This post is in two parts. The first is an essay by Charles Hugh Smith lifted from his Blog “Oftwominds” (see my blogroll). The second is my commentary on what the implications and consequences are. This is all pretty serious stuff because what it means is that instead of stopping, pulling back and then changing direction, we are all accelerating towards a cliff because we don’t want to see, deal with and accept the cost of changing direction. The cost will have to be paid regardless, but the longer we drag it out the worse it will be and the longer we will have to suffer it. Instead, the way things are shaping up at the moment is that everyone is twisting and dodging trying to avoid having to pay the costs of our past folly, and, if remotely possible, shuffle those costs off onto some-one else to deal with. At the moment the easiest recipient (victim) of that strategy is our children and grandchildren. They don’t get a vote and can’t fight back (yet). In the meantime, we can continue happily on with our shell game of hide and delay the problem while we continue to live it up on borrowed money.
At any rate: on with the analysis.
The Final Demise of A Speculative Housing Bubble
September 16, 2009
The speculative mania in housing has been extended by massive Federal Reserve and government intervention; the government now owns or guarantees 2/3 of U.S. mortgages.
While speculative bubbles may pop in terms of sales and valuations, the psychology that underpinned the mania lives on for some time–especially if government extends the speculation with massive interventions.
I sincerely doubt the average American understands the full measure of Federal intervention to prop up the U.S. housing market. The numbers casually dropped (with little context, of course–this is pure MSM “coverage,” after all) in the Wall Street Journal report No Easy Exit for Government as Housing Market’s Savior(WSJ.com) are truly mind-boggling:
To keep funds flowing to the housing market, the government bailed out Fannie Mae and Freddie Mac last year and now effectively owns the mortgage finance giants and their combined $5.4 trillion in loan portfolios. To keep mortgage rates low, the Federal Reserve is on track to purchase nearly $1.5 trillion in debt issued or guaranteed by the government’s various mortgage arms and another $300 billion in Treasurys, which set the benchmark for home lending.
What the reporters fail to mention is the value of all U.S. mortgages is about $10 trillion– meaning the U.S. government now guarantees over half of all mortgages just with Fannie and Freddie.
But wait–it gets worse–much worse:
Since the beginning of the year, the Fed has purchased $836 billion of mortgage backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, the federal body that securitizes FHA loans. The purchases have helped push down interest rates on mortgages guaranteed by the firms from nearly 6.5% last October to 5.25% today, according to HSH Associates, which tracks the mortgage market.The Fed is likely to decide to carry on buying until it reaches the $1.25 trillion target it set in March, and then taper off gradually.
So the Fed is buying $1.2 trillion in toxic, doomed mortgages, fully 12% of the entire mortgage market of the U.S., just this year alone. And why would the Fed print all that nice new money and exchange it for toxic mortgages worth a mere fraction of their original value? To clear the sludge off Fannie and Freddie and Ginnie’s books, so they can underwrite trillions more in questionable mortgages.
This is an astonishing level of government intervention to prop up a housing market which remains highly speculative.
But the Fed and the Federal government are not just buying up stupendous amounts of toxic mortgages with taxpayer funds (or freshly printed money): the government is also guaranteeing fully 80% of all new mortgages via FHA.
Teri Gifford, who runs a mortgage brokerage serving Kentucky and Ohio, says 95% of her business involves getting clients loans backed by the FHA.
According to my esteemed colleague Karl Denninger of the Market Ticker, “The FHA portfolio has doubled over the last two years, with 2.6 million loans added (of a total of 5.18 million.)”
For context: there are about 50 million outstanding mortgages in the U.S., of which about 4 million have been foreclosed or are in foreclosure. This means that Fannie and Freddie “own” some 25 million mortgages (50%) and FHA “owns” 5 million (an additional 10%). Add in VA (Veterans Aministration-backed mortgages) and Ginnie Mae-backed mortgages, and it turns out the Federal Government owns or guarantees two-thirds of all the mortgages in America.
Uh, remind me again what “capitalism” and “free markets” stand for, as it seems the nation has completely forgotten the terms’ meaning.
Simply put: “socialism” is bad except when it guarantees my mortgage and let’s me buy a house for 3.5% down, and also gives me $8,000 in “free money” to use for the down. Golly gee, it turns out socialism isn’t half bad… I only feel sorry for the poor dumb suckers who are foolishly saving up actual hard-earned cash to accumulate a 20% down payment.
But since those engaging in “free market capitalism” in the private banking sector are only 5% of home mortgages, I guess we can just write them off as outliers.
All this “government backing speculative housing” is real nice except for the fact all the money is borrowed or created out of thin air. Our “leadership” seems to believe that you can prop up a $10 trillion dollar housing market with $7 trillion in “free money” with no consequences.
Perhaps there are already consequences which are as yet beyond the control of the Fed. According to the sources listed by Mr. Denninger, total delinquencies and foreclosures in the FHA loan portfolio have reached 21.43%–so one in five of all the FHA loans the government is guaranteeing to stem the housing bust have already soured.
This destruction of housing equity is playing havoc with consumers’ ability to spend freely:
Let’s look at a chart of housing prices 1970 to 2009 to get an understanding of the speculative bubble which is being propped up by the government:
First, note that up until the housing bubble lift-off in 2002, housing more or less tracked inflation. According to the BLS (which typically understates inflation), inflation jacked prices up almost 5-fold from 1970 to 2002 ($100 in 1970 = $463 in 2002).
If the speculative bubble in housing credit and fraud hadn’t been enabled by lax regulation and lax lending standards, fraudulent credit ratings, etc. etc. (please read this heavily sourced entry for full details: Subprime mortgage crisis Wikipedia) or if Federal intervention hadn’t propped the market up, then housing values would be around their 1998-2000 levels.
Instead of falling to what might be considered “healthy” or “normative” values, this extraordinary manipulation via a flood of low-cost liquidity and the purchasing of highly toxic mortgages from government-mortgage entities has extended the speculative mania which created enormous imbalances in the U.S. economy.
As I have noted before, speculative bubbles typically have an “echo bubble” spike. Thus the Nasdaq Tech market fell from 5,000 to 3,000 in 2000, but then recovered to 4,000 briefly before its final descent to 1,000.
But how much of a speculative fever would still be present if the Federal government and Fed weren’t dumping trillions of dollars into the housing market to keep the speculative bubble alive at literally any price?
Now is a good time to review the context of the housing market and its precarious state. Here are a few of the facts which I have sourced elsewhere in the past, and which you can source via the dozens of links in the above Wikipedia article.
$5 trillion was extracted from home equity during the bubble. That propped up the “consumer spending” on which the world depends. That’s gone.
Consmer debt is $14.5 trillion, or 134% of disposable personal income. Much of which, it should be noted, is devoted to debt service. Translation: consumer is tapped out.
9.6% of mortgages in the U.S. are in default. 50 million mortgages = 5 million in default.
Home equity has fallen from $13 trillion in 2006 to $8 trillion today. Home equity is now less than mortgage debt, and highly vulnerable to further reductions in valuation. Mortgages + equity= $18 trillion. A further 20% decline in home prices would be $-3.6 trillion, dropping home equity of the entire nation to less than $5 trillion.
About 25 million homes are owned free and clear. That remains the one bit of light in this darkening picture. Not everyone mortgaged their home to the hilt and squandered the proceeds.
40% of the home sales in 2005-6 were openly speculative. Add in fraud, lies and half-truths (Uh sure, I’m gonna live here as my primary residence, heh), and you get 50% of all sales in the bubble years were entirely speculative.
There are some 18 million empty dwellings in the U.S. right now. Maybe 4 million qualify as true “second homes” for the upper classes; the rest are, well, just empty.
Fannie and Freddie floated $5.4 trillion in mortgages off of assets of $114 billion. So leverage of 50-to-1 is just normal business practice now. Or could that have had something to do with their demise?
Guess what FHA’s leverage is: 50-to-1. Yes, FHA’s “reserve” is 2% of its portfolio–and losses are driving that toward zero.
U.S. households have lost $5 trillion in home equity, $2 trillion in retirement accounts and $8 trillion in the stock market. Depending on how you add it all up, that comes to a loss of about a third of all household wealth in the past few years.
Do ya reckon that’s good news for a consumer economy? No wonder the Fed and the Federal government are so desperate to prop up the deflating speculative bubble of the U.S. housing market. A 30% decline in home values–more or less a return to pre-bubble prices in many markets–would mean total home equity of the U.S.A. would be effectively zero.
But when you borrow and leverage to the hilt, then that’s what happens when asset prices fall from speculative bubble heights: equity falls to zero or negative equity.
Can the Federal government print enough money to buy the entire U.S. mortgage market? I suppose it can; but to believe it can do so without any consequences–that’s another story.
Charles is talking about the American market and political situation. The problem is that their problem is going to (has become) our problem too. How? Well consider this:
“All this “government backing speculative housing” is real nice except for the fact all the money is borrowed or created out of thin air. Our “leadership” seems to believe that you can prop up a $10 trillion dollar housing market with $7 trillion in “free money” with no consequences.”
Hmmm, or how about this:
“total delinquencies and foreclosures in the FHA loan portfolio have reached 21.43%–so one in five of all the FHA loans the government is guaranteeing to stem the housing bust have already soured. This destruction of housing equity is playing havoc with consumers’ ability to spend freely”.
Actually I would take a different tack on all this. I would say that the real problems stems from much earlier then destruction of housing equity and that in the end – destruction of housing equity is the solution (painful as that my be), not the problem. The real problem is that houses were ever allowed to get away to such insane valuations. Valuations built on the back of government backed easy money. Interests rates were held so low for so long that what happens is that people end up borrowing to the limit of their ability. What would have been a $200,000 home becomes a $400,000, or even $600,000 home. Except that we can now see that household incomes have infact held static for the last decade. Joe Middle Class hasn’t seen any real growth in incomes for ten years. So how does Joe Average manage to buy a $600,000 property now when he wasn’t remotely able to afford that 10-15 years ago. (now consider that this is a phenomena that has run away to a much larger extent here in NZ than it has in the US and contemplate the consequences)
The answer is that Governments, Reserve Banks and the whole global Banking and Credit industry has maneuvered to flood the world with cheap money, tidal waves of it. It was never mathematically a sustainable proposition, it has been a Ponsi scheme and all these institutions have failed in their duty of fiscal responsibility and financial ethics, but while there was just SO much money to be made, everyone was turning a blind eye and pushing the party line, borrow borrow borrow. What you couldn’t afford at a 10 or 12% interest rate you could afford when the rate was manipulated down to 5%, and there was a rising market, “we’ll still make money on the capital gain – Real-Estate always appreciates”. So you take Mr and Mrs Joe Average and you leverage them out from a 3 x income/mortgage to a 6 x income/mortgage (or even higher), just so that they can buy a house to live in. More interests payment for the same house, whoo hoo, kind of like Monopoly money isn’t it. And best of all, the government statisticians don’t measure house prices as a component of inflation, so that never registers as being relevant to what is happening to our economic system.
Once again, the big financial interests manipulate the situation to their advantage and attempt to shuffle off the costs of that to some-one else. Your home is just a pawn on the board to be gamed to extract the maximum possible profit. And the mechanism that has been employed to achieve that has been manipulating our money. It was never long term sustainable, or even medium term sustainable, but for those controlling the game, that wasn’t the objective anyway. Governments borrowed money and injected it into the economy to ensure continuous growth and buy off their supporters and constituents. The Reserve Bank’s were complicit with the Government’s in manipulating financial markets because that made everyone look good and ensured you stayed in office drawing your fat salary, and the Banks/Credit institutions knew that they could game the system with their size and leverage, insider information, political contacts and cronies, and the revolving door between the banks and government institutions. It doesn’t hurt either if you are major campaign contributors for the politicians. This has all been a lot more blatent in the US than in NZ, but it happens everywhere at some level. Even just when it is that you all turn up to the same social functions and the tennis/golf club etc. Sure, Bobs a great bloke, I talk/play/deal with him all the time, you can trust his word on a deal…
Who benefits: well the people running the money system certainly benefited, but Main-street hasn’t. All we have ended up with is a bubble economy built on mushrooming debt and printed money. It has pushed the prices of everything up until it is all too high to support itself any longer. There needs to be a correction, a proper correction, and values need to regress to what is reasonable and sustainable… but… Ouch!
Consider what Karl Denninger has to say on that (seriously – read this): Deflationary Collapse. Actually I think he underplays it all, I think even the pain he is outlining isn’t the whole of it. It will hurt – a lot. Everyone who owns assets and has money saved is going to get smacked hard, maybe losing half or more of their wealth, and that is under the best possible scenario. Actually, I don’t care at all, I don’t have any money or property, so I couldn’t give a rats-arse about what will happen to everybody else’s wealth. But they all sure do, they really do, and they are going to fight tooth and nail to prevent any serious regression. Everyone with any power, money or property at all realises that they had damn well all better hang in there together and support each other – or they will all just Hang, period. They can’t let their buddies and partners fall, because that will take them all down with it. It isn’t just the big money companies, it is every home owner (sic) as well. If property values fall, if there is several mortgagee sales down your street, then your home starts making a large sucking noise as well. Not good if you then suddenly look like having negative equity.
Suddenly everyone is clamouring for government to do everything necessary to hold asset prices up – do whatever is necessary to stop my house losing value! Despite that it is now mathematically impossible to save your homes value, no-one gives a shit about that, they just want some-one to save them. Too late, the shit has already hit the fan, now it is just a question of what we do about it, and how long we have to suffer because of it. All the money pumping that is currently going on is not going to change anything. That is all being defeated as fast as it can be instituted. The slow-down in the velocity of money is soaking up much of it and much of the rest is simply going into a musical chairs game in the stock markets, because there is nowhere else that it can go, the consumer is all tapped out.
Charles asked the question: “Can the Federal government print enough money to buy the entire U.S. mortgage market? I suppose it can; but to believe it can do so without any consequences–that’s another story.”
Unfortunately, that is what they are going to try and do. In fact it goes further than that. Since billions and hundreds of billions of dollars have been lost/destroyed by the financial crash, the plan becomes simply to borrow or print as much money as necessary to replace all the money that has been lost. That way you end up nett neutral don’t you… no harm no foul. If the big Financials pissed away Mega-money into the wind, then just replace it all and carry on as usual, make them good and the problem is solved. Except you are leaving all the same people, institutions and practices in place to continue on just as before. Just how is doing more of the same going to affect a different result than we got the first time around? The definition of insanity is repeating the same actions and expecting a different result. This plan will fail as well.
The end game for that plan is sky-high interest rates and eventually massive inflation. That will finally kill what’s left of the economy stone dead and still leave you where we were heading anyway, but just taking longer and costing more. Instead of taking the bull by the horns and dealing with the realities up front, the instinct is to weave and dodge. We can either let that happen – or wake up, educate ourselves and radically reform everything about how we do business. This current economic/political model will kill us all if we leave it intact to run its course. Liberal, Capitalist Democracy has been a noble experiment, but it has been subverted, exploited and now destroyed by its own internal contradictions. Marx was right about that, even if he didn’t have a clue about anything else.
Time to wake up and smell the grass(shit) people. What is happening in the US will happen or impact here too. Karl is right about the only option that is left open to us.
The nature of a trap is that it uses your nature to trap you