprime ARMs, $152
billion of other adjustable-rate loans are scheduled to reset in 2008,
including jumbo mortgages and Alt-A loans. The Mortgage Bankers Association
estimates that 1.35 million homes will enter foreclosure in 2007 and another
1.44 million in 2008, up from 705,000 in 2005.?
$514 billion in resets. 3.5 million foreclosures.
Did I say Three Mile Island? I meant Nagasaki.
California is bound to be the state that's hardest hit by the housing
slump. Homeowners can expect to see price depreciation that could rival the
Great Depression. As Broderick Perkins says,
?The California Association of Realtors reported the median price of an
existing, single-family, detached home in California dropped 9.9 percent in
October, compared to the same month a year ago. The decline was the largest
year-to-year decline in CAR's history books....
We believe that a downturn is imminent, with sales volumes down 52 percent
from the peak (in January 2005) and inventory (11.8 months) up 100 percent
since last year. House price depreciation and credit deterioration go
hand-in-hand. We anticipate residential mortgage credit deterioration to
follow house price declines in California. Presently, credit quality (in
absolute terms) is better in California versus the national average, but the
rate of deterioration is much worse. For instance, in the second quarter of
2007 delinquency rates for prime ARMs and subprime ARMs rose 92 percent and 73
percent year-on-year respectively in California, versus 53 percent and 38
percent nationally," Goldman Sachs reported.?( Broderick Perkins, ?Record Home
Price Declines Portend Extended Downturn?, Seeking Alpha)
Wow. Home prices dropped 10% in a MONTH! Inventory is up 100%. Sales
volumes are down 52%. Its the trifecta!
Its getting so hard to sell a house in California, that people are
resorting to divine intervention. A number of websites have popped up on the
Internet promoting transcendental or occult techniques for attracting
potential buyers. Luckymojo.com recommends an old favorite; ?burying a statue
of Saint Joseph upside down in the yard?. The site even features its own ?Real
Estate Spell Kit? which includes:
1 Dressed and Blessed Saint Joseph
Candle
1 Statuette of Saint Joseph
1 Bottle Saint Joseph Oil
1
Saint Joseph Chromo Print
1 Saint Joseph Holy Card Luckymojo even provides
an optional prayer that can be recited during the ceremonial burying of St.
Joseph:
Saint Joseph, I am going to place you
in a difficult position
with your head in darkness
and you will suffer as our Lord suffered,
until this [house/property] is sold.
Then, Saint Joseph, I swear
before the cross and God Almighty,
that I will redeem you
and you
will receive my gratitude
and a place of honor in my home.
Amen.
Following the prayer, the supplicant takes the statue
of Saint Joseph and plugs him into the ground upside down and waits for the
phone to start ringing. Who needs a realtor anyway? ?If there's no yard, then
dig a hole in a large potted plant.? St. Joe won't mind. All of this can be
done without chanting, amulets, prostrations, or messy sacrificial animals.
It's worth a shot.
But sorcery won't work for everyone and the deteriorating housing market is
sending tremors through the broader economy. In fact, the accelerating rate of
foreclosures has put Washington in full panic-mode. Treasury Secretary Henry
Paulson has been frantically trying to put together a bail-out package that
will keep millions of homeowners from losing their homes. Here's Paulson's
statement from earlier in the week:
? As we are all aware, the housing and mortgage markets are working through
a period of turmoil, as are other credit markets, as risk is being reassessed
and re-priced. We expect that this turbulence will take some time to work
through, and we expect some penalty on our short-term economic growth.
To speed up the modification process, Treasury is working through the ?HOPE
NOW? alliance with the American Securitization Forum to convene servicers and
investors so they can develop categories of borrowers eligible for appropriate
modifications and refinancings, and an industry-wide solution....I am
confident they will finalize these standards soon. And I expect all servicers
will implement them quickly, and create benchmarks to measure their progress
along the way. As a result, what was a fragmented, cumbersome process can be a
coordinated effort which more quickly helps able homeowners.?
Who does Paulson think he's kidding? He knows the plan is a non-starter.
Why would homeowners opt to make outrageous monthly payments on homes that are
quickly losing value, when they can just park the keys on the kitchen counter
and vamoose. There's no incentive for them to be shackled to a home if prices
are going down. They'd be better off loading up the U-Haul, grabbing the dog,
and letting the bank worry about it. That's who Paulson is really worried
about anyway. ?Helping the homeowner? is is just a red herring.
There are a number of glitches to Paulson's scheme. For example, if he
freezes monthly mortgage payments, then bondholders won't get what they
bargained for and the market for mortgage-backed securities (MBS) will dry up.
As Tom Deutsch, deputy executive director of the American Securitization
Forum, said, ``If they no longer invest in mortgage-backed securities, you've
cut off the credit available for refinancing, you cut off the lifeblood of
being able to give better loans.? (Bloomberg)
That's right. If investors don't get the returns they were promised---or if
the government arbitrarily changes the terms of the deal?bondholders will just
take their money and put it somewhere else. It's as simple as that. That would
trigger a run on the MBS market and put the kibosh on Paulson's plan.
One thing is certain, investors will not sit by quietly while their
rights are trampled and their profits are slashed so that people can stay in
their homes. That won't happen. Any viable bailout plan will have to be
evenhanded, so that everyone shoulders part of the burden. Besides, these
bonds are covered under contract law and the investors have rights. Paulson
seems to thinks he can just make up the rules as he goes along. But he's
wrong. If he tries to void or rewrite the contracts he'll be hit with
class-action lawsuits that will stop him in his tracks.
The best summary of Paulson's plan appeared in the Wall Street
Journal:
?This whole scheme is an act of eminent domain, except the government isn't
formally seizing property rights, but emboldening private parties to do so.
Why is no one calling a spade a spade??
It's ironic that the biggest boosters of free enterprise?like
Paulson---are the first to do an about-face at the first whiff of grapeshot.
Whatever happened to principles? Does Paulson really want to promote a
scheme that forces the revision of contracts as well as repeals basic property
rights? Needless to say, Paulson's metamorphosis into Leon Trotsky has not
been warmly received on Wall Street where he has been lambasted by friend
and foe alike.
The housing blowup is having dire effects on global financial markets. The
credit crunch has spread throughout Europe where lending standards are
tightening and industrial growth is threatened by the falling dollar. Consumer
confidence has plummeted in Europe just like in the US. Last week, the Dow
Jones slipped below its August low of 12,850 following the path of the
Transports. The stock market continues to lurch back and forth furiously like
an overloaded washing machine; soaring 100 points one day and then, plunging
200 the next. The volatility is just another indication that we are entering a
primary bear market. Dow Theory suggests that the trajectory will continue
downward into recession.
The subprime debacle has cast doubt on whether the ?structured finance?
model of securitizing debt will survive. On Monday, there were crucial new
developments in this story that will have profound effects on the future of
many the country's largest investment banks. E*Trade Financial has been forced
to liquidate $3 billion of its mortgage-backed securities. Up to now, the
banks, hedge funds an other holders of these toxic MBS and CDOs have been
reluctant to sell, fearing that trillions of dollars in asset value would be
immediately wiped out (for similar investments) once a firm ?market price? is
established.
Well, the Day of Reckoning arrived on Monday and the only thing missing was
the funereal dirge and the wreath of fresh lilies.
According to Reuters:
? Financial analysts on Friday said E*Trade got anywhere from 11 cents to
27 cents on the dollar for its $3.1 billion portfolio of asset-backed
securities. The portfolio sale was part of a $2.5 billion capital infusion
from a group led by hedge fund Citadel investment Group.
"The portfolio sale, one of the few observable trades of such assets, has
very clear, generally negative, implications for the valuation of like assets
on brokers' balance sheets," Credit Suisse analyst Susan Roth Katzke said.?
$.27 on the dollar! Yikes. No doubt they'll be pulling a few weepy bankers
off the ledge before the week is out.
What is particularly distressing about the E*Trade sale is that over
60% of the $3 billion portfolio ?WERE RATED DOUBLE-A OR HIGHER?. That means
that even the best of these mortgage-backed bonds are pure, unalloyed garbage.
This is really the worst possible news for Wall Street. It means that
trillions of dollars of bonds which are currently held by banks, insurance
companies, retirement funds, foreign banks and hedge funds will be slashed to
$.27 on the dollar OR LOWER. Banks will have to hoard reserves to meet the new
capital requirements on the falling value of their assets, which means that
they'll have less money to loan to businesses and consumers. In fact, this is
already taking place. (which is the real reason the Fed keeps injecting money
into the banking system) The E*Trade ?firesale? confirms that the country--and
perhaps the world---is now headed into a downward deflationary spiral. The Fed
will HAVE to cut interest rates 50 basis points on December 11, just to keep
the financial system from freezing up entirely. That will, of course, further
emasculate the dollar and send food and energy prices through the roof.
There's really no way to overstate the importance of the E*Trade
sell-off. It is the equivalent of a neutron bomb detonating in the heart of
the financial district. Yes, everyone is still milling around with their
caramel Macchiatos clutching their Blackberries just like before. But the game
is over. Trillions of dollars of market capitalization will be lost and some
of the biggest names in banking will be carted off to the boneyard. It will be
a miracle if the Fed's interest rate cuts are enough to keep the economy
sputtering along while the losses are written-down and the country recovers
its footing.
$.27 on the dollar should be inscribed on the headstone of every Wall
Street fraudster and every chiseling ?financial innovator? who transformed the
world's most powerful and resilient markets into a carnival sideshow. It
should include every subprime ?no doc--no down? homeowner who lied on his loan
application to goose the system and get another 50 grand for a jet-ski and 42?
liquid TV; every cheesy realtor who fudged the paperwork to put unemployed
busboys with bad credit in $550 McMasions in Loma Verde; every ratings agency
stooge who got carpal-tunnel from stamping each shaky subprime loan with with
AAA seal of approval; every lacquer-hair banker in a two-toned shirt who
bundled up garbage loans and dumped them on Wall Street; every shabby hedge
fund manager who used the subprime loans to beef-up his own personal
administrative fees by leveraging the MBSs and CDOs at rates of 10 to 1; every
regulator who serenely looked the other way while the market was dousing
itself in jet-fuel and reaching for the matches; and, of course--above
all--the Federal Reserve, who initiated this whole boondoggle by producing
trillions of dollars of low interest credit which flooded the system creating
the greatest speculative frenzy in the world history. Alan Greenspan?the Ponzi
Ringleader-- deserves a place of honor at the head of the chain-gang as they
are frog-marched to some remote black site where they can pay for their
transgressions.
The rest of us will have to stay put and endure the fallout from a
?completely avoidable? Great Depression. We're dead ducks.
Managing Director of Pimco Managed Funds, Bill Gross, summarized our
present conundrum in a recent article:
? What we are witnessing is essentially the BREAKDOWN OF OUR MODERN DAY
BANKING SYSTEM, a complex of levered lending so hard to understand that Fed
Chairman Ben Bernanke required a face-to-face refresher course from hedge fund
managers in mid-August. My PIMCO colleague, Paul McCulley, has labeled it the
"SHADOW BANKING SYSTEM" because it has lain hidden for years?untouched by
regulation?yet free to magically and mystically create and then package
subprime mortgages into a host of three-letter conduits that only Wall Street
wizards could explain.? (Bill Gross, ?The Shadow Knows?, Pimco Funds)
A few months ago, Gross's observations would have been dismissed as the
ravings of a doomsday alarmist. Now they are part of mainstream analysis.
Gross is a realist. The financial markets are broken; it's time to strap the
patient to the gurney and wheel it in to I.C.U. No more band aids, thank
you.
Closing Thoughts
The President of the St. Louis Fed, William Poole, discussed many of these
issues in a speech last week. Poole insisted that it is not the Fed's
intention to ?pump up the stock market? or to protect investors from losses by
lowering the Fed's Fund Rate. Rather, the rate cuts are supposed ?to restore
normal market processes. He said, ? An active financial market is central to
the process of economic growth and it is that growth, not prices in financial
markets per se, that the Fed cares about.?
Fair enough.
He added, ?One of the
most reliable and predictable features of the Fed's monetary policy is action
to PREVENT SYSTEMIC FINANCIAL COLLAPSE. If this regularity of policy is what
is meant by the ?Fed put,? then so be it, but the term seems to me to be
extremely misleading. The Fed does not have the desire or tools to prevent
widespread losses in a particular sector but should not sit by while a
financial upset becomes a financial calamity affecting the entire economy.?
The Federal Reserve is now actively trying to forestall ?a systemic financial
crisis?. (Poole's words) The trillions of dollars that were loaned to mortgage
applicants--and which ignored traditional criteria for lending---have
created the likelihood of a decades-long downturn in the housing industry as
well as a meltdown in the broader financial markets.
The bundling of dodgy subprime liabilities and selling them as valuable
assets to unsuspecting investors; is a scam that any competent regulator
should have spotted immediately. And stopped. It doesn't take genius to
see that offloading sketchy MBSs and ?marked to model? CDOs to gullible
institutions is wrong and a danger to the entire system. Financial innovation
has created a dilemma for which there is no easy solution. The Genie cannot be
put back in the lamp. Paulson's remedies have no chance of succeeding.
Mortgage-backed securities have been so chopped up and spread throughout the
system; it would be easier to to unravel a bowl of spaghetti , separate each
strand, one by one, and lie them next to each other without touching. It can't
be done. The bad debts will have to be written down, banks will have to fail,
and government will have to investigate affordable housing alternatives for
millions of defaulting homeowners.
Deregulation has created a monster. The prevailing Reagan-era, ?supply
side?, free market doctrine has removed tariffs, subsidies and other
state-created price-distortions, but it has also eliminated all oversight and
accountability. Government agencies no longer play an active role in policing
the markets and, as a result, US financial institutions have fallen into
disrepute. This is, first of all, a credibility problem and it
will require astute leaders with a strong moral foundation, not evasive
bureaucrats who're looking for a painless way to ?cut their losses? and and
keep the wheels of industry clanking along. Asset-backed commercial paper--a
$2 trillion business--?is hardly trading at all.? The securitization of credit
card debt, mortgages and car loans has slowed to a crawl and is in danger of
stopping altogether. Many of the main engines for generating revenue for the
banks?the repackaging of debt and amplifying it through levered
derivatives?has vanished overnight.
The financial markets have never been under such stress. There's so much
mortgage-backed gunk in the plumbing, the system is grinding to a halt. This
is no the time for ?business as usual? ?garbage in, garbage out?. We need
people who really understand what is going on to step up to the plate and
propose coherent ?fiscal? policy options that will steer the global economy
away from the reef. Forget about Paulson's ?quick fix? snake oil. It's utter
bunkum. The credibility of the system is at at stake. It's time to get
serious.
By Mike Whitney
Email: fergiewhitney@msn.com
Mike is a well respected freelance writer living in Washington
state, interested in politics and economics from a libertarian perspective.