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The U.S. economy and housing – part II

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foreclosuremapAug09               Foreclosure rates and Unemployment by state

Risky lending practices have led to a stellar rise in home prices and subsequent plunge when the housing bubble started to burst in the so-called sand states of California, Florida, Nevada and Arizona. It is no surprise that delinquency rates for missed or late mortgage payments have spiked strongly in those areas but also around the country.

In the second quarter of 2009 according to the Mortgage Bankers Association (MBA) delinquency rates for one-to-four-unit residential properties have reached a seasonally adjusted rate of 9.4 percent of all loans outstanding. These numbers set the record for highest late payments rates ever recorded.

Foreclosed properties are also at record high with 4.3 percent at the end of the second quarter, leading to a total combined 13.7 percent of loans past due, also the highest amount of non-current payments in the history of the MBA survey. A welcomed exception are loans 30 days past due which are still well below the record set in the second quarter of 1985.

A sure sign that mortgage problems are being driven by economic recession rather than non-conforming lending practices is the increase in foreclosure rates with prime fixed rate loans. Foreclosure filings are now spreading to areas hit by the economic downturn. The combined percentage of foreclosure filings in the sand states has decreased slightly to 44 percent from 46 in the first quarter.

The State of Oregon is a good example with its unemployment rate rising to 11.9 percent in July compared to last year, at the same time foreclosures in the state are up a whopping 84 percent. The problem seems to be unemployment rather than toxic loans. Many first time home owners who bought at the peak of real estate prices simply have not enough equity in their homes and cannot afford current mortgage payments due to the weak economy.

Of course the actual foreclosure rates are very hard to predict. Government moratoriums have effectively created a hidden backlog of foreclosures that one day have to be dealt with. There are also more warning sign of homeowners under duress emerging as fewer are catching up on lapsed mortgages.

A report from Fitch Ratings found that cure rates for prime loans collapsed to 6.6 percent in July from an average 45 percent for the years 2000 through 2006. Cure rates have also fallen dramatically for non-conforming loans of Alt-A and subprime category. Fitch looked only at a return to current payment for loans bundled into securities, excluding GSE and non-securitiezed loans. 

This dramatic shift in the recovery of delinquent loans towards current payment is partially caused by the economic recession and fall in home prices, which puts a significant number of homeowners under water with little hope of ever recovering their investments. With toxic loans from non-conforming lending practices on the one hand and economic recession on the other, it is no surprise the outlook for both the economy and housing remains highly uncertain.

Few signs of a turn around in housing are starting to emerge. According to Case/Shiller nationwide home prices are showing tangible signs of improvement month over month in June and May of this year. In some areas where prices have fallen dramatically investors are coming back to the market hoping to snap up properties on the cheap.

The Outlook remains uncertain and yet a recovery will by and large depend on the pace of turn around in the economy. While it is no secret that recessions caused by a slump in businesses of the financial services industry tend to last longer, on average almost five years, the depth of the economic trough and the pace of recovery is still unclear.

Key to answering the question whether we will have a V, W, U, or L shaped recovery lies with the American consumer. In the past abundance of credit fueled conspicuous consumption and a debt driven economy. No wonder many are fearing a new found admiration for frugality that is exemplified by an increased savings rate in the U.S. today.

Even though less consumption in the U.S. would almost certainly have implications reverberating around the global economy, the results of this dramatic shift in behavior would be felt most severely in the U.S. itself. While there likely will have to be some shift towards a more export driven economy it is hard to imagine that policymakers in the U.S. are willing to completely adjust to this new set of paradigms without recourse to pre-crisis conditions.

In fact strong signs of reoccurrence of pre-crisis behavior are starting to emerge. Reports of once-again record compensation packages among employees in the financial services industry have angered critics who see the industry at the center of the economic storm and would like to see more humbleness instead of the same old greed.

Even more daunting is another bad habit that many consider at the heart of the financial meltdown through its manipulative prowess in credit distribution behavior. Many banks still stuffed with risky mortgage loans from frothy days of real estate exuberance are once again engaging in what some call resecuritization of real estate mortgage investment conduits.

At the heart of Wall Street’s newest innovation is the re-remic, an impaired bond that does not necessarily have a natural buyer but by splitting it into two bonds may find a buyer for both of them. Investors who take on a really risky pool of securitized loans agree to lose money first if the deal goes sour. Investors in the safer pool of assets get paid first, therefore securitized loans in this category are slapped with a AAA-rating. Sound familiar?

The financial meltdown shooting out from non-conforming lending practices is in part credited to the failed securitization of mortgage loans deemed useful by false credit ratings. Yet, here we go again relying on financial repackaging of inferior securities dubbed suitable once again by rating agencies.

Sifma and the European and the American Securitization Forums (ESF and ASF) are ambitiously drafting new rules to rebuild confidence in structured credit markets reacting to a call from financial regulators to enhance transparency in this notoriously shrouded over-the-counter market. There is clearly a consensual desire to clean up the securitization markets, no wonder given its impact on the current financial crisis.

Initiatives aimed at standardizing issuer disclosure, facilitating and broadening investors’ access to transaction information and enhancing the usability of information are all welcomed but do they really justify the inherent risks purported by this form of financial engineering? Wall Street’s history and its future always has been and always will be abusive in nature, which should give everyone a moment’s thought, unless the crisis was for naught.

While this initiative has been started more than a year ago it does not seem to get into gears. The first drafts of reform were to be implemented at the beginning of 2009 but new rules are still in the workings and have not taken off ground yet. The MBAs proposal to standard procedures for servicing non-conforming residential mortgage loans and ASF’s Project Restart aimed at the securitization market are now trying to put the squeeze on regulators to let more players get sucked back into this ailing market.

So far the magic wand of enhanced transparency did not help to lift the freeze in in the securitization market. During Goldman Sachs’ second quarter the securitization powerhouse was only able to sell $12.9 billion in securitized loans, with meager $496 million outside of safe government agency bonds. That dwarfs in comparison to upwards of $30 billion at the beginning of 2007.

Inquisitive minds might argue that policy makers are not too successful in their attempt to hawk back to pre-crisis conditions. The emperors new clothes in the form of enhanced transparency seems not sufficient to once again resurrect bad habits from the dawn of the credit crisis.

Nevertheless much will depend on future success of the credit-distribution-lifter in form of securitized mortgage or other asset backed loans. Without it the American consumer might well be maxed out, with it the financial services industry and investors will probably once and for all loose their last shirt over it. Much like the Federal Reserve also Wall Street seems to be damned if they do and dammed if they don’t.

While these contradictions contribute to the overall uncertainty credit markets in general are still not healthy. Recently the Fed extended its Term Asset-Backed Securities Loan Facility (TALF) for another six months. It was scheduled to expire at the end of 2009.

In the UK, Bank of England governor King detonated a bomb last week when it became known that he voted for an even bigger increase in the bank’s quantitative easing policy. The minutes of the August meeting revealed King wanted to expand the program by 75 billion instead of 50 billion pounds.

In this apparent game of confidence policymakers are hitting the monetary accelerator full throttle to make sure the public can have trust in their abilities to revive the economy. Yet under these strange conditions a sustained recovery in housing, the economy and on Wall Street seems to be still ways off.

The U.S. economy and housing – part I

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In 2006 when the housing market popped in the U.S. the sound of fear and uncertainty was heard in hallways of financial institutions around the world. In the meantime most investors have lost their last shirt and millions more their providing jobs over it.

The world’s central banks spear-headed by the Federal Reserve have pumped trillions of dollars into moribund financial institutions to shore up their liquidity and to guarantee the perpetual flow of credit. To this day bankers can prod themselves with mission accomplished, financial Armageddon has been avoided and instead of the Great Depression, Great Recession has taken over the tabloids.

No doubt the Greta Depression is not a very appealing alternative, it is therefore understandable that the captains of this financial fire-sale rescue have become the new heroes of the establishment. The leader of the pack is of course Ben Bernanke, chairman of the Federal Reserve Open Market Comedy, who as a scholar of the Great Depression has led the great rescue operation of 07/08/09 by pumping up the balance sheet of his institution and shoring up liquidity on Wall Street.

Today sure enough reports surfaced of Bernanke’s reappointment as Fed chairman coming January. His guaranteed position at the helm of the Fed serves the current establishment and was therefore all but certain, though his well accepted speech at economist heaven at Jackson Hole last weekend might have helped.

In his speech did he not suggest that financial institutions cannot by themselves, no matter how carefully done, take full responsibility of their liquidity risk management? This sounds surprised but it really should not. According to Bernanke, central banks now and forever must be prepared to provide liquidity and credit provisions to financial firms in trouble.

I can only imagine the applause that erupted on trading desks of Wall Street’s most venerable institutions. From now on no risk can be too big and no bonus too gratifying, ‘cause Ben the savior will always be there to provide the necessary dough and pay with taxpayer’s money for the tab.

Unfortunately for helicopter Ben his success will not be measured by the smirks on the faces of bankers alone but rather by the strength of the economy and health of the job market. This will by and large depend on the recovery in the U.S. housing market. July’s data for existing home sales have been very encouraging, up 7.2 percent from June at the fasted pace of sales rates in ten years. Still much of it is in the from of distressed sales but even there the rate is declining to 31 percent from 50 earlier in the year.

Supply is still heavy but not as strong as it once was, obviously there is light at the end of the housing tunnel. Prices are still coming down nationwide, with the median sales price falling another 2 percent on the month at $178,400. But there is more good news.

In Southern California, one of the hardest hit areas during the downturn of the U.S. housing market, home sales and prices show a surprise recovery. The specter of homeownership is starting to reemerge from the short hibernation of the last couple of years. Its no surprise really and if you can believe it, it never rains in Southern California.

In Los Angeles County sales were up a staggering 19 percent in July compared to last year and the median home price rose to $321,000 but this is still much lower than peak median Southland home sale price of $505,000 at the height of the real estate bubble. Despite its recent rise the median home sale price remains at 2002 levels and is 47 percent below its peak level. Foreclosures are still dominating the sales and suppressing prices but that could change within the next twelve months.

In the San Francisco Bay Area even high end sales are recovering with homes sold at or above the $500,000 range, the highest since September 2008. With jumbo loans reemerging the high end market finally has a pulse again. This is propping up median prices which are still 40.6 percent from peak values but 36.2 percent off the lows in March 2009.

In New York City foreclosures in the five boroughs were up 14.8 percent in July compared to last year. Auction events usually draw crowds of thousand people and more participating in the bidding and snapping up bargains. So far this year has auctioned more than 20000 foreclosed homes across the nation for $1.4billion.

Investors are rediscovering their appetite for risk in real estate assets in a big way, with some properties going for cents on the dollar at foreclosure auctions. Private-equity players are turning to IPOs in a rush not to miss the fun at the biggest buying bonanza of troubled real estate assets since the bubble burst. Since June big boys like Apollo Global Management, Colony Capital and Starwood Capital have filed with the SEC to launch their IPOs of new real estate investment trusts (REIT).

The specter of returns in excess of 100 percent is what makes the investor’s heart beat faster. Some are still cautious and think the biggest buying opportunities are twelve months out, but with federal financing programs like TALF and PPIP low cost financing of troubled assets is a win-win-win situation, for some even the best one in the past 50 years. Of course this strategy is not without risk, the economy is far from healthy and the job market is still declining, which could make expected bargain prices still a bad deal if the underlying value does not come back.

Asked if the housing market could set itself up for another bubble, perpetual housing bear and U.S. economist Robert Shiller entertained at least the possibility (see video). According to Shiller low interest rates and high affordability are positive, high inventory of unsold homes and recent experience are negative for the housing market. An exceptionally weak recovery would of course trump everything else and push the U.S. economy closer to depression.

Historic facts do not support those eager housing bulls now crawling out from under their covers. Historically, from peak to trough, it takes more than four years for housing prices to bottom. Since prices nationwide peaked in 2007, for some areas prices will still have to fall further. Moreover, usually it takes 10 years for house prices to fully recover.

For the housing market to turn around the economy needs to recover first. Now the annoying thing is that for the economy to recover the housing market needs to recover as well. A strong interdependence is here at work and the economy reinforces housing and vice versa. In other words what happens to housing is crucially important to the economy.

Another bear, Nouriel Roubini, who correctly predicted the recent downturn in the debt fueled U.S. economy suggests the recession is far from over. In many other advanced economies, similar to the U.S., the bottom in the economy is quite close but has not been reached yet. In the U.S. overcapacity, a damaged financial system and still overleveraged households will dampen any strong recovery in the economy and therefore in the housing market.

Even if some would insist to dip once and then end it, Dr. Doom’s diagnosis is a double dip recession. The dilemma is with monetary policy, because Bernanke and friends are damned if they do and damned if they don’t, mob up excess liquidity that is. All things equal according to Mr. Roubini the economic recovery will be anemic rather than robust.

In the past during economic downturns the economic model of the Federal Reserve has worked like a rubber band, you pull it hard and the economy snaps back. If asset prices plunge on one side a re-inflation trade props up asset prices somehow somewhere else. This time the rubber band could just have popped.

Historically downturns caused by financial crises are not typical cyclical recessions and last on average of 4.8 years. Growth spurts can occur and inventory restocking will contribute to positive growth in the coming quarters, but at this point it is unclear what would come after that.

The key to the gates of heaven or Dante’s inferno for a recovery in housing and the economy are the credit markets. Availability of loans for people and businesses is critical in any sustained recovery going forward. Yet the shadow banking system with its many corridors and lifts of credit distribution is still dysfunctional.

While the recession is raging the ratio of private household debt to the nation’s total economic output rose to 97 percent in the first quarter, up from 45 percent in 1975. Americans are saving more to pay down debt and savings rate has jumped to 5.2 percent of disposable income by the second quarter of this year. Roubini thinks savings rate has to go much higher, and this will hold down consumption. Shockingly, savings going up a percentage point decrease spending by more than $100 billion.

This newfound frugality might be well underway and the world has to prepare for a cutback in consumer spending and residential investment. It is difficult to see what could replace the American consumer in the global economy.

Krugman – one unflinching Keynesian economist

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Today employment in the US is lower than it was ten years ago, the stock market is lower than it was ten years ago. Keynesian economics has created a two tier society, with the investor-ownership class on one side and the working poor on the other.

Keynesianism has brought an end to the democratization of capital markets and helped to foster a politically inept society with less opportunities for fewer people. Before the advent of Keynesianism bubble economics occurred rarely and if it did it was linked to natural product cycles. Today bubble economics are part of the intricate mechanism of capital flows almost unhinged from natural product cycles and rather dependent on artificial and corrupt political initiatives.

US economist and Nobel laureate professor Krugman is a very outspoken representative of governement-spending-saved-the-world defenders of Keynesianism. In times he is so convinced by his ideas that he does not shy away from indulging policy makers with his nuggets of knowledge.

A good example for how far Mr. Krugman was willing to go, was his fierce attack of Germany finance minister Steinbrueck in December of last year. Steinbrueck warning of crass Keynesianism, in the midst of the largest government economic rescue effort in history, caught Mr. Krugman’s anger and earned Germany a collective boneheadedness from the professor.

Of course in the meantime more and more green-shoots are becoming evident and most national economies have stopped their abysmal plunge, with some even showing humble signs of growth in the second quarter. Mr. Krugman and other Keynesian economists find themselves now in a somewhat awkward position having to defend themselves over their radical support for stimulus.

Professor Krugman ventures deep into wonkish territory in his defense for deficit spending and why we should not fear it in the context of higher interest rates. Interest rates are of course important because as a discount to future earnings they are the most important factor in determining our wealth. Deficits and interest rates are the topic of one of his most wonkish blog posts in the New York Times to date.

The core of professor Krugman’s post is a positive correlation between GDP and interest rates and a negative correlation between interest rates and deficits. The core fallacy of Keynesians is what follows, lower GDP merits higher deficit spending and nobody needs to fear high interest rates because they are inversely correlated and therefore lower with higher deficits. This is despite the fact that most would acknowledge that deficit spending is inflationary.

deficits-interestchart shows neg. correlation btw. T-Note interest rates and government deficit spending

Most economic formulas (S-I = G-T is the one Professor Krugman is using), to the contrary what economist want you to believe, are not universally true laws of nature like a physical law or even most scientific laws. Economists of course believe that the only true science is economics.

In mathematics a formula about events at some future time-horizon always acknowledges uncertainty of a predicted outcome inherent in its logical argument. Economists though using mathematics merely extrapolate a present situation into some future time-horizon rather than acknowledging uncertainty. In other words they think what is true now has to be true also in the future. It seems to me that Keynesians are the world’s champion in extrapolating the facts ad infinitum.

The problem is not i.f., deficit spending. The problem is rather not knowing when its enough and when to withdraw, not knowing when to hold ’em and when to fold ’em is the real problem. It is this uncertainty that’s inherent in their economic formulas and yet they do not account for it. Keynesians live for the here and now, they completely discount the future. The crisis of 2007,08,09 should be proof enough that it can’t be done.

Economists are wrong about the economy nine out of ten times. Some Keynesians think they are right because they have not been wrong so far. I got news for ya, not being caught with a lie is not the same thing as telling the truth.

Talking about a promise!

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The Times has an interesting piece about deficit projections in the US and how they have changed over time. That’s what I would call a severe neglect.


Written by Alfred

10. June 2009 at 8:46 pm

The myth that keeps Keynesians going

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– it is never quite the cigarette butt.

US economist and noble price winner, Paul Krugman, writes in his newest Times’ column about the "origins of the current disaster". In short lack of financial regulation that started during the Reagan administration turned us in and caused the current financial and economic crisis. The Reagan mantra and later neoconservative mantra ‘government is the problem’ becomes the focus point of criticism in the pre/post- prevention discussion.

For the more one looks into the origins of the current disaster, the clearer it becomes that the key wrong turn — the turn that made crisis inevitable — took place in the early 1980s, during the Reagan years.

The world class economist is in trouble. Krugman is a declared disciple of Keynes and his hand is leading the cavalry of government interference against "the worst economic crisis since the Great Depression". This is Keynesianism in its purest, something German Finance Minister Steinbrück and declared Krugman villain called “crass Keynesianism”. Why is the professor in trouble, well not really in trouble but lets say academically challenged?

The followers of Keynes like Milton Friedman, Alan Greenspan, Ben Bernanke, Paul Krugmann etc. believe in the almighty power of money that flows through the pipes of the economy. It is according to their believes, that manipulation of total amount of money available in an economy determines its direction. It is mainly in this context that the Federal Reserve finds the appropriate level of interest rates. A Keynesian will always believe in the dogma of inflating one’s way out of every macroeconomic problem by lowering interest rates and devaluing the nations currency.

Why not? It worked at least till now. Though the current crisis clearly shows the limitations and flaws of this philosophy. If Keynes was right how can he explain the current economic disaster? He can’t. In the words of past time guru, Alan Greenspan, ”shocked disbelieve” takes hold among Keynesians these days.

Since Keynesians cannot understand they try even harder to explain it. Krugman’s column in the NYT goes to the point. He writes about regulation and the lack thereof, taking hold during the Reagan administration. He even identifies the Garn-St. Germain Depository Institutions Act, that Ronald Reagan introduced into law in 1982, as the bill that "did it".

When Krugman blames the Reagan administration for scrapping "precautionary rules" he is absolutely right. It is just not the complete picture. To pinpoint our current problems to mortgage deregulation is part of the truth but not all of it. It is like pinpointing a bush fire to a single carelessly dropped cigarette butt when the real cause is climate change. Finding it and neglecting climate change will not prevent another fire down the road.

The idea that mere lack of regulation causes an economy and its financial infrastructure to overheat is not seeing the big picture because no matter what regulation always comes second to macroeconomic events. To Krugman’s second point, higher interest rates would have helped to improve the low savings rate of the private sector. How could regulation have helped to do the job?

At the height of the real estate bubble the whole mortgage market in the US was about 11 trillion dollar and subprime, the unregulated part Krugman writes about, was only 1.3 trillion dollar. At a delinquency rate of 40 percent and a recovery rate of 50 percent the cumulative losses should be about 200 to 300 billion dollar.

The US economy produces services and goods worth about 14 trillion dollar every year. The budget for military and defense in the US is about 500 billion dollar and that does not include the spending on the wars in Iraq and Afghanistan. The ensuing economic disruption caused by ‘mere’ lack of regulation is hard to grasp even after taking into account leverage and the Ponzi scheme of the securtitsation market in the financial industry.

In conclusion the Federal Reserve and its rate setting policies, that were guided to no small part by the ideas of Keynes, contributed substantially to the current crisis. It seems though that Krugman and his Keynesian friends are not ready to acknowledge it. How can we learn and get better, and at this point this is the best we can hope for, if our brightest do not strive to identify the root cause of the problem?

Die erdrückende Schuldenlast der U.S.A.

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Die folgende Tabelle erstellt vom US Ökonomen Woody Brock veranschaulicht auf drastische Weise wie sich die Schulden (debt to GDP ratio) und die Wirtschaftsleistung der U.S.A. bei unterschiedlichen Wachstumsraten bis 2045 entwickeln, ausgehend von einer Schuldenlast von 12 billionen Dollar und einem GDP von 14 billionen dollar für 2011. So liegt die debt to GDP ratio in einem Extremfall bei 40 Prozent bei einer kumulativen Wachstumsrate der Wirtschaft von 4 Prozent jährlich und im anderen Extremfall bei simbabwischen 1800 Prozent und einem jährlichen Wachstum von negativ 1 Prozent. Natürlich sind diese Beispiele sehr unwahrscheinlich aber aus der Tabelle ist ersichtlich dass die Schuldenlast Amerikas ein erdrückendes Ausmaß angenommen hat. Es ist also nicht weiter verwunderlich das sich die ersten schon zu Wort melden, die das Tripple A Rating der U.S.A. anzuzweifeln beginnen. 


die Tabelle kann auch hier gesehen werden!

Written by Alfred

20. May 2009 at 10:03 pm