Capitalism 2.0

Whatever happened to Pollyanna?

2009-03-06T10:36:21-08:00

Where is she? For the past four-five years I and many others of similar mind have been called every name in the book for daring to express the view that there just maybe, perhaps, might be some kind of "housing bubble". If I had a buck for every used house salesperson who assured me that "this is the bottom", well...

The real reason I started this thread is because of accountability. Yes, accountability. For the first time in history we've experienced an episode that has been well documented in a democratic, not-easily-corruptible manner. Because of blogs like this and thousands others, there can be no claim that "no one predicted all this". Not that any of us had the entire picture -- we did not. But in aggregate, a small group of internet "bloggers" seem to have predicted the current state of affairs with striking accuracy.

And what of all the blurry eyed optimists? Well, not only do we have their comments of record in blogs and other extracts, preserved in the web's wayback machine for eternity. But we also have thousands of hours of video documentary in the form of youtube and metacafe and others. Here we can see what all these pundits, shills and outright con artists have said over the years. We can watch the "economists" from the NAR lying quarter after quarter after quarter in the face of overwhelming evidence contrary to their rosy view of a "spring rush in 2007!"

Not that I'm going to hold my breath, but I'd love to hear from some of those who attacked me and others on this blog so viciously over the years. Your comments are now on the record. But where are you now? I'm still here, as are many of my readers and commenters. But you, the Pollyannas, where have you gone?

Mortgage Cram-Downs a Terrible Idea

2009-02-17T14:37:02-08:00

I had hoped to pen a considerable article about the Obama administration's currently (rumored) mortgage "cram-down" plan. But I won't have time until after Wednesday of this week (at which point I'll revise this article and spell out the arguments) [Note, I've decided to just contribute my thoughts in the form of comments below. I may write a more formal essay later, but for now I'm just going to argue in real-time].

But in case anyone wishes to discuss in the interim, have at it.

In short, I think mortgage cram-downs are a terrible terrible terrible idea. I agree that something needs to be done regarding the flood of foreclosures. But I'm more for an "orderly devaluation", if you will. I'd slow down the process, and put more effort into being thorough. I'd go after those who committed mortgage fraud aggressively, lenders & borrowers. I'd also go after lenders, borrowers and home builders who exploited or outright avoided taxes.

But I would not punish responsible homeowners who've been paying their mortgages, along with responsible savers who waited to buy, along with the struggling people who are working 2-3 jobs just to barely make the mortgage they can't really afford by _rewarding_ the worst of the worst.

Yes, this plan punishes someone who's working 3 jobs to just make payments, and rewards his lazy neighbor who'd rather sit around and whine for a bailout. And don't get me started on the banks/lenders. Yet another bailout for them? The government will "match" their loan workouts?

This is getting ridiculous.

--- More on why my plan to allow foreclosures to take place in an orderly fashion *helps*, later. First I must make a living...

Sticky Bay Area Housing Prices, Redux

2008-12-15T20:36:21-08:00

A thoughtful question from reader "sun_kan" asked:

randy, i have read your price stickiness argument (in patrick.net) in detail & i have seen it play out precisely as you expected it to be, in the bay area, till the recent credit crisis. now i see a slightly different behavior from sellers, with a lot of them accepting the reality & cutting prices in bigger chunks. it is still expensive but i do see cuts in the range of 50K-100K, even in nicer areas (hills, school district etc). in not-so desirable areas where there is a lot of foreclosures/short sales, i am seeing sellers trying to price very competitively with (or sometimes lower than) the reo prices. is there a tipping point in the sellers psychology, just like the one in stock market? and if so, how would that affect the price stickiness?

Thanks for the question. And it is very nice to hear when something I've written has been useful to someone.

The San Francisco Bay Area has definitely moved into a new phase of price stickiness. It is roughly in line with the article I wrote all the way back in August 2006 (Housing Bubble Economics). The thing I most missed in my analysis back then was the huge amount of time the stickiness would last. Even I underestimated the psychological staying power of sticky sellers. And to think, I was roundly attacked by a large number of Patrick denizens who thought I was nuts, a shill, or even a realtor in disguise (in once case).

So what about now? In my opinion we're now in the phase where sellers have:

Yanked their listing, gone into denial or deeply flawed reasoning, and decided to "sit out" the market. This group includes most sellers who are able to do so monetarily and situation-wise. We already know that most people are severely retarded when it comes to finances and money decisions.
Accepted the market for what it is, whether willingly or not, and are prepared to price competitively. Most will still walk-down the market, fearing underpricing more than overpricing. That is, unless the seller is desperate (or compensated some other way like a relo package) then he/she will try to price right around where they think the highest-paying possible buyer might be. From there, they'll walk-down the market as the listing grows stale.
Entered the "end-game" phase. These are sellers who are probably going to lose their home anyway. Most will try to "work out" the loan. Few [in the inner Bay Area due to prices] will succeed. This phase keeps getting longer-and-longer with all the government intervention. Even the mention of possible, maybe, perhaps, government intervention slows this process down, as lenders and troubled owners alike fear taking the loss right before the cavalry arrives.

Anecdotal, what I'm seeing here in southern Marin is indeed price reductions. Some huge. One I saw about three weeks ago was more than $600K off the "original listing price". The problem is, those "original listing prices" were vintage 2005 peak-peak. So now homes here are all the way back down to say $850/sqft. There is a very long way to go before prices fall to within income supportability.

The bottom line: I expect prices to bump along, walking-down the market in most areas. They won't hit any sort of accelerated free-fall unless or until there is a dramatic decline in employment. When people lose their jobs, then others fear losing theirs, then more homes get sold under duress, and more sellers start racing to simply unload.

That won't start before next summer (2009). Probably late summer, at the earliest. It will require (a) lots of bad news about jobs, very publicly features, and (b) passage through the "spring selling season", which now apparently lasts until August, with yet another dud. That would be 3 years in a row of basically no selling season (2007-2009, homes in Marin at least were still selling in spring/summer 2006).

Vacation

2008-11-24T20:33:30-08:00

As you've all noticed, I haven't been contributing much to the blog lately. I'm going on vacation next week, and have been busy getting everything done before the holidays basically shuts everything down.

I have a ton of ideas for new articles on old subjects and some new topics. If any of you want to pen an article in my absence, send me an email before Saturday (you can find my email on the blog).

The Great In/De-flation Debate

2008-10-22T20:13:49-07:00

Presently there is an increasingly raucous debate brewing between those who believe there will be long-run inflation, and those who see an extended period of deflation. I have elaborated my position here and elsewhere, which is basically that we're currently at the head-end of a deflationary period which risks collapsing into a broader deflation cycle. The actions of the Federal Reserve in concert with other world central banks strongly suggests that monetary policy leaders also fear deflationary forces.

This subject is particularly interesting being that it has generated the most email I've received on any topic since I wrote about the Second Life virtual world economy. Following are a few examples...

The first is a typical article of many that are appearing with increasing frequency on seekingalpha.com. It is entitled First Comes Deflation, Then Comes Inflation. It starts out reasonably enough, but upon reading it quickly becomes apparent that the author has an ideological bias. And, that is ultimately the problem with so many of these economic debates: ideology. Many are tied to an outcome for deeply ideological reasons -- for some, those border on matters of religious faith. Others have specific financial outcomes riding on a particular outcome, so the end up wrapping themselves in whatever dogma supports their desired ends.

But there is a theme emerging. Many who point to the prolonged, exaggerated inflation scenario don't really understand the theories upon which they are basing their arguments. Put bluntly, they are wrong. They repeatedly point to the Fed (and now others) "printing money" as sufficient reason to cause inflation. That argument is a monetarist one. Unfortunately, the quantity theory of money also incorporates a strong demand-side function, expressed as velocity. When that demand outpaces the supply, then there is deflation regardless of how much money is "printed up".

A well reasoned author and frequent commenter on seekingalpha responded to the above linked article. I believe he hits the nail squarely on the head, and he also expresses my frustration with the inflation-is-coming-I-tells-yas-so-buy-gold-now crowd:

Ideologues can't admit they are wrong and let go of their slander-script.

The error lies in thinking only the supply of money determines its value. Name any other commodity whose value depends only on its supply, and not on demand for it as well.

For the millionth time, demand for money is not a constant. It is money illusion in spades to think that it is.

Money is not wealth, it is not the "real" form of wealth with others being fake, nor is it a scam itself, with only "real" assets having value. Money is merely one asset among others, with a small and relatively stable *transactions* demand and a huge and quite unstable *safety* or investment demand.

When the investment demand for money changes dramatically, the objective exchange value of money changes too, if the quantity of money does not immediately change in exact proportion to that shift in demand. Even if the quantity of money is increased dramatically, its value can still rise, if the demand is increasing even more.

Why is the demand for money rising? Because real interest rates are rising, and doing so dramatically. This is making long dated claims fall in value compared to short dated claims. Risk premia are also rising dramatically, making safe claims rise in value compared to uncertain claims. Money is rising in value dramatically, compared to every kind of commodity that bubbles were blown in, making *nominal* claims more valuable than *real denominated* ones. (Being paid in dollars a year from now is worth *more* than being paid in steel a year from now, for example).

All of this is an entirely predictable consequence of too many people believing simultaneously that real assets would be worth infinity and dollars worth nothing, and every one of them being hopelessly wrong.

Who was going to pay them all if they were right? Were central banks ever going to print enough money to justify all the bubbles you-lot blew? No, it was pure slander on your part, and chutzpa.

From March of 2005 to March of 2008, the Federal Reserve did not allow the M1 narrow spendable money supply that it directly controls, to move one inch.

That broke all of your bubbles. Real estate first.

In case nobody has noticed, the whole trade that blew up and caused the credit crisis, was exactly this insane belief that any real asset - like a house - would always be worth infinitely more than any amount of nominal debt used to carry it. Sorry, no, untrue. Bid prices high enough and the debt is worth more than the real asset.

What will it take before you-lot get this slanderous inflationary brainstorm out of your system? How about grinding you to atoms for a decade? Whatever it takes.

Bonds at the current huge spreads are going to pay. None of your bubbles are.

Your unwillingness to simply lend on nominal claims to investment grade credits, will choke off all fuel for any of your bubbles forever, and they will not go anywhere. Not until bond owners are first *paid*.

Savings capital will be paid in full for its services ,and in real terms. Every attempt to avoid that will blow up in your face. Nobody is going to ride in and reinflate your cockamamie schemes. Not until you disgorge all of it and pay bondholders back every dime stolen from them, twice.

It isn't complicated. You just don't like it. Tough toenails, you are wrong.

I don't agree with this commenter exactly in that I obviously think there is a greater risk of deflation than he does. But he elaborates well the problem with the self-described "inflationists". They don't seem to realize that for their outcome to be realized they are demanding another, new bubble. Bear in mind that many of these folks came out of the real-estate-bubble[head] camp. They argued, along side folks like me, that a mega-real-estate-bubble had inflated and was becoming dangerously close to popping. They railed against Greenspan and Bernanke for creating the bubble. They welcomed its popping as a beginning to a return to sanity.

But that's where they got off the rationality train and boarded another bubble-cheerleader express. Most of them are in the gold & precious metals camp, as the seekingalpha author is. Others like Peter Schiff embraced a worthless dollar theory and started cheering for the euro to replace the dollar as the world's reserve currency, and to buy all things European and euro denominated. Yet others are holding out for $500 oil. And then there are all those who simply want real estate to re-inflate.

Suffices to say, I've yet to meet one in this camp who recognizes the ironic hypocrisy of their position. They are wishing for a bubble to replace the bubble.

...

I received another, more reasoned email from a reader who firmly believes that we are more likely to inflate further, then default, and finally deflate. This reader also believes that stagflation is unlikely-to-impossible. I, however, believe we have actually just emerged from a stagflation which lasted from 18-24 months, maybe longer. A lot of that depends upon how gamed the government stats really are -- and I think all of us can agree that the government stats are at the least "lacking".

The main issue I have with the overall conclusion that the US will default is that it is not necessary. The same can be accomplished without a default, which is arguably what occured in the 1930s. In essence, the rest of the world has much more to lose in the case of a US default than we do. We derive roughly 4/5 of our economic activity from internally generated GDP. That means we keep 80% of our standard of living after a default, give or take, with oil being the only real problem for a while. Europe, on the other hand, loses from half to 3/4 of theirs. Japan loses 80% of theirs. And so on.

Also, after a default there would not be deflation. There would be little left to deflate. The US stopped deflating by the late 1930s, but didn't start really re-inflating until the 1960s. And that brings me back full-circle: monetary theory.

See, the reason we didn't inflate after the Great Depression and WWII for decades even though they drastically increased the money supply was because we were growing. That's really the key. Growth. If an economy is growing, then it needs more money or it deflates by definition. If an economy experiences increased demand for money, then it needs more money, or that money becomes more and more valuable and deflates prices. It actually has nothing to do with the gold standard, etc. It has to do with the theory of money, which is really unrelated to which form of fiat money is. Keep in mind that a gold-standard system is still a fractional-reserve banking system, and the money is still fiat. It's just a different sort of fiat. The only non-fiat money system is one without any money at all, which seldom exists in societies with more than a few thousand people.

...

I know this was one of my longer articles, but I hope this prompts some reasonable debate. I, for one, believe it's very important to move past the ideological and self-serving conclusions such as typified by the seekingalpha article's author. We are headed towards rough times, and it is in all our interests to cut the bull and deal with this thing for what it is.

--Randy

How about a $600 trillion headache?

2008-10-19T20:07:00-07:00

Coming Soon: The $600 Trillion Derivatives Emergency Meeting (link). The Prudent Investor posted the linked article on SeekingAlpha over the weekend. It's a must-read.

Realizing that by no means is the entire derivatives market at risk, and that a good deal of the notional values of these derivatives net out (theoretically) should give some comfort. But only some. This is still a big problem. Well beyond the ability of any government to "bail-out". Not even all governments acting in unison could hope to bail-out the derivatives-related fallout should systemic failure spread.

Will it spread? I wish I could say no. But, right now, everything is on the table.

One interesting notion I'm hearing discussed more and more, including in the comments on that article, has to do with a purely legal solution to the looming derivatives defaults and unwinding problem. It goes roughly like this:

Default swaps (and related instruments) were unregulated. Those instruments were basically a form of trade-able insurance positions; sometimes used to insure, sometimes to hedge, often to simply speculate -- ie., to bet. Not regulated by financial authorities. Not regulated by insurance authorities. Not regulated by gaming regulators. Therefore, these things constitute a form of illegal gambling. As such, they violate public policy, are not protected by any international treaties or trade agreements, and are subject to nullification by a court. So, just nullify them all. All; every single one. Tell all the parties, "Tough, you should have known better. Be happy we're not going to prosecute you for illegal gambling".

Then, effectively, every party has what they have today, and we move foreward tomorrow. Lot's of upset folks. Lot's of rhetoric about the end of capitalism, the end of markets, the end of credibility. But it will pass quickly. Only a select, elite few ever played in this market to begin with, and they were just running giant bets against one another. So, knock out the hundred trillion or so of default swaps and dependent derivatives and move on to the next crisis -- which is consumer credit defaults.

Thoughts?