Tuesday, September 26, 2006

The Availability of Money and the Causes of Crash

How is money made?

Did you say by working? You're wrong. Maybe by selling goods or services? Wrong again. You don't make money when you work. You don't make money when you sell things. In fact, YOU don't make money. At all. Ever.

Working, or selling stuff, allows money to be TRANSFERRED from one place to another. When you go to your job and work, you do not create any money. The money already exists. It exists in your employers account. And in exchange for your work, it is transferred into yours.

Working does not create money. Working only transfers money.

Selling does not create money. Selling only transfers money.

I apologize if I'm being didactic, but this point cannot be stressed enough. It is absolutely key to understanding the nature of the problem facing the economy right now. Our day to day activities do not create money. They only transfer it around.

So, where does the money come from? Well, where do you keep YOUR money? Obviously, the bank.

Unlike us plebes, banks DO create money. And I don't mean print it. Forget all that green stuff in your wallet. Tangible currency represents only a tiny, tiny fraction of the actual money supply. The vast majority of 'real money' doesn't really exist at all. It's just numbers in a computer somewhere.

Banks create money. In theory, they can only create a certain amount of it. And that amount is supposed to be governed by the Federal Reserve. But the Federal Reserve can only do so much. In fact, they only have three major buttons they can push.

The first is the funds rate. This is how much banks charge each other for overnight loans. Next is the discount rate. This is how much a bank pays to borrow money from the Fed. And finally, the reserve requirements. This is supposed to determine how much money a bank can invent. With these three buttons, the Fed is supposed to guide our economy down the wide path of prosperity. But what happens, when the road starts to curve?

So, we're driving along and all of a sudden, the tech bubble bursts. We swerve to avoid a wreck, only to get hit by a bunch of terrorists flying airplanes into buildings. We swerve again. The Fed is worried about a crash. So, to avoid it, they do the only thing they can do. They start pushing their buttons. They start pushing buttons 1 and 2, lowering the rates and effectively telling the banks to get out there and Loan. More. Money.

What they don't realize is that button #3 is broken. The reserve rate that is supposed to limit how much banks can lend no longer functions. Thanks to new funding sources, most of the loans created by banks have nothing to do with their reserves. They can invent money at will. So the banks are unleashed with no way to control them, while the Fed helplessly watches and mashes buttons.

With nothing to stop them, the banks go nuts. Money is cheap and widely available. The banks are practially giving it away for free. And the people can't get enough. The table is set, the guests are seated. The housing boom begins.

Jump a few years into the future.

Housing is a runaway train, and the someone needs to put the breaks on it. They now realize button 3 is jacked, so they go back to pushing buttons 1 and 2 over and over again, raising the rates. Stop lending! They are practically screaming now. But the banks listen! They stop inventing money... and the magic money machine STOPS.

But do all those loans that the banks made disappear, too? Nope. Those are still on the books. And people still need to pay for them. But look at what just happened... they turned off the machine. There's no more money available.

The money supply dried up!

So, let's ask another simple question. What happens when the demand for something (money) remains the same, but the supply shrinks? Welcome to Surviving the Crash.

Sunday, September 24, 2006

An ARM and a Leg

Although there are a few reports of stability and improvement from around the country, the majority of the news coming in right now about the housing market has not been good. Take this quote from a recent article in the Pioneer Press...
As the housing boom ends, experts worry that rising interest rates and slowing home values will push thousands more Minnesotans out of their houses.
The article then continues to talk about a family that lost their home, and how many others are following suit
But soon, the Schlenners will move on, like the more than 4,200 Twin Cities-area homeowners who have lost their homes to foreclosure so far this year. That's a low figure, compared with other cities, but a steep increase for the seven-county area, which is on pace to double last year's record number of foreclosures.
The trend is clear, foreclosures are on the rise, and the middle to lower middle class is going to be hit hardest. Most of us understand this in individualistic terms. Yes, some people will lose their homes. But, what about the cumulative effect that these kinds of losses can have on a community? What happens when entire swaths of neighborhoods get foreclosed?
The surge of home losses has shocked city and state officials, startling some veteran city planners and foreclosure-prevention pros. Community activists say pockets of foreclosures in the core cities have reached crisis proportions, threatening years of community development. In St. Paul, it's left city code-enforcement workers struggling to keep tabs on a mushrooming crop of empty properties. More than 800 houses in St. Paul are now officially vacant, double last year's list.
This is not going to be a unique experience. In fact, if you plotted a density map of foreclosures and layered it over a map of ARM lending hot spots, I bet you'd find a nice correlation. In the meantime, the people who got lured into spending beyond their means are going to get increasingly desperate to hold on to their gains.

Unfortunately, it's going to be a losing battle for most. If you can't pay the note now, you probably won't be able to pay it later. All you can really do is buy more time. But, to do that, you will have to go deeper into debt. And, I think that's exactly what a lot of people are about to do.

For the people who can afford it, or who are not locked in to tightly, I think we will see a lot of refinancing as people try to get OUT of the ARMs race. People who can successfully do this may be able to dodge a bullet - for now. But people who can't afford to do that will have fewer options.

Most will probably try to go deeper into debt just to stay afloat. But, will the money be there for them? I doubt it. Forget the fact that the money supply is vastly smaller than it was when this boom got started. How are you going to get a home equity loan when your home is worth less now than it was when you bought it?

It's hard to see an easy way out of this. And it's NOT from a lack of trying. All the talk of soft landings a few months back was a collective game of wishful thinking. But, you don't hear that kind of talk now. At some point, reality has to set in. And, it looks like we're about to get a heavy dose of reality.

* photo by Ben Garvin, Pioneer Press

Thursday, September 21, 2006

Check out my NEWS SITE!!!

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Wednesday, September 13, 2006

Assessing Option ARM Risk

Check out this article from Bankrate.com. It discusses 5 ways to asses the risk of your option ARM. If you're not familiar with these products...
An option ARM is an adjustable-rate mortgage that gives the borrower four choices of a payment each month. The borrower can pay the amount necessary to pay the loan off in 15 years or in 30 years. The borrower can pay only the interest charged in the previous month. Or the borrower can make a minimum payment that doesn't even cover the interest, so that the loan balance increases.
For the unwary, they are financial quicksand. When you hear the experts talking about 'exotic loan products', this is what they mean. Borrower beware!

Senate Banking Hearing Statements

Here are the statements from the Senate Banking Hearings:
David Seider sees the crash bottoming out middle next year:
The downswing in home sales and housing production should bottom out around the middle of next year before transitioning to a gradual recovery that will raise housing market activity back up toward sustainable trend by the latter part of 2008.
He also acknowledges that prices may drop:
National average house price appreciation is likely to be quite limited in the near term. Indeed, some decline is a distinct possibility, and the rate of price appreciation should remain below trend for some time.
But as we move along, we start getting into deeper waters:
However, much of this negative impact should be offset by strengthening activity in other sectors of the U.S. economy, keeping GDP growth reasonably close to a sustainable trend-like performance.
Let me paraphrase: Housing is out of gas, and something else needs to step up to the plate and carry us for a while. It's easy to say, but hard to do, considering how much overall impact the housing boom has had on jobs, wealth, and growth.

He makes an interesting prediction:
It’s likely that the bulk of the downswing in home sales and housing production will occur this year, with market activity stabilizing around mid-2007 and moving back up toward trend by late 2008.
Again, let's paraphrase: The bubble has popped, like everyone said it would. But, the recovery will only take a year or two. Put a star by this one, I have a feeling we'll be adding it to the quote list later on.

More soon...

Housing Bubble vs. Great Depression VIDEO

Here is the updated, new and improved, higher quality version of the Housing Bubble vs Great Depression video. Enjoy!

They are taking notice on the Hill...

Reuters is running a story about the Housing Market and Innovative Mortgage Products:
U.S. lawmakers will question some leading government and industry economists about the perils of a possible 'housing bubble' in a Wednesday hearing.
It goes on to say:
Next week, the same committee will hold a hearing on the growth of innovative mortgage products that have mushroomed along with the housing sector.
I'll be watching this fairly closely. It's interesting to see politicians starting to set expectations in their talking points. Jack Reed (D-RI) used the phrase "Bumpy Landing". I'm not an expert on etymology, but it will be interesting to see if that "Bumpy Landing" morphs into "Crash Landing" soon, and then is simply truncated to "Crash."

The list of people slated to speak is fairly interesting. Among the Housing Experts are:

  • Mr. Richard Brown, Chief Economist, Federal Deposit Insurance Corporation
  • Mr. Patrick Lawler, Chief Economist, Office of Federal Housing Enterprise Oversight
  • Mr. Dave Seiders, Chief Economist, National Association of Homebuilders
  • Mr. Tom Stevens, President, National Association of Realtors
If you've been following this blog, you'll recognize some of those names. Dave Seiders made a few contributions to our Great Depression vs. Housing Bubble article. And Patrick Lawler's office is responsible for the OFHEO index that we discussed in our Housing Heating Up Overseas + Flawed Index article. Not that the index itself is bad... it's just that it is a lagging indicator, and so for predictive purposes, it's completely useless.

At any rate, if you missed Dancing With the Stars yesterday, tune in to CSPAN... there will probably be a lot of dancing going on during these hearings.

Tuesday, September 12, 2006

Meeting Notes

Seems I've been focused a lot on the housing bubble lately. It IS fascinating to me, especially watching it unfold in my local area. But, I want to assure you all that I am by no means fixated on just housing.

I don't have time to talk about currencies and monetary policy at this point, but I promise to do that in a future article. I am also planning to blog about my personal finances, and how I went from debt-full to debt-free in a few months. In the meantime, Thank you for visiting! I hope that you return (and bring your friends), and I wish you great success in all your endeavors. Best wishes!

No Housing Bubble?

Interesting article stating that there is no Housing Bubble. Interesting in that it is based on a lot of false premises. Some of the key arguments:
"The greatest pain will be felt by the biggest speculators and the most overzealous people participating in unorthodox loan programs."

"real estate is a finite resource."

"There is a need for more housing, period!"
I don't know if I agree. It's true, the speculators and bad credit loans will get pinched. But I look at them like the canaries in the coal mine. It's not that they will get hit WORSE than anyone else. It's just that they will get hit FIRST. And the wave that takes them out will by no means stop after it hits them. It will keep rolling on.

Consider this statement about US economic growth over the past few years:
Consumer spending and residential construction have accounted for 90 percent of the total growth in the American GDP over the last four years, and more than 40 percent of all private-sector jobs created since 2001 have been in housing-related sectors, including construction and mortgage brokering.
You can't attribute that kind of growth to a few speculators and mortgage brokers. Housing has been driving this train for a while now, and when it stops... or even slows down... it is going to hurt. Consider recent reports on how residential home builders are shedding employees:
U.S. homebuilders and residential specialty trade employers cut 21,200 jobs in May, June and July, usually the peak building months, according to the most recent preliminary numbers from the Labor Department. The statistics, adjusted for seasonal variations, also showed a significant job loss in March.
They aren't the only ones. Think about how many new realtors have been spawned in the past few years. Or the number of mortgage brokers. Or the number of lending products. The housing market is part of a vast ecosystem that has created a great deal of wealth in this country in the past few years. And when it tanks, believing that only the people on the outermost fringes will get hurt could be a fatal mistake.

Housing Heating Up Overseas + Flawed Index

A story in the recent Economist about Housing Prices just reinforces what we already know. The US housing market is 'cooling'. They don't want to come right out and say it's crashing, but considering the index that they use, they don't really have to.

You see, the "OFHEO index is thought to be more reliable because it tracks price changes in successive sales of the same houses." And that sounds very nice and good. But there is a fundamental flaw in an index of that sort.

Unlike a stock market, where there is massive liquidity, you can't just unload a house and sell it. Houses are not as liquid as stocks. Wasn't that the great selling point that realtors used over and over during the boom? Well, it's a double edged sword.

When housing markets collapse, the values of the homes don't immediately start dropping. Instead, the entire market chokes up and grinds to a halt.

A disconnect forms between the sellers of the houses and the buyers. The buyers, faced with numerous options, float lowball offers knowing that the seller is behind the eight ball. They have no sense of urgency. They know they can wait the sellers out.

The sellers, on the other hand, refuse the offers, trying desperately to hang on to the paper profits they have already counted in their minds. They don't want to admit that they mistimed the market. So, they decide to sit on their property and wait. It's the old buy and hold strategy. Unfortunately, the only thing they are holding is the bag.

The Mexican Standoff is now in full swing. Both sides think they can wait the other side out. Housing sales stop happening. Inventory piles up. All of a sudden, your comps are not from houses that have sold a few weeks ago, they are from houses that sold last year. It starts to get hard to establish the value of a house.

Nothing happens.

Open houses are exactly that... open houses. Empty. The prospects are nowhere to be seen. Time passes. Now, the weaker parts of the boom herd start to go down. The people with ARMs and the like. Or the flippers, who swam in with the tide and got trapped on the beach.

They can't afford to wait things out. They see their losses mounting with each passing day. They will be the first to cut and run. And that's when the bleeding will start. But, the OFHEO index won't show any of that.

You see the problem, right? The index is based on consecutive home sales. But what happens if nothing is selling? The index goes blind. It goes blind until the panic sets in, and the prices get low enough to coax the buyers off the sidelines. It's a great indicator during a fast paced market. But it sucks when things slow down or stop.

Still, there seems to be good news. The real estate game seems to be in full effect in many European countries. So, if you can't bring yourself to stop playing with fire at home, maybe it's time to take your chances abroad. After all, having lived through this market, you should be an expert by now. Best luck, and much success!

Monday, September 11, 2006

Housing Bubble vs. Great Depression Quotes

"Stock prices have reached what looks like a permanently high plateau."
- Irving Fisher, Ph.D. in economics, Oct. 17, 1929

"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”
- David Lereah, Chief Economist, National Association of Realtors

"There will be no interruption of our permanent prosperity."
- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928

"It's impossible for prices to go down this year."
- Gary Watts, Spokesman Orange Country Association of Realtors

"I have no fear of another comparable decline."
- Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929

“I don't worry about new home sales,”
- James Glassman, JP Morgan Chase Economist

"In most of the cities and towns of this country, this Wall Street panic will have no effect."
- Paul Block (President of the Block newspaper chain), editorial, November 15, 1929

"There is no national housing market, so there can't be a national house-price bubble."
- Michael Youngblood, Managing Director, Friedman Billings Ramsey & Co

"I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future."
- E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928

“If you own your own home free and clear, people will often refer to you as a fool. All that money sitting there, doing nothing.”
- Anthony Hsieh, CEO Lending Tree

"Buying of sound, seasoned issues now will not be regretted"
- E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

"I think investors will have a good reason to come out here and buy again."
- Jeromith Sutton, 2006, NAR Investment Advisor

"...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression..."
- Harvard Economic Society (HES), November 2, 1929

"We're now in the 'middle innings' of the current economic expansion, and the next economic recession is not yet in sight.”
- David Seiders, Chief Economist, National Association of Home Builders, Jan 2006

"For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over."
- Business Week, November 2, 1929

"Speculators and people who bought homes with (adjustable-rate mortgages) in 2004 are in a lot of trouble and they're trying to get out,"
- Steve Bottfeld, a senior analyst with research firm Marketing Solutions 2006

"This crash is not going to have much effect on business."
- Arthur Reynolds, Chairman of Continental Illinois Bank of Chicago, October 24, 1929

"We may see a blip up in foreclosures and delinquencies."
- Leslie Appleton-Young, Chief Economist, California Association of Realtors

"For the immediate future, at least, the outlook (stocks) is bright."
- Irving Fisher, Ph.D. in Economics, in early 1930

"...housing activity will remain healthy for some time to come."
- David Lereah, NAR’s chief economist, October 28, 2005

"Financial storm definitely passed."
- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929

"There is no bubble to burst,"
- Jim Folkman, VP of the Home Builders Association of Central New Mexico

"The end of the decline of the Stock Market will probably not be long, only a few more days at most."
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929

"I'd say this is another very important signal that the economic soft patch we were all worried about is pretty much confined to March"
- David Seiders, Chief Economist, National Association of Home Builders

"Hysteria has now disappeared from Wall Street."
- The Times of London, November 2, 1929

"These long-run worries, there's an element of truth to them, but I think frankly the fears are exaggerated.”
- James Glassman, JP Morgan Chase Economist

"... a serious depression seems improbable"
- Harvard Economic Society, November 10, 1929

"The idea that we're going to see a collapse in the housing market seems to me improbable”
- John Snow, Secretary of the Treasury

"Gentleman, you have come sixty days too late. The depression is over."
- Herbert Hoover, responding to a delegation
requesting a public works program
to help speed the recovery, June 1930

"People who talk about a bubble are blowing smoke,"
- Michael Carney, Real Estate Economist
California State Polytechnic University Pomona.
Thursday, February 10, 2005

"This is the time to buy stocks."
- R. W. McNeel, market analyst, New York Herald Tribune, October 30, 1929

"There was never a "bubble", so there is nothing to "burst".
- Jeromith Sutton, 2006, NAR Investment Advisor

"There may be a recession in stock prices, but not anything in the nature of a crash."
- Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929

"When I hear [about a housing bubble] I get the sense that people aren't connecting the dots.”
- James Glassman, JP Morgan Chase Economist

"There is nothing in the situation to be disturbed about."
- Secretary of the Treasury Andrew Mellon, Feb 1930

"I think the bloom is off the rose, but there is no doom and gloom."
- Alan Nevin, Chief Economist, California Building Industry Association.

"Unless we are to have a panic -- which no one seriously believes, stocks have hit bottom."
- R. W. McNeal, financial analyst in October 1929

"The national media is reporting a housing bubble. Don't believe it.”
- Dale Akins, President, Market Edge

"While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover."
- Herbert Hoover, President of the United States, May 1, 1930

"I'm calling it a soft landing -- a return to what is considered to be more normal market conditions,"
- Leslie Appleton-Young, Chief Economist, California Association of Realtors

"Maybe we need something new. That's all I'm prepared to say"
"I'm sorry I ever made that comment."
"When I get my new term, I'll let you know."
- Leslie Appleton-Young, Chief Economist, Cal. Assoc. Realtors
When asked about her "Soft Landing" prediction

"...good stocks are cheap at these prices."
- Goodbody and Company market letter quoted in The New York Times, Friday, October 25, 1929

"Existing-home prices have not collapsed. They've come down to a more normal pace..."
- Larry Murphy, President SalesTraq, Real Estate Trend Tracker

"[1930 will be] a splendid employment year."
- U.S. Dept. of Labor, New Year's Forecast, December 1929

“The continuing shortages of housing inventory are driving the price gains. There is no evidence of bubbles popping.”
- David Lereah, NAR’s chief economist, August 2005

"The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin."
- Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929

"I'm so mad at my neighbor. I bought my new home here in Ashburn last summer and plan to sell it next year (after holding two years to avoid taxes) to make a nice return on my investment. The problem is my neighbor is trying to sell his house (very similar to mine) right now and he keeps lowering his asking price. Each time he lowers his price, I see my potential profits next year getting squashed. Doesn't he realize he's hurting the comps for all of his neighbors by doing this? I don't think he is acting very "neighborly" by doing this. I want to say something to him and tell him he should stop putting his interests ahead of his neighbors. It's people like him who are ruining the market for the rest of us. If he would just refuse to lower his price, we could maintain our comps and everyone would benefit. What can I do to stop him?"
- Question during a real estate chat held by the Washington Post.

"The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
- Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

“What the market is doing is going through a correction, which it really needed. It’s getting down to where it’s reasonable."
- Ted Martinez, representative to the National Homebuilders Association

"I am convinced that through these measures we have reestablished confidence."
- Herbert Hoover, December 1929

"We are really on track for a soft landing. There are no balloons popping.”
- David Lereah, NAR’s chief economist, December 2005

"All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
- President F.D. Roosevelt, 1933

"One of the reasons we think this market will start to run out of gas at some point is that you've essentially created as much gold from straw as you can from this financial alchemy,"
- Scott Simon, mortgage chief at California bond house Pimco.

"...there are indications that the severest phase of the recession is over..."
- Harvard Economic Society (HES) Jan 18, 1930

"... the outlook continues favorable..."
- HES Mar 29, 1930

"... the outlook is favorable..."
- HES Apr 19, 1930

"...by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..."
- HES May 17, 1930

"... irregular and conflicting movements of business should soon give way to a sustained recovery..."
- HES June 28, 1930

"... the present depression has about spent its force..."
- HES, Aug 30, 1930

"We are now near the end of the declining phase of the depression."
- HES Nov 15, 1930

"Stabilization at [present] levels is clearly possible."
- HES Oct 31, 1931

"The retreat in housing-market activity that's now under way amounts to a simmering-down process...rather than a classic cyclical contraction that could spiral down for some time."
- David Seiders, Chief Economist, National Association of Home Builders, Jan 2006

"Buying of sound, seasoned issues now will not be regretted"
- E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

"Housing is still the best investment, without question"
- Stan Sieron, Illinois Association of Realtors President

It's About That Time...

Grab your popcorn, kiddies, and hit CTRL+D! Some economic asswhup of biblical proportions is about to go down, and this blog is your front row seat ;)