Montag, Dezember 14, 2009

A Road Paved With Good Intentions...

So, let us understand, one more time, the effects of the subprime crisis. I know, it's tedious, but the effects are going to be with us for quite some time.

This time: housing prices.

Fundamentally, housing prices, despite their drop, are still, in the aggregate, too high. Why?

Because of this effect.

In order to prevent the full unrolling of the effects of the subprime crisis - which would take down most of the mortgage industry (and rightfully so) - the government has chosen, in its **infinite** wisdom, to prop up housing prices.

At the same time, the banks are in retrenchment mode, i.e. the next generation of housing buyers will face the most intense scrutiny and due diligence of any generation past the initial birth of the modern American housing market.

Which will result in one thing exactly: housing prices will be artificially held high to ensure that banks that hold those mortgages, even when they are foreclosing on them, can maintain the fiction that they are actually worth anything in order to prevent the bank holding the mortgage from having to write them off as more or less complete losses. This is done by subsidizing exactly that class of mortgagee that has caused the problem: those who shouldn't be in houses, the subprime cohort. Hence our tax money is being spent to pretend that the problem will go away.

The problem, however, won't go away if the cost of buying a house remains so high that few, if any can afford one. Remember, the average wage in the US is around $40k, which, if you follow the kind of conservative financial planning that most should be doing (and fail to, obviously), means that they should not acquire debt more than three times their earnings, i.e. shouldn't be paying more than $120k for a house.

Go to a realtor today and tell them that's what you can afford and most will laugh; they might point you to a foreclosure auction for a fixer-upper.

The real problem we're facing here is that someone has to pay the piper and no one wants to be that someone. Houses have a unique quality: they are real investments, ones that don't go away. Make a mistake out there in the bond market and your investment simply disappears, gone forever; make a mistake out there in the real estate market, and the house remains. It's there, it's not going away, it's a problem.

The problem arises when demand dries up and you need to sell that house. In that case, you normally (based on markets) take a huge loss on the house in order to clear your books. That's a financial tragedy when it happens to someone who can't afford to lose the equity in the house, but that's how the markets work (and is something that should be told to anyone who thinks a house is anything but a speculative purchase: houses are never investments (unless you are renting them out) and when you factor in the real price of the house (purchase+closing costs, financing costs for 20 years, minus rent equivalent, plus appreciation), houses are not a very good bet except when there is serious, long-term inflation. They're a rather expensive hedge against this right now.

In reality, they're not even that at this point: the individual financial tragedy turns into a massive problem, which is the reason why housing prices are kept artificially high. The problem here is that there is an irrational hope driving the entire real estate industry, a chimera that is preventing a proper market correction that would restart the housing industry.

The hope that if we all just hold on for a bit longer, housing prices will start to pick up again as jobs return and people get back into wanting to own.

The reason I call this both irrational and a chimera is that ... it's not going to happen.

Housing prices are fundamentally determined by income and equity. Equity reduces the amount needed to be financed, and there are - or were - rules about how income flows can be tapped to finance the rest of the house. The idea that housing prices can be driven by market appreciation expectations - that I can "afford" to buy a really expensive house, one that I cannot afford, because before I go bankrupt I can sell it for a lot more money and hence avoid financial ruin - is the chimera of the industry, a non-existent creature.

Coming out of such a major blow to the banking system and to the real estate industry, both sides - suppliers and builders - are going to be extremely financially conservative.

Yet the median down payment on new purchases is around 4%, according to the link. Four percent: that is, under normal circumstances, a recipe for disaster, as we have found over the last three years. Mortgages continue to be issued with nothing down, reflecting desperation on the part of sellers after the collapse of the housing market, who are able to sell at the artificially higher prices because the US government continues to subsidize them and guarantee those loans.

They do so because they cannot afford to sell it at any other price.

Prices should be dropping sharply, given that foreclosures are at an all-time high. New buyers should be making 20% down payments on significantly cheaper houses, and those who own the equity right now - now a theoretical equity at best - should be losing everything because they built based on heavily distorted market signals.

Instead, the market is being rigged to keep prices high. The Treasury has already spent $100 bn to keep prices up in order to prevent a market melt-down: the bubble, despite a massive tear along its side, is having plenty of resources plugged into it, despite leaking, and will continue to do so as long as resources continue to be pumped in,

The problem is: the bubble burst. It cannot re-inflate, it cannot soar to new highs. That's a fantasy, that's chasing a rainbow, and it is supremely irrational.

And it is happening because ...

People like Barney Frank can't allow it to go any other way. If they do, their world falls apart. Their goods deeds become undone, they won't be re-elected, they no longer have the favors to pass on to their cronies and supporters, and their entire world crashes and burns.

So they are more than happy to play pretend, much like someone who has lost their job and has no prospects at getting any job whatsoever continues to maintain their lifestyle with savings, pretending that something, somehow will magically happen to make their lives good again.

It is a road paved with good intentions, but if there is anything in this world that is unsustainable, it is this one. These politicians are dead set on taking the whole financial structure down before they abandon their shibboleths and failed dreams.

A problem of this magnitude postponed is not merely postponing some dire reckoning: it is actively making the problem worse, with the potential of a major meltdown in prices as the government runs out of resources. They believe that the market turnaround will happen before then.

That's one hell of a way to bet the financial health of the entire country.


Longhawl hat gesagt…

Is there any way to email or contact you directly?

John F. Opie hat gesagt…

johndotopieatgmaildotcom...just say it and parse it... :-)