by Calculated Risk on 3/31/2008 10:24:00 AM

Paul Krugman explains the Paulson plan in the NY Times: The Dilbert Strategy

Anyone who has worked in a large organization — or, for that matter, reads the comic strip “Dilbert” — is familiar with the “org chart” strategy. To hide their lack of any actual ideas about what to do, managers sometimes make a big show of rearranging the boxes ...

You now understand the principle behind the Bush administration’s new proposal for financial reform, which will be formally announced today: it’s all about creating the appearance of responding to the current crisis, without actually doing anything substantive.

One of the key points is this plan was mostly in place to further deregulate the financial industry:

... the new plan was originally conceived of as “promoting a competitive financial services sector leading the world and supporting continued economic innovation.” That’s banker-speak for getting rid of regulations that annoy big financial operators.

Now, using the credit crisis as cover, the plan is being sold as "a fix" for the current problems.

I’ve been disappointed to see some news outlets report as fact the administration’s cover story — the claim that lack of coordination among regulatory agencies was an important factor in our current problems.

The truth is that that’s not at all what happened. The various regulators actually did quite well at acting in a coordinated fashion. Unfortunately, they coordinated in the wrong direction.

For example, there was a 2003 photo-op in which officials from multiple agencies used pruning shears and chainsaws to chop up stacks of banking regulations. The occasion symbolized the shared determination of Bush appointees to suspend adult supervision just as the financial industry was starting to run wild.

by Calculated Risk on 3/31/2008 10:01:00 AM

From Bloomberg: New York City Real Estate Market Slows as Wall Street Cuts Jobs

New York City's residential real estate market is showing the first signs of fallout as U.S. banks and securities firms cut the most jobs in seven years.

Manhattan apartment sales fell in January and February from a year earlier and new properties came to the market at the fastest pace since at least 2000 ... Transactions slid 6.4 percent to 3,250, while the number of condominiums, co- operatives and townhouses for sale at the end of last month climbed to 6,225, 15 percent more than at the start of the year.

With sales falling, and inventory rising, price declines will follow.

by Calculated Risk on 3/30/2008 02:05:00 PM

John Mauldin writes: Where is the Bottom in Housing? (hat tips: many!)

Mauldin provides a good overview of the housing market. His analysis is based on information from John Burns Real Estate Consulting and T2 Partners. Both Burns and T2 have made their presentations public.

There is all kinds of charts and information available, but I'll comment on a couple of points. Mauldin writes:

Bottom Line? There is no Bottom in Sight

[Burns] most likely timeline is that resale stability will come back by 2011, and it will be even earlier for the homebuilders. He is projecting 6,000,000 home sales (new and existing) in 2008, but falling to only 4,000,000 in 2009. Low sales volume and high foreclosures will delay inventory reduction, which is required for there to be a stable market.

This means that home ownership will fall to 66% of the population in 2009 from the recent high of 69%. He thinks that may overcorrect to 65% in 2010. When I asked him why the overcorrection, he said it has to do with psychology. Housing will go from the greatest investment in 2006 to a bad one by 2009. The market typically overcorrects at the end of every cycle. It will take rising prices to lure the marginal homebuyer back into the market.

We discussed the recent rise in the price of the homebuilder stocks, which he attributes to short covering. Many of the homebuilders, public and private, are selling land at 16% of book value, or are trying to. He suggests that many of the privately owned homebuilders are in the worst shape.

Bottom line? We are nowhere near the bottom in the home markets.

First, on sales, I think Burns is too optimistic for 2008 and too pessimistic for 2009. Right now we are on pace for just under 5 million existing home sales in 2008, and 600 thousand new home sales (and sales will probably fall further). A forecast for 6 million total sales in 2008 is probably too high.

Similarly a forecast of 4 million total sales in 2009 is probably too pessimistic. The reason Burns is probably too pessimistic on total sales in 2009 is because prices will likely decline further than Burns is forecasting (helping sales). Burns is only forecasting a 16% nationwide price decline from peak to trough. Based on the Case-Shiller National index, house prices are already off 10.1% as of the end of 2007 - with much more declines likely in 2008.

Also according to Burns, there are "3.5 million excess homes that need to be filled by qualified buyers". This is really a confusing metric. Burns arrives at this total by adding excess vacant units to his estimate of future vacant homes due to the declining homeownership rate.

But this approach really confuses a few numbers and concepts. Burns estimate of 1.55 million "vacant homes" is about right, but this includes about 560 thousand excess vacant rental units! (see Inventory, Inventory, Inventory) So a decline in the homeownership rate cannot be added to this number directly - or there would be some double counting.

Also Burns is probably too pessimistic on the decline in the homeownership rate. Recent academic research by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf (Sep 2007), "Accounting for Changes in the Homeownership Rate", Federal Reserve Bank of Atlanta, suggests that there were two main factors for the increase in homeownership rate between 1994 and 2004: 1) mortgage innovation, and 2) demographic factors (a larger percentage of older people own homes, and America is aging).

The authors found that mortgage innovation accounted for between 56 and 70 percent of the recent increase in homeownership rate, and that demographic factors accounted for 16 to 31 percent. Even as we unwind some of the excesses of recent years, not all innovation is going away (securitization and some smaller down payment programs will stay). And the population is still aging, so the homeownership rate will probably only decline to 67%, or maybe "over correct" to 66% - but will probably not decline to 65% or lower. (No one has a crystal ball, so maybe Burns pessimistic view will be proven correct).

And one more point on the declining homeownership rate: this is probably better viewed as a head wind for demand, not as additional supply. Using an excess inventory number of 1.6 million or so is probably more useful when discussing supply.

Even with these minor flaws, this is a good overview.

by Anonymous on 3/30/2008 09:29:00 AM

Taking notice of the endless silliness in the political blogosphere is no part of the mandate of this blog, and we normally try to carry on with our main mission while pretending that we can't hear most of the background noise and cannot feel that terrier gnawing on our ankles. It has never, really, been that we're stupid; it was mostly that we didn't want them to come over here and ruin a perfectly good nerd blog. Political discourse in this country has been so poisoned for so long that we were quite attracted to the possibility of pretending that it wasn't there in case it decided to go away while we weren't looking.

However, I for one did argue, quite early in this mess, that 1) housing policy is political in this country and 2) financial crises are even more so and that therefore 3) whether or not it "should" be that way is immaterial; it is so. The housing bust and the debt bubble pop have been and are going to remain political footballs for the foreseeable future. The least we can do about that is insist that everyone get the elementary concepts right.

Let me therefore do my obligatory least by pointing out that this kind of thing just has to stop:

Apparently, a lot of foreclosed tenants like to trash the house before they leave. I don't get it. It's hardly the bank's fault that you can't make your mortgage payment. I mean, I understand the rage at fate that has pushed you out of your home and left your credit record in shreds--yea, even if you had a hand in that fate yourself. But I don't get pointless destruction.

I can't do anything about anyone who can't quite "get" vandalism, as if it had never existed in the world before middle-class homeowners got in over their heads with mortgage loans. (Really. I was "not getting" the point of cutting off the handset on pay phones and stealing the directory back in the days when we had pay phones and they cost a dime. I was therefore prepared to "not get"--or to "get," as it were--foreclosure "trash-outs," at the point they began to arise (again, in this cycle), since, well, it's a reusable conceptual paradigm thingy.)

But it isn't the not-getting of the "pointless" destruction that makes it less than completely pointless for us to examine this silly little blog post. It's that first sentence with the term "foreclosed tenants" in it.

I "get" vandalism a whole lot more than I "get" a self-described "economics blogger" weilding the English language like that. Which is to say, I suspect I do "get" it. And I don't approve of the latter any more than the former.

There has, for a long time now, been a certain persistent critique of a variety of boom-lending that went something like this: when you take an interest-only no-down-payment loan to buy a house at market price--that is, at anything other than a significant discount to market price--you are in effect, if not in fact, merely "leasing" the house from the bank.

This is a "critique" because, see, "secured lending" only really works when the collateral that secures the loan belongs to the borrower, not the lender. I suppose I could write you a loan that involved my promising to hand over an asset that I already owned to myself--that'll teach me!--in the event that you fail to pay me back as agreed. I'm not sure I could pass a licensing exam with an understanding of the process like that, but you never know.

So the critique came in on the grounds that 1) this is self-defeating for lenders and that 2) it is self-defeating for borrowers. I occasionally run into newbies to the financial world who demand to know why anyone would buy one of these "PO strips" or bonds that do not pay interest. They "get it" once you explain that such bonds are purchased at a "deep discount" to their par or face value. Of course their next question was always why people were using wacky subprime and Alt-A loans to buy houses at "par," and out of the mouths of babes came wisdom.

The point being that "foreclosed tenant" is not simply a curious misunderstanding of law and fact. It is, you know, a way to "get" the "pointless" behavior, if you apply any degree of attention to a contradiction in terms. Possibly some borrowers are coming to the belated recognition that they were, de facto, not much more than tenants who were paying well above "market rent," but the market no longer allows them to "sell" the "lease" to the next sucker, and the law does not allow them to simply forfeit the security deposit and move away. To be a "foreclosed tenant" is to live in the worst of both worlds.

It is possible, you know, that about-to-be-former homeowners understand these things better than self-anointed "economic thinkers" do. They begin to grasp that they had only ever been given a short-term lease on the "American Dream," not a piece of the "ownership society" pie. More than a few of them are very, very, crabby. This, I can "get."

What I also "get" is that here you have a classic example of where the rush to start making a list of people you don't have any "sympathy" for gets you: nowhere, fast. It always disappoints me whenever a thread on one of our foreclosure or predatory lending posts immediately degenerates into a lot of people writing the same comment repeatedly: "I have no sympathy for these people."

It has, actually, been hard for me to "get" why some people think that the first question to be established in any discussion of the real world is whether their own personal sympathies are engaged or not. You'd think I'd be more familiar with the profoundly self-involved than I apparently am, coming out of the banking industry, but there you are. Some entertainment can be wrested out of the situation by responding that I don't have any sympathy for people who don't have any sympathy for other people, but it's limited entertainment because we are often dealing with heads over which such a response tends to fly at a fairly high altitude.

The trouble is I do "get" it. I get why some people need to turn it all into a matter of which contestant is more conventionally attractive, sympathies-wise. The original point of the "joke" about borrowers with these dumb loans just "renting" from the bank was about puncturing the claims of a certain class of economists, who seemed ready to believe that a finance-based "ponzi" economy could go on forever, and that it ought to. If you require to have the joke "foreclosed" in order to defend against its implications for the kool-aid you've been drinking for years about the larger economy, not just real estate, then you might want to willfully misunderstand the point of making jokes. Namely, to see it as making fun of "contemptible" people rather than unmasking the contradictions in economic silliness.

Joking around actually has a long and storied history in the old, old project of arriving at conceptual clarity about important problems, you know. Jokes are not merely "transgressive" of a kind of stuffy demeanor of academics and legislators and courts of law and so on, although they do have an invaluable function in ratcheting down the pompousness to tolerable levels. Jokes are, in fact, often funny because they fail to "resolve" or paper over real contradictions and conflicts: the joke drags it out into the light of day, and leaves it to squirm while we all laugh. We are all subprime now. Is a joke. With, as they say, more than a bit of "truth" in it.

It is of course not always easy to distinguish between a joke and a bog-standard stupidity. We touched on that the other day with the Zippy Tricks. Sometimes the joke actually arises when we find the naive or uninformed or logic-impaired coming up with an inspired phrase like "foreclosed tenants."

Sometimes people feel like they're being "laughed at." That, say, the joke's on them. It has been known for them to get very, very angry. Enough, say, to knock holes in the drywall and rip out the plumbing before following one's belongings to the curb.

Those whose only understanding of humor is to ridicule the victim--not to deflate the hot air filling the designers of this doomed system--will never quite "get" why the butts of the joke become so "pointlessly" destructive. Those humorless souls who do not see an appropriate role for humor in intellectual critique--who really just have to say that this is too serious for such lightmindedness, tut tut--will fail to grasp the overall dynamics of the situation from the other end of it. Between those who have no sympathy for others and those who have only sympathy--syrupy, patronizing, Sunday School-tract simple-minded sympathy--it's a wonder you can get a good joke going some days. Not that I've ever quit trying.

It is within the realm of possibility that some folks engaging in "trash-out refinances" are, well, making the point that the joke's on you, Mr. Bank. You might consider it a kind of performance art of the gallows-humor subgenre. I do think it's a usual expectation that people who write for outfits with the pretensions of The Atlantic are, frequently, expected to try to "get" that. We call these attempts to try to "get" such things intellectual effort. Expenditure of this kind of effort is way harder than, well, just asking yourself if you feel sorry for someone today. Or yukking it up at someone else's "expense."

by Calculated Risk on 3/29/2008 06:29:00 PM

Nelson Schwartz and Floyd Norris provide an analysis of the new regulatory plan from the Treasury: In Treasury Plan, a Reluctant Eye Over Wall Street

[T]he proposal would impose the first regulation of hedge funds and private equity funds, that oversight would have a light touch, enabling the government to do little beyond collecting information ...

The plan hands vast new authority to the Federal Reserve, essentially formalizing what has been an improvised process over the last three weeks.

There is much more in the analysis.

by Calculated Risk on 3/29/2008 04:41:00 PM

Last night I spoke with a land developer. He just purchased improved land in SoCal (update: Inland Empire) for $0.15 on the dollar from a homebuilder (builder's total cost). The deal closed Friday. The purchase price was less than half the cost of just the improvements (grading, streets, etc)!

The deal has no leverage, and the buyers are hoping to sell in 3 to 5 years to another homebuilder. They can wait much longer if necessary. The other details (like buyer and seller) are confidential.

This is an important step. The homebuilders are finally starting to liquidate surplus land at prices that are attractive to "vulture funds", and this potential inventory is also being removed from the market.

I expect to see many similar deals this year as the homebuilders, and their lenders, struggle to survive.

by Calculated Risk on 3/28/2008 09:39:00 PM

From Edmund Andrews at the NY Times: Treasury Dept. Seeks New U.S. Power to Keep Markets Stable (hat tip AllenM)

The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability, in effect allowing it to send SWAT teams into any corner of the industry or any institution that might pose a risk to the overall system.

Here is the Treasury’s Summary of Regulatory Proposal. Just some light reading for a friday night.

by Calculated Risk on 3/28/2008 08:01:00 PM

From Reuters: S&P cuts FGIC insurance unit's rating to junk status

S&P cut FGIC Corp by six notches to "B," five steps below investment-grade, from "BBB." It downgraded FGIC's insurance arm, Financial Guaranty Insurance Co, by six notches to "BB," two steps below investment grade, from "A."

The outlook is negative

This was expected (Fitch cut FGIC to junk on Wednesday), and FGIC will probably be in run-off (they've already stopped writing new business). Unlike insurers AMBAC and MBIA, FGIC was unable to raise new capital.

by Calculated Risk on 3/28/2008 04:13:00 PM

From the WSJ: UBS Cutting Value Of Auction-Rate Securities In Brokerage Accounts

... UBS AG is marking down the value of the securities in its brokerage customers' accounts.

Until now, customers who were unable to sell securities in regularly scheduled auctions were told that the securities retained full value and would receive higher interest rates.

UBS ... will mark them down this afternoon and inform clients via their online statements shortly thereafter ... The markdowns will range from a few percentage points to more than 20% ...

I know investors in ARS, and their banks have been telling them they can't sell - but their principal is safe - it is just a liquidity problem. UBS is telling their customers they can't sell, and their principal is no longer safe.

by Calculated Risk on 3/28/2008 01:47:00 PM

The BEA releases Personal Consumption Expenditures monthly (as part of the Personal Income and Outlays report) and quarterly, as part of the GDP report (also released separately quarterly).

You can use the monthly series to exactly calculate the quarterly change in PCE. The quarterly change is not calculated as the change from the last month of one quarter to the last month of the next (several people have asked me about this). Instead, you have to average all three months of a quarter, and then take the change from the average of the three months of the preceding quarter.

So, for Q1, you would average PCE for January, February, and March, then divide by the average for October, November and December. Of course you need to take this to the fourth power (for the annual rate) and subtract one.

The March data isn't released until after the advance Q1 GDP report. But we can use the change from October to January, and the change from November to February (the Two Month Estimate) to approximate PCE growth for Q1.

Click on graph for larger image.

This graph shows the two month estimate versus the actual change in real PCE. The correlation is high (0.92).

The two month estimate suggests real PCE growth in Q2 will be under 1% - but still positive.

In general the two month estimate is pretty accurate. Sometimes the growth rate for the third month of a quarter is substantially stronger or weaker than the first two months. As an example, in Q3 2005, PCE growth was strong for the first two months, but slumped in September because of hurricane Katrina. So the two month estimate was too high.

And the following quarter (Q4 2005), the two month estimate was too low. The first two months of Q4 were negatively impacted by the hurricanes, but real PCE growth was strong in December.

Looking at the data, real PCE has been essentially flat for four straight months. Based on various economic reports, I'd expect March to be even weaker. This suggests that real PCE in Q1 will still be positive, but somewhat below the two month estimate of 1%.

In Q4, real PCE increased 2.3%, but real GDP only increased 0.6%. With real PCE below 1% in Q1, I'd expect a negative real GDP report for Q1. This is very similar to how the last consumer led recession started in 1990.