Tuesday, June 10, 2008

Negative equity is everywhere.

Say you put 10% down on a purchase of a property. You borrow the next 90%. Say the price of the property goes down 10%, let's say you sell your property, you have lost your 10%. Let's say you walk away: you have lost your 10%. You have an incentive to go "long" on the property, hoping the prices will go back up.

But when your loan is "zero down" you don't care if the prices go down. This phenomena has been described in the US press as "jingle mail" and it is now appearing all over the EU. I just came back from Spain where it is starting to be particularly acute. People buy their second residences there, sometimes as investments. So when the prices go down, your financial incentive is simply to WALK AWAY.

This of course piles on the banks with a positive feedback loop: the prices go down, a lot of people walk away, so the offer increases, so the prices go further down until, accelerating the fall.

I don't see an easy out (even with bubble blowing from the FED).
1/ FED and ECB are making noise of INCREASING rates due to inflation concerns
2/ EURIBOR/LIBOR are at historic highs indicating 2 things a/ banks don't trust each other, someone is going to fall Bear style b/ Since so many loans are based on the EURIBOR it means the payments increase dramatically.
3/ Debt availability is going down. M3 is going down.
4/ I believe the demographics curve does not support growth of demand. The combination of the baby boomers numbers reaching full earning potential and now retirement means we have seen a temporary spurt of demand that is not likely to continue as the demographics curve is turning flat.

The drop in housing price, the source of the subprime crisis, the dollar debasing (via rates), the oil spike, and therefore generalized inflation is a self-reinforcing "positive feedback loop".

There is no stopping this thing. I come back from Spain where rentals yield 2% of capital. Just not really worth it from an owners standpoint and already rental prices are above what most people can afford.


Roy Russo said...

Back in the day... In the US, your second property didn't qualify you for a 0-down loan, and most banks not only asked for down payments (10-20%) on the second property, but you were stuck with a higher rate. Anything seen as investment property was treated this way.

As for your fears of doom and gloom... Bernanke just announced that fears of a downturn are diminished, so it should make you feel better. Maybe no one told Bernanke that Obama is getting the nomination? ;-)

Marcf said...

getting down payments on second property was the right thing to do, higher rates as well. Subprime isn't inner city ghetto, it is well to do (somewhat) white folks buying properties they can afford at the lake.

Marcf said...

Also Roy,

Bernanke said he was more worried about inflation than the downturn of the economy at large. My comments are purely on the housing market at this point. I do not believe in a recovery of the housing market. Goldilocks is dead, as in ... dead. It is funny to see the real estate agents naively clapping their hands. Chumps. It is time to move on... that market is radio-active (like the Bush administration is radio-active)

Roy Russo said...

No need to tell me, I'm living it. Lots of whiteys selling their McMansions out here, several bank-owned for sale in my community, and nothing's moving.

Market corrections are healthy and shake the silliness out of the industry. This is all good.

PS: If Bush could run for a 3rd term, I'd vote for him again. ;-)

Marcf said...

I can't wait for him to get out of there. What a train wreck. The anti-intellectualism, the dogmatism, the incompetence. It is weird to have a cretin as president. That will teach y'all to vote for someone "I can have a beer with".

When Obama gets in I will buy you a beer. You are someone I like having beer with, not to mean you are a cretin.

Tom said...

Did you see the 2 year US treasury note today? It's around 3%. This indicates that rates should rise. Whether they will is another story. Usually the 2 year hovers around the Fed funds rate.

Tom said...

Oh, and on your Goldilocks comment. You didn't get that from Larry Kudlow did you?

Marcf said...

I don't know who Kudlow is (really) but the goldilocks comment is everywhere in the blogosphere, I am just repackaging :)

You know, with the rates on bonds where they are I am getting more and more entrenched in a defensive portfolio management: bonds (which on municipal yield 4.5 + tax = 6 equivalent) which is pretty good given the current environment that is the only way I can see myself playing an increasingly stagflationary outlook. Oh that and synthetic exposure to markets via structured options (I am big fan of knockout absolute returns)