Long Term House Prices

This is Bob Shiller's famous plot of the US housing bubble.

This is using Shiller's more accurate repeat sales method instead of median prices. You can see how house prices go up because everything goes up. This is called inflation.



Shiller made another study of repeat sales of identical properties along the canals in Amsterdam. This is also pretty fascination. There is no upward trend once corrected for inflation though there is lots of variation tracing the history of Holland. Here is a version in Dutch.


This is Bob Shiller's famous plot of the US housing bubble.

How banks plan to survive

The banks have a survival plan and the Fed and Treasury seem to be on board. It looks like this. They are going to earn their way out of trouble. Sure, the capital they have now is probably not truly there if they really took all the marks that they should. But they will write it down slowly over the next few years and replace it with earnings.

They think they will be able to do this because of a few things

• High interest rate spread. Their deposit cost is very low due to the Fed's zero interest rate policy.
  
• They can raise interest rates on loans.
  
• They can borrow cheaper in the capital markets because the government is guaranteeing their debt
  

Now lets look at these in detail to show how all of them are direct wealth transfers from individuals and businesses to the banks.

First, the Fed's zero interest rate policy (ZIRP), forces deposit costs down. People with money in the bank are now getting 0.25% or something instead of 3% or so that they were getting a few years ago. This punishes seniors and other savers including businesses with large cash balances. This results in about $200 Billion dollars per year of interest income getting shuffled from the savers back to the banks.

They can raise rates on loans. They are already doing this. Here are a couple links from the New York Times and ABC News talking about how they are increasing credit card rates on people with good credit. Why are they doing this? Simply because they can. The right question is why didn't they do this in the past. Well, the credit card business is very competitive and people frequently do balance transfers to get better rates. But in this deleveraging environment, no one wants new credit card customers. They would love it if their customers paid off their balance and dropped off the face of the earth. They are not growing these portfolios. They are trying to reduce them. So it is an easy problem for them. Raise rates and fees through the roof. Either you pay them and make them lots of money or you pay off your balance and they reduce their leverage and so reduce the amount of capital they need to raise.

How much does this get them? Well, there is $2.5 Trillion in US consumer debt. If they can raise interest rates (or fees) by 5%, that is $125B/year in extra income. And that is just consumer debt. Total household debt (minus consumer debt) is about $11.5 Trillion and there is another $7 Trillion of non-financial corporate debt. Banks owns about $5 Trillion of this. If they can squeeze another 2% interest rate out of that $5 Trillion, that is $100B/year. Again, if the borrowers don't like it, they can try to find a loan elsewhere. If they leave, the bank has successfully delevered. So raising interest rates on borrowers might get another $225B/year.

Finally, there is all the government guarantees on their debt and direct government lending. I won't estimate the impact on earnings other than to say that without it, they would probably cease to exists. Certainly the Wall Street "banks" would have failed just as Bear Sterns did without the access the discount window and other such programs.

So the impact of lower deposit cost and high interest rates creates a much larger spread which might be roughly $425B/year in extra income for the banks. This is money that is transfered from US individuals and businesses directly to the banks. Most estimates of US banks losses is around $1 Trillion. So the banks can replace this capital through higher interest income is roughly two years.

In summary, the Fed and the government have orchestrated a massive wealth transfer in favor of the banks. This, of course, is in addition to Federal bailout of the banks through the TARP and other such programs. The banks are able to so this because they have essential control over the US government and have power over the central bank with its ability to create money and determined interest rates that banks have to pay for deposits. The banks will probably survive and replace this $1 Trillion capital hole with our money but ownership of the banks will largely remain in the same hands.

There is perhaps a bigger point to be made here. Banks are really intermediaries between borrowers and lenders. They don't produce anything. When you deposit money in a bank, and your neighbor gets a mortgage from that banks, it is really you lending to your neighbor. The bank is a useful intermediary. It performs credit analysis and protects you (with final backstop from the FDIC) from losses. For this service, it collect a fee. But the fee that is collected is a cost to the greater society, i.e. the real economy. The economy therefore is better off with banks being less profitable. Large bank profits, result in capital piling up at the bank which leads to a need to produce more and more credit. This obviously leads to a credit bubble and a crisis when it collapses. At the top of the bubble financials produced 40% of all corporate earnings, without producing anything. This is up form the long term average of about 15%. Those bank earnings which could have been income or industrial earnings would have resulted in a stronger US economy. Instead we had a credit bubble. The lesson is that the banks should not be the dominant force in an economy. They should be the oil that greases the wheel not the wheel itself.

More real estate madness

Jess and I used to live in a funny neighborhood of LA called Montecito Heights. It was basically Mexico hidden away in the hills above downtown LA. This is East LA where Cheech and Chong come from.

We used to go for a walk from our place and pass this boarded up place that looked like a former crack-house. It was basically a wooden box on metal stilts hanging on the side of a steep hill. I would doubt that even cock roaches would sleep inside. Very gross. These pics are not so great but, believe me, it doesn't look better from close up.






Yes, that is a chain link fence two feet from the front door. They are not much for zoning in the Montecito hills. To get in the front door, you open up the chain link fence and walk across a piece of plywood into the front door. If the plywood was not there, you would tumble down the hill rolling underneath the house. Lovely!

I looked on Zillow today to see how much it is worth. They say $300K. But funnier still is that it sold near the top of the bubble at over $700K. What utter madness, this housing bubble!

Swine Flu

I had previously read a lot about the Flu of 1918 and so when I heard about the possibility of pandemic swine flu coming out of Mexico, I immediately got very worried. I expected people to start dying in the US. After a few days, no one died. The media started saying that the symptoms were mild, about the same as normal flu. So naturally, I calmed down a bit.

But maybe that was not the right reaction. There is the curious case of Dr. Gitterles. The doctor in Texas is saying that the situation is far worse than the authorities are saying. Read the email, especially this part

Since it is such a novel (new) virus, there is no "herd immunity," so the "attack rate" is very high. This is the percentage of people who come down with a virus if exposed. Almost everyone who is exposed to this virus will become infected, though not all will be symptomatc. That is much higher than seasonal flu, which averages 10-15%. The "clinical attack rate" may be around 40-50%. This is the number of people who show symptoms. This is a huge number. It is hard to convey the seriousness of this.

Taking this as face value, it means that the flu will likely spread around the world and infect maybe 20% of the world population or 1.2 billion people (60 million Americans) If the "clinical attack rate" is 40%, that means that 480 million people (24 million Americans) will get sick. Note that the US has only a million hospital beds. It has enough antiviral medicine (Tamiflu and Relenza) to treat about 50 million people. So we likely have enough medicine. But we don't have the capacity to treat so many people. In poor countries, they lack the medical capacity and the medicine. This scenario would likely lead to total chaos if not huge numbers of deaths.

The death rate is so far unknown but probably nothing like the 1918 virus. It seems to lack the key gene that made the 1918 flu do so much damage to the lungs. But viruses can mutate and it seems new viruses like this tend to mutate more easily. Who knows where that would lead. The 1918 flu started in a milder wave and came back as a much more deadly virus the following winter. How deadly can a flu get? The H5N1 bird flu killed 60% of infected people but thankfully did not spread easily between people. The death rate for the 1918 flu was probably about 3%.

For the time being, I am not going to freak out. But keep an eye on this and think about how you will respond if the facts begin to indicate that it is worse than we now think. Even if the death rate stays low, this could cause real problems.

Portfolio.com on Geithner

Portfolio.com has a cover story on Tim Geithner which is decidedly negative.

Another ray of hope

Neil Barofsky seems to be taking his job seriously as TARP watchdog.

He seems to be warning about the same kind of abuses that I am worried about. That is good news for Americans.

But it is bad news for bank stocks and probably bad news for the markets. It means that the banks are going to have a harder time swindling their way out of trouble and so the question of how to save the banks is back on the table. Sorry, it won't be by defrauding hard working Americans. On to plan B or it is M by now.

Strange NYTimes article

This New York Times article is certainly strange. Apparently the Obama administration is floating the idea that they have more ammo for recapitalizing the banks than everyone thinks.

Oh,really? What is the latest shennanegans? Well, remember that $350B in TARP money that Paulson put into the 8 largest banks. Well, that was preferred equity shares. That is sort of like a loan that never needs to be paid back (except on liquidation) where the company must pay a fixed dividend to these shareholders before paying the dividend to common shareholders. The yield (annual dividend over the price) was a measly 5%. What a great deal for the banks! But if times gets tight, it can stop paying both dividends without there being an event of default. The shares are non-cumulative so missed dividends never need to be paid back.

Because not paying the preferred dividend is not an act of default, this is considered equity not debt. Preferred equity is not counted any differently than common equity in the three capital ratios that are used by bank regulators although there are guidelines on how high the preferred portion can be - more than half is frowned upon.

These rules are well established in banking. Until now that is. Now the Fed wants to redefine what equity means. Now they want to pretend that all that matters is tangible common equity, bank regulation tradition be damned. So now you can increase the tangible common equity by converting the preferred equity to common equity. Presto, the banks have more capital!

Huh? This does not increase the total equity by one bit. It does nothing to change ASSETS-LIABILITIES which is the definition of equity. They have just shuffled the form of the equity. Really, they have just lowered the standard of acceptable capital levels and made it so that the banks fit the lowered standard.

While they are at it, maybe they can change the definition of liabilities as well. They can redefine it as all debts except those to the federal government. There you go again, instant improvements in capitalization! Just ignore those liabilities when calculating capital ratios.

Honestly, what a joke! Do they really think the market is going to buy this nonsense. The market knows what capital means and they know these banks ain't got it.

Latest T2 Partners presentation on housing

T2 Partners Presentation on the Mortgage Crisis-4!3!09 3

Publish at Scribd or explore others: Finance Business & Law subprime housing crisis

China's bubble economy

While many people trumpet the strength of the growing Chinese economy, there are other signs that it is on the verge of collapse. Note the following Financial Times article .

Property prices in China are likely to halve over the next two years, a top government researcher has predicted in a powerful signal that the country’s economic downturn faces further challenges despite recent positive data.

The property market, along with exports, were leading drivers of the booming Chinese economy over the past decade and the slumps in both have taken a heavy toll.

Cao Jianhai, professor at the Chinese Academy of Social Sciences, a leading government think tank, said an apparent rebound in the property market was unsustainable over the medium term and being driven by a flood of liquidity and fraudulent activity rather than real demand.

He told the Financial Times he expected average urban residential property prices to fall by 40 to 50 per cent over the next two years from their levels at the end of 2008.

"being driven by a flood of liquidity and fraudulent activity". Hmm, why does that sound familiar? Ah, that's right. It sounds like our housing market in 2006.

Real estate agents in the residential property bellwether of Shanghai said the market seemed to have bottomed out as a result of government stimulus measures, falling prices and pent-up demand from owner-occupiers.

But Mr Cao said preliminary government investigations had turned up numerous examples of real estate developers using fake mortgages to offload apartments on to the books of state-run banks facing enormous pressure from Beijing to rapidly increase lending to boost the economy.

Does that sound like the basis of a sound economy? A sound housing market is one in which houses are affordable for the majority of the population. So how is that working out in China?

At a national level, average housing prices tripled between 2003 and the peak in mid-2008 and are now 10 to 12 times average income, which means 60 per cent of homebuyers’ monthly income must go to mortgage repayments, Mr Cao said.

Ok, I am pretty sure we all know how that story ends. Good luck China in your quest to prop up the world economy.

Here is more from the Times Online.

China faces a surge of bad loans and speculative bubbles as the country’s banks open lending and flood the market with record levels of money supply, economists are warning

... The peril appears to lie in the speed and geographical spread of lending: the mostly state-owned banks, scattered throughout both economically weak and strong parts of the country, are duty-bound to follow Beijing’s orders to lend. Few analysts believe that the banks have the mechanisms or expertise to assess the quality of the borrowers.

In short, China has a command economy. It doesn't have a real banking system. The "banks" in China are just state owned entities who don't know how to say no to loans. Even if China keeps growing due to this forced lending, it will eventually end badly. It is classic boom bust ponzi lending. Since capital is being allocated by fiat rather than based on economic soundness, it will result in inefficiency and waste and ultimately economic stagnation. Another result will be excess supply which will export deflation to the rest of the world which the boom finally goes bust.

William Black Interview

Great interview on PBS with former banking regulator William Black.

Get the word out and forward this around.