Wednesday, June 23, 2010
What Einstein Said
National sales down 18.3% YoY for May.
This is due to the end of the housing tax credit. I don't recall any economists not employed by realtor organizations who recommended the housing tax credit as a stimulus, and this is why.
So let's review:
Funny money sales (mythical appraisals combined with speculative loan terms combined with no underwriting) pulled many people who should not have been buying homes into buying, and caused many who should have bought to buy over their heads. This caused prices to rise and affordability to drop, but it also increased individual borrowers' willingness to buy over their heads, because cashing out was extremely easy and extremely profitable. The theory eventually became that the house would pay its own mortgage. Eventually, the mortgages busted and tragedy ensued as lending standards had to tighten and homes bought with bad mortgages flooded back onto the market, causing a rapid downward pricing spiral.
So to fix it, the government issues a housing tax credit and allows people to use it as a downpayment (FHA), thus pulling many people who should not have been buying homes into buying. FHA losses began to skyrocket, and mortgage rates cannot be pushed lower. Prices sort of stabilized in many areas, but now the housing tax credit has expired and the buyers have been pulled forward, plus FHA has raised initial insurance rates once and now will have to raise monthly rates, which will keep the pool of buyers lower going forward.
Any moment now Congress will be putting the housing tax credit back in, which will start a new vicious cycle.
There is only one real consolation here; very few are describing this as "unexpected". Bloomberg:
Sales collapsed a record 33 percent to an annual pace of 300,000 last month from April, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down.I'm sure we'll find a new way to make this worse, but I may need sedation before I can write about it.
I know most people don't sit and think about mortgage pools or how to work your institution out of bad lending, but there are several important fundamentals in trying to recover:
- First, take your losses ASAP. A bad loan is akin to a dead fish - the longer it lays around the worse it smells. Eschew financial air freshener, lest the final stench drive you out of business.
- Recycle your recovered capital less loss into GOOD loans ASAP. These would be loans extended to borrowers who have demonstrated financial responsibility, will have real skin in the game, and will have reasonable Debt-To-Income ratios after the loan closes.
- Resist the temptation to make the new good borrowers pay for your previous sins. If you try to load up their interest rates, you'll take a reasonable pool of loans and induce future adverse sorting as all the good borrowers refi at lower rates, and your bad borrowers stick around to stink up the joint once again. (This is why low interest rate environments can work in your favor - if interest rates rise later, your better borrowers are very unlikely to exit so your net losses on the portfolio or pool will be lower than if the reverse occurs.)
- Lay off your interest rate risk, originate for sale, or sell out substantial portions of your portfolio BEFORE rates rise. Otherwise you'll end up in a bind even if the loans are good, because as rates rise, your cost of funds goes up, and your NIM (Net Interest Margin) collapses - even while you are really still trying to recover your losses from the previous bout of financial recklessness.
This began in the private sector, but as the upward spiral accelerated, the GSEs were pressured to participate. And then, as we peaked and slumped, the GSEs were pressured to basically take the bad loans off the private sector's hands, which they did. And now the net result is that Fannie and FHA are poisoned wells.
The thing about FHA is that it just insures loans, thus separating the risk premium from the rest of the interest rate. And because FHAs insurance pools are longer running, the net premium charged for insurance used to be pretty stable, so that as the external risk environment fluctuated, during the rougher times the borrowers did not have to pay an excess risk premium. Now that is gone - for FHA to stay alive, borrowers are going to have to pay an excessive risk premium, which is really going to hurt their ability buy, and will push prices down somewhat.
We are about at the bottom of the pricing cycle. Real world inflation will now intervene, hopefully in a controlled fashion. Producer prices are going to have to rise, food prices will mostly inch up, and import goods from places like China will rise in pricing. The companies importing products from China will either have to raise pricing to end-users or take margins cuts or a combination.
And oil prices are now necessarily higher - there is a risk premium there that did not exist a few months ago before the BP blowout. So we will all have to grit our teeth and forge onward trying to squeeze out the margins; from here on things get much tougher.
PS: CR has a good post on this with graphs. In particular, please look at this graph and his comment:
The 300 thousand annual sales rate is a new all time record low. The previous record low annual sales rate was 338 thousand in September 1981.This was one of the very real factors in the double-dip recession of the early 80s. As interest rates rose sales dropped, employment dropped, good sales dropped, and lalala, 82 happened.
And regardless of what the FED says about its intentions on interest rates, there are always components of interest rates that central banks do not control. One of those components are risk premiums.
I will be watching freight very carefully! So far so good - for instance, the huge jump in metals is a great sign. And diesel demand continues nicely up (flash Weekly Petroleum)
A little off topic here but worth reading given your recent interest in the Gulf oil disaster. Provides more on the murky machinations of government.
We are about at the bottom of the pricing cycle.
Huh? Based on what evidence?
Real world inflation will now intervene, hopefully in a controlled fashion.
What is real world inflation? I suggest you figure out what causes inflation before making predictions.
Producer prices are going to have to rise
Have to? Please explain why.
Angry Saver - I don't think you understand deflationary cycles. All prices do not drop in tandem. Those providing the essentials of life - the producers and providers of essential services - do far better than the providers of less essential services. The plumbers and farmers will end up having the gonads of the college professors in a tight grip.
Demand could be stimulated by reducing capital gains taxes for the next five years for investors who buy and rent out the houses. There are pelnty of investors out there with money. There is no confidence in the administration being investor friendly. So, IMO, the market sags further.
Just as the stock market is an indicator of economic confidence, so too with the housing market. Trillions sitting in savings, bonds, and CDs at piddling returns equals no confidence. When Obama quits wanting to redistribute money, (Which is, as I read it, never!) confidence will return.
The housing tax credit (especially round 2) was a particularly egregious instance of the working and middle class subsidizing housing purchases for people who were quite wealthy.
Every time Krugman writes another article about the need for more spending, I think of the housing tax credit and The Onion's "Great American Moneyhole"..
So now we find ourselves in the bizarre position of cutting off unemployment benefits to people who cannot possibly find jobs because we've blown our wad on futile, gimmicky programs like that.
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