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Wednesday, September 05, 2007


There's some very good stuff over at Calculated Risk, but first, we will let Stagflationary Mark provide a few graphs to set the stage:
Illusion of Prosperity 1:

Use the link for an explanation of the data he is using before you decide this isn't so. (This means you, Anon.) Also see this post regarding home mortgage debt. Think about what the different slopes on the graphs mean.

On July 2nd I posted regarding commercial lending going splat. The period of plausible deniability having expired, Bloomberg now contemplates the matter:
U.S. commercial real estate prices may fall as much as 15 percent over the next year in the broadest decline since the 2001 recession as rising borrowing costs force property owners to accept less or postpone sales.
Investors in July bought the fewest commercial properties since August 2006 and apartment building acquisitions were down 50 percent from June, data compiled by industry consultants at New York-based Real Capital Analytics Inc. show.
``There are so many deals falling apart,'' said David Lichtenstein, chief executive officer of Lakewood, New Jersey- based Lightstone Group, an owner of more than 20,000 apartments and 30 million square feet of office and retail space. ``People who can get out are getting out.''
The reason why CRE has gone splat is the same reason causing the problems in residential real estate. Overbuilt and overborrowed, with irrational expectations of returns. See Calculated Risk also.

Now we turn to S&P's claim that they are in no way to blame and that all of this is just a complete misunderstanding. Start at Calculated Risk's post on the subject, which takes issue with statements such as:
Ratings are designed to be stable. Unlike market prices, they do not fluctuate on the basis of market sentiment.
But they can and do change -- either as a result of fundamental adjustments to the risk profile of a bond or the emergence of new information.
New information? Cut me a break. This is pure nonsense. Look at the graph above, and tell me what new information came to light? Suddenly?

When we come to high finance (leveraged buyouts, etc), the picture is not really very different. Again, overleveraged deals based on unrealistic expectations. Again, some of these deals were initially closed on the basis of utterly unrealistic debt levels, that is, the corporate unit carrying the debt did not have the income to support it.

Nor is this solely a US problem. The phenomenon has occurred all over the world, from Asia to Australia, on every continent.

No go read some FOMC statements. Let me just give you this sample from their last released minutes:
Participants thought that consumer expenditures likely would expand at a moderate pace in coming quarters, supported by solid gains in employment and real income. Though growth in consumer spending had slowed in the second quarter, the slowing likely reflected temporary factors in part, including some payback from unusually strong growth in prior quarters and the surge in gasoline prices. Several participants noted the risks that house prices could decline significantly and that credit standards for home equity loans could be tightened substantially as factors that could weigh on consumer spending. However, the sizable upward revision--from negative to positive--in estimates of the personal saving rate during the past three years suggested somewhat less need for households to rebuild their savings.
There are no adults standing around, my friends. The will to believe has overcome contact with reality, and nobody, but nobody, who was in charge of any part of this is ever going to stand up and admit the truth about it.

The failure to admit what happened and how is very likely to create a toxic social and political environment. As we speak, the financing for smaller businesses is starting to dry up. How bad it will be depends on just how bad the previous lending has been, so the effect isn't fully quantifiable yet. This will be a shocking event to those affected, and a broad range of individuals will be affected. The aftermaths of bubbles always leave the survivors dazed, confused and harboring a sense of injustice. Those who bought into the bubble claim it is everyone else's fault, and those who acted responsibly and suddenly get caught in the undertow created by all the irresponsibility know it is not their fault. Everyone will be looking for the culprit.

Historically speaking, such events are associated with social and political instability and nasty turns in mass psychology. Pogroms, for example. Persecutions. Ejections of minorities.

Democracies have the ability to deal with these events differently, but only if accurate information is disseminated through the society.

The graph is indeed alarming, and there's unquestionably been a lot of irresponsible propaganda to the effect that home prices will go up at 10-15%/year, forever.

However, I wonder how much of the graph is accounted for by a shift from renting to owning. If an individual lives in an apartment, then the financing of that apartment is presumably included in some commercial financing category, rather than as mortgage debt. But if he buys a house, then the financing for it will be mortgage debt.

I doubt if this accounts for the majority of the upward slope, but it surely accounts for some of it.
Yes, David, that's right. All those marginal FTHB plop on in there. Of course, we've already dropped about 1.6-1.8 percent in homeownership since the peak.

But we know that the FTHB don't account for the bulk of it, because of the numbers I showed a few posts ago.

Commercial multifamily debt ballooned upward over the same period.
As P.T. Barnum commented, there's a sucker born every minute!!!
It isn't (just) that there's a sucker born every minute but that there's a member of the greatest generation dying every minute and leaving behind one house to their 4 children thus creating a new high priced mortgage somewhere somehow.
Rob, yeah, the demographics are pretty chilling.
I managed to track down the source of my site's seemingly increased populariy. It figures that Mama would be responsible, lol. ;)

I just thought I'd stop by, say thanks, and let you know I just put up a another article on this topic titled The Physics of Home Mortgage Debt.
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