Monday, September 8, 2008

Communist America?

The bailout of the GSE this weekend was a momentous event. One we will likely remember in the history books.

The US govt is now officially the owner of half the mortgages in the US. Just like communist Russia of yesteryear, the US govt now officially sponsors living above our means by funding it by... our means. The circular logic of it is scary.

All taxpayers will be paying for the other segments that paid inflated prices during the boom days. At best this stabilizes the market. One thing I do like about this Paulson move is that ideology be damned, free markets be damned, taxpayers be damned, the financial administration lives in reality not in ideological extremes. SAVE OUR BANKS. (SOB :)

Of course the press and the blogosphere are alit with analysis. Most of it really interesting of the consequences of this momentous move. Here is what is being said.

1- On the good news, this will lower the spread on the GSE debt, meaning they will more easily raise some of it, most of it rolling debt, meaning mortgages will be available, not necessarily cheaper but at least available.

2- This will have a stabilizing effect. It most likely will not STOP the downward trend of houses but at least with taxpayer guarantee on debt, it will likely prevent the downward SPIRAL that would overshoot on prices and truly be devastating. We still need to have 1T losses recognized but it will likely stop there is the hopeful theory

3- This is addressing the symptons of the crisiss (GSE imploding) but not the root cause which is the housing market reverting to mean (price to rent ratio).

4- This will be paid by taxpayer which means either raising taxes (unlikely) or printing money by emitting treasuries, which will further depress treasuries. Short the dollar mid-term and long-term.

5- Ignore short term market reactions. Delevering is only starting, no assets are really safe. This is an ATTEMPT at controlling the rate of delevering on the largest single monetary mass (mortgages). At best M4 stays constant, at worse M4 goes down, at crazy the US govt inflates M4 in a desperate attempt to re-inflate the economy and taxpayers in 20 years be damned. The taxpayer in ON THE HOOK for the GSE and a lax administration may well want to go counter cyclical ahead of time on debt. See 1929 interventionist catastrophy (M4 skyrocketed between 29-33, transforming a market crash into the Great Depression). I do not believe we will see a great depression, just a great stagnation.

6- I still do not believe in the long-term inflation scenario. This is not monetary inflation, this is commodity cost inflation (we are all poorer, end of story). This will give some leeway for the US govt to run the monetary presses a la GSE, it may even out.

7- EURO/DOL is the one to watch for me. Great commentary by munchau in the FT. With the spread on Libor/Euribor monetary pressure is on the dollar and the FED is not likely to raise rates anytime soon while Trichet is taking a very tough stance on rates. As I have argued in a previous post, time will tell who is right, Trichet gamble seems ideological and may lose on both counts (price stability and financial stability).

8- Foreign investors are halting buying debt it seems. This move is designed for them to buy the debt. If they DON'T buy the debt, then there is no source of funding. The kindness of stranger has never been so important, will there be a vote of no confidence on the US govt like was reported massively this morning in the press? Or worse a FU given the past 8 years of unilateral foreign policy? It is urgent the US repair its standing in the world. Note that some are making noises that stopping this war in Iraq would help cover some of the losses at home. Let's invest in our homes instead on the homes of others? Hyper-inflation as argued by Munchau is another interesting scenario that should be noted as is the simplest one to repay the debt. It would be the end of the US hege-money though :)

9- On the positive this morning, the dollar is still so low and the local state incentives so high, that many manufacturers are moving to the US bringing manufacturing jobs onshore. This is a positve income move although it represents peanuts right now. But the trend is that markets will work and as the US dollar falls, local income should offset some of the housing losses.

10- Moral Hazard. Oh wait! Uncle Sam is on the hook, let's screw him! This is what has happened with the Originate to Repo market of the investment banks, abuse the tax-payer for the benefit of wall street, because the taxpayer is too dumb to know better. This is what Trichet moved to choke last week with great integrity but alas imho somewhat mistakenly. Can you imagine what this will do to jingle mail and other defaults on payments once the not-so-dumb tax-payers understand this? it is ok, at the end of the day the US govt will pay for my mortgage!!! all of the sudden the mass of US citizen is the too big to fail entity and the mass of US citizen is on the hook. Me-first is the basis of micro-economics and this move may completely distort that reality. You pay for you house and your mortgage? SUCKER! What is this saying... This is one that truly scares me as 1T losses could move to 1.5T easily shooting down the FED balance shit (pun :).

11- The last point is less numerical than it is emotional. Has the US govt signaled complete panic and that things are so out of hand and worse than we are made to believe that this was a completely FORCED move (which it was)? Already the noise coming out of foreign buyers of US debt seems to confirm a wait and see attitude and if no one is going to fund this bailout, I have a hard time seeing how it is going to work without massive inflation, strong damage to the dollar and the US reputation of defaulting on payments through inflation.

12- On the positive side, I do see an opportunity in home automation, with the housing market in the doldrums upgrading your current house to a state of the art Digital Home is well worth your time and investment, give us some time with Open Remote.
I apologize for the stream of thought writing but I am kind of working in real-time as I scan blogs and press coverage. May we live in interesting times?

13 comments:

Andrew Meyer said...

Marc,

this is all very interesting. I believe we will enter a period of asset deflation, regardless of what the People's Republic of the United States does.

Home prices have to keep falling and here is my reasoning.

Through most of US capitalistic history, housing prices were about 3 to 4 times after tax income. This is not exactly true, but if you think about how much one can afford to pay on loans, it's reasonable.

If you consider that the average household income in the US is around $44K, the median is about $43K, to make the math easy, lets go with a pretax income of $45K. assume that around 33% will be paid in taxes, so the take home income will be $30K, or an after income of $2,500 per month.

The average home price in 2004 was about $264K, the median household price was about $221K. To make the math easy, let's go with a house price of $250K. On a 30 year, 6% interest loan, the monthly payment would be about $1,500. That means the average household is paying about 60% of their after tax income in house payments. Not sustainable.

For comparison purposes, if we look at the average house price in 1989, it was $120K, the average household income was $30K, so the median, after tax take home pay was $1,675. With an average monthly payment of $720, after taxes, homeowners paid 43% of their income for their house. Still high, but there have been a lot of assumptions made, so it's probably closer to 35%, but it's really only for comparison purposes.

As a point of reference in 2004, average rent price was about $650/month, or about 26% of monthly, after tax income.

Now, let's just say, for the sake of argument, that someone makes the reasonable assumption that they don't want to pay more than 1/3 of their after tax income to own a home. That means that someone earning $45K doesn't want to pay more than $825 per month. On our same 30 year, 6% interest loan, that means the average home price would be about $138K.

Compare this amount to the average home price in 2004 of $264K, and there's only one thing to say. "Look out below!!!"

Data information:

Home prices 1989:
http://www.census.gov/const/uspriceann.pdf

Real median income 2004: http://www.census.gov/Press-Release/www/releases/archives/income_wealth/005647.html

Real median income 1989:
http://www.demographia.com/db-stateinc2000.htm

Rental price information:
http://www.census.gov/prod/2004pubs/H150-03.pdf

Average home sales price in 2004:
http://usgovinfo.about.com/od/consumerawareness/a/avghomeprice04.htm

Average and median prices of homes between 1963 and 2007:
http://www.census.gov/const/uspriceann.pdf

Marcf said...

in spain they have 50 year mortgages. Can you imagine taking a 50 year mortgage out? It is crazy.

Good point on the price to income ratio. I was looking at price to rent ratios which are also out of what (see charts in previous posts for a graphical depiction). I googled for a picture and found this from calculated risk

http://calculatedrisk.blogspot.com/2008/06/ratio-median-home-price-to-median.html

It says 30% peak to trough, in line with price to rent predictions (probably means they are linked btw... but it is not obvious how). Since we are 15% that does mean another 15%.

Again, hopefully this weekend action makes sure we end up at 30% which would stretch the FED and Treasury but not kill it. 40% was game over.

Jean-Luc van Hulst said...

Where do you think the dollar/Euro will be at the end of this year?

Marcf said...

Hey Jean Luc,

yah, you and I share the EURODOL need for opposite reasons.

Making FX predictions is the job of fools... :) I was actually reading the abstract of a paper just published this week by the FED on the fact that finally some evidence that fundamentals tune a RANDOM WALK in FX have emerged. In plain english is means that academics are puzzled as to why a random walk is better at predicting FX movements, but finally some faint evidence that fundamentals have an impact is emerging.

With all these disclaimer in place (which say I don't fucking know) here is what I know about the fundamentals

1- EURIBOR 4 LIBOR 2... difference in central bank character has created a wide spread. This favor EUR. EURODOL UP.

2- Economic growth prospects. US blah, EU super blah? favor Dol, EURODOL down. The EU super blah is heavily debated as it is mostly based of sentiment, and you know the germans, they have replaced the french at being chronically depressed about their outcomes, it could be better than we thought and vice versa. Add rates per above and you see compounding however. This incertitude tampers the URODOL down a bit.

3- Foreign account deficit. US is a piggy, bad bad piggy. 800B. Chinese are tired of buying the debt... no debt buyers, no debt emmission, bad bad unless current account goes positive and flows reverse. That's a tough one. BTW this is the single most important factor driving URODOL UP of lately.

4- Fuzzy on oil impact. To me the price of oil works the other way, if dol goes down, oil goes up to compensate since people are paid in dol. If price of oil in dol goes up, demand for dol goes up, price of dol goes up. At constant demand it is a wash and I am tempted to rate this URODOL irrelevant. Energy consumption/yr is 500B so margin of error yield significant numbers

5- GSE, 300B, funded by Treasuries. Add to debt glut, DOL goes down, EURODOL goes up. Current account deficit: 800B so 300 in a year is no peanuts and could seriously further damage the dol, URODOL UP

6- Perception, war in Iraq. 1T cost, 200B year? URODOL down. Could become UP but not in the time frame you talk about.

I have 5 URODOL UP, 1 URODOL DOWN.

Obviously the URODOL down is a scenario that says EU goes to shit, Trichet HAS to cut rates and wham!

This highly scientific excercise yields a VERY BEARISH long term view for me at least.

That being said, 1/re-read the disclaimers, it says that I am likely to be COMPLETELY wrong
2/ I am contemplating placing EU monetary to take advantage of the spread but I am shy to jump the gun do to the recent dollar rally. Dead cat bounce???

Army No Va said...

"10- Moral Hazard. Oh wait! Uncle Sam is on the hook, let's screw him! This is what has happened with the Originate to Repo market of the investment banks, abuse the tax-payer for the benefit of wall street, because the taxpayer is too dumb to know better. This is what Trichet moved to choke last week with great integrity but alas imho somewhat mistakenly. Can you imagine what this will do to jingle mail and other defaults on payments once the not-so-dumb tax-payers understand this? it is ok, at the end of the day the US govt will pay for my mortgage!!! all of the sudden the mass of US citizen is the too big to fail entity and the mass of US citizen is on the hook. Me-first is the basis of micro-economics and this move may completely distort that reality. You pay for you house and your mortgage? SUCKER! What is this saying... This is one that truly scares me as 1T losses could move to 1.5T easily shooting down the FED balance shit (pun :)."

This WILL happen with 80%+ of those underwater by 2012-13 - jingle mail. Saw this in Texas in spades in and around 1988-1992 during and after the 1985-89 crash. 1990-91 was the bottom.

I miss the old RTC (govt owned foreclosures for sale) ads in 4 point font every Sunday... :-) ... now we get to use the Internet (but a bit too soon yet).

Now, when can I get some North Ga. land in a good location (say 5 acres) for, say, $25K, owner financed with them begging me to take it?!? Or Cobb County 3-2s for $40K-$50K?!? Or Palo Alto for $300K? :-0

Juha Lindfors said...

FX < Random Walk = True

Marcf said...

And like a jackass I went and placed a short bet on a rally and lost my shirt. Rally was done Friday after hours by insiders, by monday it peaked and just went down yesterday and today... I paid my sucker fee and learned a lesson.

That will teach me to play the casino. I should just stick to long-term analysis, that's what I am good at :) And I should follow my own advice.

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