January 8, 2008
JustQuotes: Just Don’t Bet On (Or Call It) A Potential ARM Bailout
""There is no evidence it is bottoming,"' [Treasury Secretary Henry Paulson] said of the housing decline on CNBC television during a trip to New York. "The evidence would be that it has further to run."
The Treasury chief indicated the outlook may prompt an expansion of the plan Bush administration officials brokered with mortgage lenders last month. The initiative is aimed at helping as many as 1.2 million Americans keep their homes by making it easier to negotiate affordable loans and freezing some adjustable-rate mortgages at current rates.
"We have this wave of resets coming," Paulson said, referring to the almost 2 million of adjustable-rate loans forecast to jump to higher rates in the coming two years. "One thing we will consider is maybe expanding this beyond subprime borrowers to other borrowers.""
∙ Paulson Sees `No Evidence' Housing Decline Is Ending [Bloomberg]
∙ Pending Sales of Existing U.S. Homes Fell in November [Bloomberg]
First Published: January 8, 2008 8:00 AM
Comments from "Plugged In" Readers
and reality finally sets in, even at the NAR ...
The National Association of Realtors also said Tuesday it no longer sees even a modest rebound in existing home prices this year, as it had previously forecast, and pushed back its estimate of a full-year uptick in prices to 2009.
The group also cut its existing home price estimate for the current quarter to more than 5 percent below year-ago levels, which would mean the current period would see the steepest drop in that price measure on record. Only a month ago the group's estimate was for only a 2.5 percent drop in prices in the first quarter.
Posted by: Badlydrawnbear at January 8, 2008 8:43 AM
Of course they need to roll the program beyond subprime. Everyone has known for some time that this is specifically NOT a subprime problem, rather a credit problem including severe overleveraging using ARMs in a now-declining (national) market.
thus, it only makes sense that if you are going to try a bailout that it must extend beyond subprime into at least Alt A (where the dollar amounts are far higher) and perhaps into Jumbo ARMs as well.
Look for more of this going forward.
In fact, the President met with his working group on Financial Markets (commonly called the "Plunge Protection Team") over the last week. This is somewhat rare to occur. It would indicate that Washington is finally worried.
Paulson wouldn't say what was said in the meetings (I listened to the CNBC interview this morning), but it sounds as though there are more stimulation packages being dreamed up. (tax breaks, tax refunds, who knows?). the Dems are sure to have their stimulation proposals as well.
I recommend people simply:
pay down debt
raise an emergency fund
watch you expenses
these are all good ideas IF we hit recession. If we avoid recession, it's still a great idea! If you're soon to buy a house and need a mortgage, it's a phenomenal idea!
Posted by: ex SF-er at January 8, 2008 10:23 AM
I still don't get how a bail-out and keeping people in homes they can't afford is going to help avoid a recession. People will curb spending drastically once they need a bail out.
Loans are going to get super tough because banks are barely getting enough from fixed up loans to keep afloat.
Housing market prices are dictated by prices people can pay tomorrow not what some one paid for yesterday. So if lending is tough prices will come down, period. Its not possible to keep this fantasy from becoming horrible reality. Eventually the politicians will come to terms with it.
Posted by: akrosdabay at January 8, 2008 11:32 AM
In case you didn't witness it, trading in Countrywide was halted briefly due to rumors of a BK filing. The company denied it, and trading has reportedly resumed (though Bloomberg still reports trading is halted)
CFC dropped below 6 per share. Merrill Lynch announced today the recession in the U.S. has started.
It's starting to get ugly. Man, 12 years of this, ala Japan, is going to be really, really bad.
Posted by: tipster at January 8, 2008 11:33 AM
@akrosdabay -- the purpose is to keep everyone from defaulting "at once", allowing financial markets to chew thru the problem (recession or not).
Everyone defaulting at once might cause a "contagion" effect, seizing up markets which have nothing directly to do with subprime/alt-A, etc -- *that* would definitely cause a recession, or worse because of the psychological shock. Spreading default over a year or three makes things more orderly.
ex-SF: I think others have said this, but I'm not sure paying down existing (fixed rate) debt is a good idea -- having manageable debt, of course, is important, but you never know how debt might be forgiven/restructured in an emergency. What do folks think?
Posted by: dub dub at January 8, 2008 12:14 PM
"I still don't get how a bail-out and keeping people in homes they can't afford is going to help avoid a recession. People will curb spending drastically once they need a bail out."
They're not interested in avoiding a recession. The Fed wants one (or at least it is not going to stand in the way at this point from allowing it to happen). If it wanted to try to avoid a recession, it would not be shrinking the adjusted monetary base.
All the bailout talk has one function. It is designed to slow the pace of housing price declines. The bailouts for ARMS, and Alt-A and Option ARM prime loans will ONLY be available to people who have NO (or very little) equity. Negative equity will be OK (even preferable in many cases). That is my prediction for what is coming FWIW.
The rationale is simple. The Fed and the government know that housing is going to undergo a drastic adjustment. On the order of 20-25% across the board (an average, not necessarily a prediction for SF or any other particular region). That will be a loss of $4-6 TRILLION, all of which value will have to die and go to money heaven.
If the declines are rapid, many people will throw the keys on the roof, leaving the banking system in shambles with enormous (likely fatal) losses. To get some idea of the magnitude of the problem, consider that Fannie Mae "insures" something like $2.5 TRILLION of loans on a capital base of $40 BILLION. Thus, the game will be to have the homeowners absorb as much of the coming decline as possible. Towards this end, endless bailout hopes will be stoked, as will fears of future inflation. All this (it is hoped) will have the effect of keeping people paying on depreciating assets from which they would be better of walking away.
It is cynical, but even a small amount of perceived "equity" in a home will keep the homeowner paying a ridiculously large portion of his income (which is after all, the only source of wealth for most people) for a long, long time. This is exactly the mechanics of the proposed subprime HOPE NOW bailout scheme. If I am right about this, we will see similar "no equity" conditions for participation in the forthcoming Alt-A and prime "bailout" schemes.
Posted by: Satchel at January 8, 2008 12:16 PM
Thanks Satchel and Dub Dub. I concur.
I was trying to point out that homeowners will eventually end up losing big over the long run if they take the bailout. But it is a necessary evil it would seem. At catastrophic meltdown is probably bad for everyone. Slowing the pace will hopefully make it more manageable.
Posted by: akrosdabay at January 8, 2008 1:10 PM
In simplistic terms why and how is the Fed shrinking the monetary base? What is there motivation?
Posted by: eco101 at January 8, 2008 2:55 PM
Thanks for the question. It's nice to know someone is listening to my rantings :)
The "how" is pretty simple. The monetary base (this is a very simplified sketch) is basically currency in circulation, plus "reserves" - which is what member banks keep on account with the Fed. The basic concept here is that the ability of banks to extend credit is correlated with reserve levels (hence indirectly with the size of the monetary base). The Fed regulates the size of the base by doing temporary repo operations (TOMO) or permanent injection of cash (POMO), which is when the Fed buys treasuries and "prints" the money used to buy them. They haven't done a POMO since last March (if I'm not mistaken), and TOMO is VERY small, and even shrinking. This is not because the banks are not seeking the funds. TOMO is consistently lower than demand (i.e., the bidders are being "stopped out"). You can follow this in (almost) real time at the NYFed 's website, but the easier way to do it is through a site called "The Slosh Report".
The "why" is a little tougher to explain. My belief is that the Fed knows we are facing a debt crisis, a very large one. Developed economies in the modern era have only faced this level of debt/GDP (resulting from an insane level of credit expansion) three times in my understanding (although there may be others - I don't know everything): US late 1920s/early 1930s; Japan late 1980s, and US post-1999 or so. It is a mathematical certainty that the level of debt that we have cannot be serviced at any positive real interest rate, and hence is unsustainable. It will either be retired through a dramatic lowering of the standard of living of the US people, or it will be defaulted in a hyperinflationary blowout of the currency.
My belief is that the Fed will opt for the former, just as they did in the 1930s. (People who think the Depression was caused by a "liquidity mistake" made by the Fed are mistaken IMO. They knew exactly what they were doing. Unfortunately, FDR's policies made the outcome worse than what would have prevailed had the market been left alone IMO.) A hyperinflationary blowout helps no one.
Some of the above ideas are in the spirit of an interesting article from earlier this year. http://www.bullnotbull.com/archive/deflation-2.html
I hope that is helpful to you.
Posted by: Satchel at January 8, 2008 3:27 PM
"ex-SF: I think others have said this, but I'm not sure paying down existing (fixed rate) debt is a good idea -- having manageable debt, of course, is important, but you never know how debt might be forgiven/restructured in an emergency. What do folks think?"
I maintain my stance overall.
Obviously, holding debt may be ok if you have a fixed home loan or similar at a very low rate. However, in a downturn it is best to not owe ANYBODY ANYTHING. I'm certainly not going to wait around and hope that the government can "bail me out" of my debt! Look at how the govt "bailed out" Katrina victims!!!!
in a true recession, "manageable" debt can quickly become unmanageable with a simple pink slip.
if the superbears are correct, there may be significant pain for many people, INCLUDING those who think they're so smart and safe right now...
none of us is immune IMO.
sure, instead of paying down debt you can save cash in an easily accessible liquid account... or by holding it in gold, etc... but be careful here... we've seen that "liquid" assets aren't always so "liquid".
besides, doing the above could be construed as "saving an E fund" anyway.
keep it simple, not too cutesy.
pay down debt
raise an emergency fund
watch your expenses
I posit that it may not be the best time to dabble in oil futures or speculate in gold or buy a new luxury car or take a big vacation on the credit cards etc.
Posted by: ex SF-er at January 8, 2008 3:56 PM
Wow Satchel, that article is one of the most frightening things I've read in a while, and I'm a pretty cynical, bearish guy. Keep the analysis coming, it's very interesting. Meanwhile, I think it's time to take some profits and get out of the market before things get really, really ugly.
Posted by: Phil at January 8, 2008 4:44 PM
Satchel -- you should write your own blog! I'm sure it would find a devoted following and suck up all your free time.
Despite the widely reported contractions in credit markets, impending recession and so forth, pretty much everyone I know is still spending (on credit) like there's no tomorrow. A cursory search of realtor.com shows that in about a 10-block radius of where I live there's only 2 properties that are for sale at any price! Where is all the money (still) coming from? (My answer-- overall, people here still have good jobs to support discretionary spending).
And the second question would be: what about all the millions of people who sold their investment homes and profited handsomly during the bubble. There are many people sitting on piles of cash; won't that serve to prop up the economy of San Francisco to some degree? After all, for every buyer-in-trouble, there's a seller who in prior years ('04, '05) likely pocketed a huge profit.
Clearly, real estate is dead as an investment vehicle (we're seeing that amply represented by exurban house price declines), but all of that cash in the hands of sellers has to go somewhere.
Posted by: Jimmy (Bitter Renter) at January 8, 2008 6:02 PM
Well, if all this money is not going into the equity markets or real estate, what's the next bubble?
Posted by: anon at January 8, 2008 8:51 PM
If you really want to be scared, take a look at this chart of historical total debt/GDP (by Ned Davis Research - they are top notch, and used by all the best macro hedge funds):
(For some technical reasons relating to changes in the composition and measurement of GDP over the time period, debt/GDP is certainly higher today than shown - my estimate is more like 400% - so this data is even scarier.)
Now, think about it. Suppose a moderate required real return of 2% or so (of course that is very low). If the US economy can only "grow" (in real terms) at something like 3% (population growth approx 1% and productivity of roughly 2%), how can the debt be maintained, if you need 8% just to service it? (the exact numbers are not critical - so many economists are slaves to the data that they miss all the basic intuitions of the problem). IMO, you can't. How big of a hit do you have to take to living standards if you (gasp) start to pay it down? The only palatable choice is to keep the scheme going, with debt growing at an ever accelerating pace, until either it is deflated or it collapses.
At some point, the lenders and investors sense the basic insolvency of the scheme and refuse to lend. Exactly where that point is - the point at which you cannot stuff any more debt into the system - is anyone's guess. But the fact that the credit market seized up during a period of supposed strong growth, low unemployment, low interest rates, etc. is a big clue tht we might be there.
In any event, I think Bernanke is scared to try to blow any more bubbles - to stuff any more debt - and that is why the Fed is actually restricting liquidity and allowing base money to contract as credit contracts. And there just might not be any more bubbles left - the foolishness of treating a consumption item like housing as an investment asset might just have been too much, because it involved too many people and too many countries in a leveraged speculation on a basic necessity (shelter).
Posted by: Satchel at January 8, 2008 9:11 PM
tipster said: "I recommend people simply:
pay down debt
raise an emergency fund
watch you expenses"
No way man, this is exactly the kind of depressing thinking that is causing this stupid recession and I'm sure your recommendation is always the same. I encourage everyone on here to act like good Americans and go out and have a good time and buy some things. You only live once.
Posted by: GoodAmerican at January 8, 2008 9:21 PM