Housing Bubble Bursting?

[Randolph Kinney]

Will it be? Or, won't it be?

THE CRUX OF THE DEBATE IS HOUSE PRICES

If the inflated prices are justified by economic fundamentals and sustainable, then the 82 percent increase in mortgage debt since 2000 will probably turn out to be innocuous and the risks to the economy minimal. If, on the other hand, prices are out of whack, painful adjustments lie ahead.

Roughly a quarter of the jobs created since the 2001 recession have been in construction, real estate, and mortgage finance. Even more important, consumers have withdrawn $2.5 trillion in equity from their homes during this time, spending as much as half of it and thus making a huge contribution to the growth the U.S. economy has enjoyed in recent years (consumer spending accounts for two-thirds of GDP).

For the past five years, Americans have spent more than they have earned--last year, the net borrowing amounted to 3.7 percent of GDP, or over $500 billion. The high level of spending compared with disposable income is also in uncharted territory.

But consumers cannot keep spending more than they make. Eventually, home prices will flatten, the flood of "cash out" refinancings will become a trickle, and consumer spending will slow, as will job creation in housing-related industries.

Yet the concerns about unsustainable growth in consumer debt and home prices are dismissed.

A recent study by First American Corp. shows that many of the borrowers who have taken advantage of the lowest teaser rates and are going to experience the greatest payment increases have little or even negative equity in their homes. Fully 22 percent of the borrowers who borrowed at initial rates of 2.5 percent or less during the past two years have negative equity in their homes, and 40 percent have less than 10 percent equity. The study also finds that a third of people who took out adjustable rate mortgages last year have negative equity and 52 percent have less than 10 percent equity. How is this possible? One reason is that 43 percent of first-time home buyers paid no down payment last year.

If home prices fall modestly, millions of homeowners will see their equity wiped out. Many of those with the least amount of equity, as we've already shown, are going to face significant increases in their monthly payments.

So what has been a virtuous but unsustainable cycle for the economy--higher home prices, more borrowing against home equity, higher spending, increased job creation, even higher home prices--could easily reverse and become a vicious cycle--higher monthly payments, declining home prices, less spending, job losses, foreclosures, even lower home prices.

 

[JSmith43]

A counter argument is that the vast majority of 80-20 purchasers actually thought the payment was worth avoiding rental hassles and uncertainties and will do what it takes to hang on to their new found freedom. Don't be too quick to discount the human spirit and resiliency of MOST people.

2nd Counter Argument: Having a low equity position among a significant proportion of homeowners has a price stabilizing aspect built right in to it! If they can't afford to sell, they either won't move or will rent to bubbleheads that think they are experts in market timing and/or think renting isn't much of a crimp on their lifestyle anyway and expect rental levels to remain competitive with total cost of homeownership, including the forsaken joy of homeownership

Prediction: Ever more increase in market share of seller assistance companies. And, the next grand experiment: CASM.....Computer Assisted Sales Modules

 

[Big ole Boy]

Predictions

About 2 to 4 more months .... government will go into bunkers .....

Stock market will no longer exist .......

 

[JSmith43]

About 2 to 4 more months .... government will go into bunkers .....

Stock market will no longer exist .......

How are you at Liars Poker, David?:happy:

I have seven nines!

 

[Mr Rex]

Roger, your cards are upside down, we know you are holding the 3 sixes.

 

[Bobby Bucks]

2nd Counter Argument: Having a low equity position among a significant proportion of homeowners has a price stabilizing aspect built right in to it!

It pains me to have to agree with a loan officer, but the USPAP pups are still way behind on points on this thread.

 

[Big ole Boy]

Its four sevens .......

Roger,

More like four sevens ...... seven missles out of N.Korea, seven bombs go off in India .... two more cards to be played for this hand ....

 

[George Hatch]

All the action occurs on the margins, ya? It'll be great if the vast majority can service their positions regardless of how upside down those positions may become. But the people on the margins will still be folding and it is the size of that margin that will determine how this whole thing plays out. If the margin isn't very big then the losses probably won't be bad at all. Around here, we need people to be able to keep on keeping on as their $2,800 monthly mortgage payments reset to $3,600. Some can and some can't, the question is how many of the can'ts does it take to hurt the cans?

I notice that many of the SFR assignments I'm reviewing that aren't new construction have a sale among my research dataset that is noted in the MLS as being either a short sale or as bank-owned. That trend is increasing at a rapid pace. Now that July has sprung appraisers aren't going to be able to use the higher yr2005 sales to prop up their appraisals so I think it likely that our margin is going to continue to grow substantially by the end of this year.

Obviously, your mileage will vary but some of you might want to keep in mind that many economists have identified our market as the canary for this side of the cycle. They don't agree much as to how it will play out but they do agree that we're the ones to watch.

 

[Big ole Boy]

They don't agree much as to how it will play out but they do agree that we're the ones to watch.

I got your canary right here ....... North Florida, affordable ...... but slowing down .... Ocala ..... affordable, but slowing down .....

.... now we burger wars ..... a large chain of Burger Kings just went belly up .....

.... San Deigo is the head real estate market and North, Florida is the tail ......

Middle America - Iowa and such are the agrarian middle .... they don't count .....

 

[moh malekpour]

an open letter to Ben Bernanke

United States: An Open Letter to Ben Bernanke

Stephen Roach (New York)




Dear Ben,

It’s time to take a deep breath. You are off to a rocky start as Chairman of the world’s most powerful central bank. Your policies are not the problem. Given the über accommodative legacy you inherited from your legendary predecessor, the three 25 bp rate hikes in each of the three policy meetings you have chaired have made good sense. The issue is more subtle —- your ability to send a consistent message to financial markets. This is a critical element of your job description. It defines your credibility as a policy maker as well as the credibility of the great institution you now lead. In the end, without credibility, a central bank is nothing.

You know this, of course. As one of the world’s leading academic apostles of inflation targeting, you have long stressed the merits of anchoring financial market expectations of monetary policy with a simple price rule. With price stability now widely accepted as the sine qua non of central banking and with core inflation rates in the US and around the world not all that far away from the hallowed ground of price stability, there is considerable merit in underscoring a determination to preserve the hard-won gains of the past 25 years. This could well be your golden opportunity.

With all due respect, Ben, you are close to squandering that opportunity. A transparent policy rule has real merit in minimizing unexpected and undesired swings in financial markets. But any such rule is as good as its disciplinarians — the central bankers who are charged with delivering the message to the public at large. It pains me to say this, but your message has been all over the place.

What I am alluding to are several reversals in your official pronouncements in the past couple of months. It all started with your 27 April testimony before the Joint Economic Committee of the US Congress, where you openly entertained the possibility of an “unjustified pause” in the Fed’s monetary tightening campaign. That was followed by your 5 June speech at an International Monetary Conference in Washington DC that sent a clear warning about your concerns over “unwelcome developments” on the inflation front. Then there was the policy statement immediately after the 28-29 June FOMC meeting, underscoring the Fed’s forecast that a “…moderation in the growth of aggregate demand should help to limit inflation pressures over time.” Nuanced or not, in this brief two-month time span, your official statements have gone from dovish to hawkish and back to dovish again. Such inconsistencies raise serious questions about your credibility as the world’s leading monetary policy maker.

Speaking of that, you and your colleagues at the Fed must be mindful of the international context and consequences of your posture. Your back-and-forth waffling comes at a critical juncture in the global monetary tightening cycle. Jean-Claude Trichet of the ECB surprised the markets with his own tough talk last week — in effect, pre-announcing another rate hike for August, a month when Europe is normally at the beach. At the same time, the Bank of Japan’s Governor Toshihiko Fukui has also been talking tough for several months, signaling the end of a seven-year zero-interest rate regime and the onset of a long-awaited normalization of Japanese monetary policy. His first step could well be imminent — most likely at the BOJ’s upcoming 14 July policy meeting.

Ben, that puts the consequences of your recent reversals in a very different context. Global investors are perfectly comfortable with the notion that the Fed, which began its tightening campaign long before other major central banks, would be the first to attain its objectives. The idea of the “policy catch-up” by foreign central banks has long been embedded in the consensus view of a cyclical dollar weakening. However, to the extent that the European and Japanese central banks stay on message while you do not, the monetary policy credibility factor could well shift away from the United States. Given America’s outsize current account deficit, a relative credibility erosion could spell sharp downward risks to the dollar — and equally sharp upside risks to real long-term US interest rates. That’s the last thing an asset-dependent, overly-indebted US consumer needs. A resumption of the greenback’s weakness in recent days suggests that you can’t take this possibility lightly.

It was always going to be difficult to wean the markets from the measured Fed tightening campaign that has unfolded without interruption over the past 24 months. When the federal funds rate was 1% in June 2004, the next move was a no-brainer. But now at 5.25%, it is obviously much trickier. The key for you is not to let your understandable sense of uncertainty over the economic and inflation outlook morph into an on-again, off-again assessment of policy risks. This was supposed to be the sweet spot in the policy cycle for inflation targeters like yourself. Lay out the metric you are targeting, provide a clear assessment of the risks, and then let the policy rule generate the unambiguous answer. Easier said than done, I guess.

I think the best thing you can do at this point is to borrow a page from the Greenspan era and make a simple statement of your policy bias. For example, as long as you perceive inflation risks to be on the upside of your tolerance zone, you and your colleagues can endorse a tightening bias. Conversely, if inflation risks tip to the downside, it may be appropriate at some point to announce an easing bias. The bias statement works best when the policy rate is near the so-called neutrality threshold. It is less appropriate when the overnight lending rate is far away from such an equilibrium. In the current context, the verdict would be clear — a tightening bias is in order until inflation risks recede. There’s nothing automatically actionable about such a bias that locks you into a move at each and every policy meeting. There is ample leeway to pass on a policy move and still maintain your concerns.

There may well be a silver lining in your unfortunate experience of the past couple of months. Central banking is as much art as it is science. In that vein, it is equally important to be mindful of one of the major pitfalls of the current financial market climate — seven years of one asset bubble after another, driven by the mother of all liquidity cycles. It is high time to bring this dangerous state of affairs to an end. These are the same bubbles that spawn wealth-dependent distortions to saving and massive global imbalances. Not only must you commit to price stability in the narrow sense of your CPI target, but you and your central banking colleagues in Europe, Japan, and China must be equally willing to commit to an orderly withdrawal of excess liquidity in order to put a seriously unbalanced world on safer footing. That underscores my recommendation to maintain a tighter policy bias at low rates of inflation than a strict price rule might otherwise imply. If that’s what it takes to break the moral hazard of the “Greenspan put,” it is a risk well worth taking.

I guess in retrospect we should have seen this coming. After all, history tells us that transitions to a new Fed Chairman invariably don’t go well. The “transition curse” saw the equity market quickly challenging Alan Greenspan with the Crash of 1987, the bond market promptly testing Paul Volcker, and a dollar crisis immediately confronting G. William Miller. The so-called risk reduction trade, which commenced in early May, could well go down in history as the Bernanke test. There’s nothing like unforgiving financial markets to find the Achilles’ heel of a new central banker.

The good news is that you have another important chance to recover your credibility — your midyear appearance in front of the US Congress slated for 19 July. The bad news is that this may be your last chance for a while. A third reversal could well spell a serious and damaging setback to Fed credibility. A serial bubble blower was bad enough — the last thing world financial markets need is a serial flip-flopper.

Sincerely,

Stephen S. Roach

Chief Economist

Morgan Stanley