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Wednesday, November 28, 2007

A Dose Of Political And Financial Reality

I have added several new blogs to the sidebar links. Calculated Risk, The Housing Bubble Blog and the UK Housing Bubble. Bloggers have done a superb job in chronicling and analyzing the mess - a much better job than even the financial press.

I know it's hard for Americans to believe that other countries did the same thing, so I think you'll find the UK blog very enlightening. For starters, a post with this graph:

As in the US, the UK housing bubble was fueled by low interest rates, short term adjustable rate loans, and a big rise in "buy to let", which is Brit for N/O/O, or specuvestor purchases.

In a prior post, this blogger looked at the rise in demand for rentals:
Will the rental sector save the bubble?

Of course not. However, we are detecting an increasing number of stories pointing to higher demand for rental properties. According to the Association of Residential Letting Agents (Arla), the level of tenants seeking to rent property privately has hit a five year high in the UK. "This peak demand should come as no surprise" said Ian Potter, head of operations at Arla. "Softening in the sales market is always a driver of further demand in the rental market," he added.

However, is it a good time to go out and invest in a buy to let property? Unfortunately for BTLers, rental values are very closely linked to incomes. So far, banks and building societies haven't found a way of providing loans to pay for bloated and overvalued rental properties. As we all know, you can't have a speculative bubble without masses of credit. So there will be no bubble in rental values.

When rents go up, tenants tend to move out and seek cheaper properties. Thanks to the BTL Brigade, there are plenty of choices out there, even in London. This keeps rental inflation very close to wage growth.
That rise in demand for rentals is a dead giveaway that the UK bubble is ending. Our UK bubble blogger contemplates the situation across the pond and notes that it forecasts the UK future. True. Nor is it just the UK. The situation in Spain is really bad, and a lot of UK buyers were buying homes in France and Spain. There were numerous bubbles in Europe, especially in the ex-Soviet bloc countries.

There was a grumpy yet accurate comment at CR yesterday:
I think American economists are saying, "Hell, not too much chance of recession because the weak dollar means we'll be exporting like crazy." The only problem with this reasoning is that the rest of the world is about to enter the same housing-induced recession. Europe (except for Germany and a few other parts) has seen a greater increase in housing prices than the U.S. That's about to end, and European consumers are going to start spending less, and those American exports will have one fewer place to go.
And then yet another commenter from Spain:
You, lucky americans, will soon touch the bottom and recover from this mess. Finantial and housing markets will be repaired cause you have the ability to identify the problems and act accordingly.

We, stupid spaniards (from Spain), will struggle with the inflated housing markets for decades because we are not able to react so quickly. We deny the reality. There's not such subprime issue in Spain, we say. Our lenders almost always ask for relatives that guarantee up to 80% of LTV, making default much more difficult, Many of us are poised to spend more than 40% of our personal income in debt servicing for many years.
The grass always looks greener on the other side. Rather than indulge in this "our bubble is bigger than your bubble" stuff (heh, size does matter, I suppose), we should all sit down and ask ourselves how this happened?

The imprecations against Bush and Greenspan don't explain why the same thing has happened in Asia, in Europe, in Australia and even in some places in Africa.

The way this happened is that banks had insufficient regulation. In the US, we followed the trend rather than having started it by repealing Glass-Steagall during the Clinton administration. One of the arguments for doing so is that the US was becoming uncompetitive because of outmoded Depression era restrictions that just didn't (harharhar oops!!!) apply in the modern era.

We must now pause to quote Albert Einstein:
Insanity: doing the same thing over and over again and expecting different results.
The truth is that any time you let the banks run wild, the risk takers will create so much short term profit that everyone will be pulled along to match them, the bad money chases out the good, and eventually the crash will come. This will happen in any country during any era. I have linked to the FDIC Summer 2006 Outlook so many times, because that was the issue in which the FDIC gently tried to hint that we were in for a rough ride:
Nineteenth-century economic downturns tended to be sudden and were often attributed to a lack of investor and creditor confidence, as opposed to downturns since the Great Depression, which have usually been preceded by other types of shocks, such as rising interest rates. Hence these earlier downturns, with their roots in financial markets, were usually called “panics,” whereas modern downturns are more often called “recessions” (see Table).

A great deal of blame for these financial panics was placed on banks contracting credit, as “the banks were … accused of aggravating the panic [of 1857] by their policy of calling in loans both precipitately and indiscriminately.” 7 The Great Depression, wrote a contemporary economist, was precipitated by excessive credit creation, particularly by selling goods on installment plans, a popular financial innovation of the time.8
The FDIC started the article with a bit of Greek history:
Since ancient times, credit markets have undergone periodic booms and busts. In 594 BC, for example, the Greek state of Attica found itself under severe economic stress because of the massive debt incurred by many of its citizens. The ensuing civil disorder resulted in a handover of power to Solon, one of the “seven wise men” of Greece. Solon took radical steps to restore balance to the economy, such as canceling debts, freeing those enslaved for failing to repay their loans, and devaluing the currency by 25 percent.
So this is where financial innovation got us 2,500 years later. Henry Ford may have believed that history was bunk, but Henry Ford didn't know squat about credit cycles. When you forget your economic history you are doomed to repeat it! Greenspan and Rubin were very instrumental in repealing many of the Depression-era Glass-Steagall restrictions, thus proving that they didn't know their financial history either.

When you create a debt bubble, you have two options to deal with the inevitable consequences. Depression, during which time the overloaded debtors struggle to pay their debts and consumption plummets, thus reducing incomes even more and increasing relative debt loads, or restoring consumption by devaluing your currency and wiping out some debts. There are no other alternatives. There is always a deflationary element when debts crash, because money is destroyed and credit is withdrawn to cover the destroyed money.

The ECB and the Fed are trying to dump enough money into the economy to offset the destruction of money, but we have a long way to go in redressing the situation. If it were only the US, the situation would be quite different - as happened during Japan's bubble and bust, the rest of the world would be able to escape our suffering. But when most of the major economies have indulged, we are facing an intimidating situation.

Blaming the Bush administration is like taking a placebo for cancer. It may give you a temporary warm glow and sense of well-being, but that's all it can do, and in the meantime you are just getting sicker and sicker. The Bush administration couldn't do squat about this, because you need the regulations which were dismantled to provide a framework for controlling risks. If Congress will not act to bring mortgages and credit in non-banking companies under a unified and strong system of regulation, NO president can do anything. Under our Constitution, presidents have limited power. This is wise, because they would almost certainly bubble if they could. However when Congress throws caution to the winds and jumps on the speculative bandwagon, there is no alternative force that can prevent the race toward financial destruction from beginning.

Ron Paul, by the way, is largely insane in his financial prescriptions. Really. Destroying the Fed would give politicians the license to create instant prosperity, and politicians are infinitely less responsible than the Fed. The democratic countries evolved the institution of central banks to deal with the reality that in each generation, voters and politicians will always choose to create instant prosperity at the cost of a nasty downturn later. I do blame the Fed and Greenspan for a lot, but the US has actually been one of the more restrained countries in this regard. You don't want to know about banking history in China and India, really you don't.

As for Japan, it has a far more massive public debt in ratio than the US does. Everyone should stop and think about that ugly fact.

One of the healthy elements of American culture is that we are quite self-critical, and admire greatly what works in other countries. However, admiring what works will only translate to benefits in our culture if we figure out how to implement it in ours, which means that we also have to look at the tradeoffs.

The banks gone wild and Bush isn't to blame part I get, but what about the lack of individual responsibility? It is infuriating to me, that people have pulled out 300,000 cash from their home, tried to sell it at a ridiculous price while telling qualified buyers that they will let it go back before they take less, following through and letting it go back after which they promptly take a vacation in Greece... and it's OK! Whatever, don't do it again. I am fully aware that kind of thinking is loaded with self-righteous indignation, but the kicker is wondering if maybe I'm not the idiot. Trying to do the right thing, even if it means living in an apartment, because my husband's job of 30 years required us to transfer 3 times in 4 years... when I could be living high on the hog and hey, if worse comes to worse go on vacation! Why save $$ when they're trashing the value anyway, there's no safe banks to keep it, and we see how well the experts are doing at investing it for us. Yep, I'm upset with certain individuals. Or maybe just jealous.
I grant you that it is infuriating, but in the end you will be in a better position than most of those who paid this game.

There is no possible bailout for almost all of the individual gameplayers in this one. The numbers involved are too huge. Banks will lose somewhere around 900 billion, and about 1.5 trillion of the debt out there is gonna bust.

All those state programs we heard about have refinanced less than 100 borrowers nationwide.
Okaay... Bush isn't to blame, I get it. [barf] Nobody was to blame for the S&L crisis or the junk bond market of the 1980s either. Hey, these things happen. Icky.
Hey, MOM, OT but CR is reporting the melt down in Commercial Real Estate.

You called this many months ago - I bet you are sad to be correct though.
Ron Paul, by the way, is largely insane in his financial prescriptions.

I have had run-ins with Ron Paul disciples. They remind me too much of Ross Perot's Perotistas back in 1992. i.e. "HAVE YOU ACCEPTED ROSS PEROT/RON PAUL AS YOUR *PERSONAL* LOORD AND SAVIOR??????" nonstop 24/7/365.

Trying to do the right thing, even if it means living in an apartment, because my husband's job of 30 years required us to transfer 3 times in 4 years... when I could be living high on the hog and hey, if worse comes to worse go on vacation!

Like buying the new Hummer and plasma-screen just before filing personal bankruptcy and screaming to Nanny Hiwwawy for The Bailout and walking away rich.

i.e. "SUCKER!!!!!!!!!!!!!!!!"

The Headless Unicorn Guy
Frank - yes, I know. It's inevitable. Anyone in the business who hadn't overloaded on the antidepressants knew this was coming.

I am more than sad. I'm really depressed. I wish I were able to start writing about the invisible growth trends in the economy rather than seeing nasty predictions come true. This too shall pass, but it worries me that we are so delusional about what is happening.

As for credit default swaps, the cost of insuring FNMA has more than tripled over the last few months. There is no safe haven except government-insured bank accounts.
Edgar - no, Congress and Wall Street is to blame. Really. And Wall Street has a lot of money to spread around, and lalala, they sure did spread it around when the banking deregulation measures were on the table. The Fed has been irresponsible, but Congress is way, way more irresponsible.

I do think Bush is to blame for putting Hank Paulson in as Treasury Secretary. I blogged about that G__d_____d fake hedge fund regulation proposal months ago. I'm still furious.

The voters need to wake up and demand restoration of reasonable financial regulation. That includes hiring a whole cartload more of bank examiners and regulating the non-financial activities on the same basis as banks. It can be done a number of ways, but it must be done.
I've accused Ron Paul of being the new Eugene McCarthy ;)
I just don't get it. I can't understand why I could look at all those houses being built and wonder exactly who was going to live in them. I also can't understand why I can see that we now build giant hospitals and schools, instead of factories. That is going to impact the job market big time and not in a good way. I can't understand why they said there were historically low interest rates and people didn't move to lock them in. So yes, it's high time we start making people accountable. The only downside is that we will have to go back to means testing voters. If you don't have anything, it's easy to recommend a big fat tax hike on those that do.
I don't know much about Ron Paul (or anything else HA!) but in his defense, he does seem to 'get it' that our Constitution is not just a piece of paper at least. And after I read 'On Wings of Eagles' I was impressed enough to get the book autographed by Ross Perot. How does it go... There's a bit of good in the worst of us and a bit of bad in the best of us?
Average Citizen - I like some of what Ron Paul stands for as well. I did confine my remarks to his financial proposal, which amounts to suggesting that we put out a fire by dousing it with gasoline.

Teri - the hope is that we will turn from building houses people can't really afford to building factories. Let's hope.
Looks like someone got a copy of The History of Interest Rates by Sidney Homer. Excellent!!

I have a first edition!
Oh, sure, boast. How many jets is it now? I guess given the results we can take that as a strong recommend on the book.
Sorry MOM, I don't buy it. The system is not salvageable. Retribution is called for, and some day, cosmic muffin willing, the guillotines will do their grisly task once more. Too late for patching the system, payback time's a coming.
UK is a hot cake as a buy to let market. But before entering in this property investment, one should thoroughly research about the property, where they should invest to gain maximum profit at the minimum time frame. For this you need some good property education about the latest trends.
By the way, it's worse in Japan now. The article you posted was from 2001, and stated that the debt to GDP ratio of Japan was 136%. According to this: https://www.cia.gov/library/publications/the-world-factbook/print/ja.html the debt to GDP ratio is now estimated, in 2006, to be 177%. Scary.

I know, Dan, and it keeps going up. I just thought that article explained it in non-econospeak.
You know we are all in trouble when Ron Paul sounds like the only sane person in the room :)

I have to say, I think GWB has a hand in the troubles we are in. Greenspan turned all partisan when he took office, WHY I don't know! I think there was huge pressure to hold rates artificially low after 911. It was all about confidence.

You can add NZ to the list, property prices have doubled and tripled in the last 5 years, average house price went from 3x average wage to 7.5x. FED rates drive our rates here as we borrow from overseas. Its all looking like US 2006 markets here, sales down by a third, prices holding.

Cracking at the edges, credit woes excellerating. Same same, rentals will save us, pft rent has barely gone up as it is truely about affordability.

MOM keep up the good work.
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