[NYTr] Housing Flameout: California Falls into the Sea

[All the News That Doesn't Fit]

Counterpunch - Oct 20, 2007
http://www.counterpunch.org/whitney10202007.html

Housing Flameout:

California Falls into the Sea

By MIKE WHITNEY

Is it really fair to blame one man for destroying the US economy?

Probably not. But Alan Greenspan is still tops on our list. After all,
Greenspan "presided over the greatest expansion of speculative finance
in history, including a trillion-dollar hedge fund industry, bloated
Wall Street-firm balance sheets approaching $2 trillion, and a global
derivatives market with notional values surpassing an unfathomable $220
trillion." (Henry Liu, "Why the Subprime Bust will Spread" Asia Times)
Greenspan is also responsible for slashing the real Fed Funds Rate so
that it was negative for 31 months from 2002 to 2005. That decision
flooded the housing market with trillions of dollars in low interest
credit creating the largest equity bubble in history. Now that that
bubble is crashing; Greenspan has hit the road. He now spends his time
leap-frogging from city to city hawking his revisionist memoirs of how
he steered the ship of state through troubled waters while fending off
protectionist liberals. Look for it in the Fiction section of your
local bookstore.

Still, can we really blame "Maestro" for what appears to have been a
spontaneous flurry of "free market" speculation in real estate?

To a large extent, yes. Apart from Greenspan's tacit endorsement of all
the dubious loans (subprime, ARMs etc) which flourished during his
reign; and despite his brusque rejection of the Fed's role as
regulator; the Federal Reserve's own documents ("House Prices and
Monetary Policy: A Cross-Country Study") indicate that housing was
"specifically targeted" acknowledging that it would serve as "a key
channel of monetary policy transmission". This is not even particularly
controversial any more. In fact, we can see that this same scam has
been used in England, Spain and Ireland---all now suffering the
ill-effects of massive real estate inflation. Low interest rates
continue to be the most efficient way of stealthily shifting wealth
from one class to another while decimating the foundations of a healthy
economy.

Bankers fully understand the effects of cheap credit on the economy. It
is branded on their DNA.

CALIFORNIA HOUSING FALLS OFF A CLIFF

We are now beginning to see the first signs that the listless housing
bubble has sprung a leak and is careening towards earth. This week's
news from Southern California confirms that home sales have plummeted a
whopping 48.5% from the previous year. This represents the biggest
decline in home sales since the industry began keeping records more
than 20 years ago. Sales are at a standstill and builders and
homeowners have begun slashing prices in desperation. (See you tube
"Central California Housing Crash)

The news is only slightly better in the Bay Area where DataQuick
reports that "Bay Area home sales plummet amid mortgage woes":

    Bay Area home sales sank to their lowest level in more than two
decades in September, the result of a continuing market slowdown and
borrowers' increased difficulties in obtaining "jumbo" mortgages

    A total of 5,014 new and resale houses and condos were sold in the
nine-county Bay Area in September. That was down 31.3 percent from
7,299 in August, and down 40.1 percent from 8,374 for September a year
ago.

40.1% year over year. That is the definition of a market collapse.

"Foreclosure activity is at record levels."

September sales figures for the rest of the country are not yet
available, but what is taking place in California, is what we
anticipated after the stock market "froze over" on August 16th. Most
people don't understand that the market nearly crashed on that day and
that the tremors from that cataclysm changed the way the banks do
business. Many of the loans which were available just months ago
(subprime, piggyback, ARMs, "no doc", Alt-A, reverse amortization etc)
are either much harder to get or have been discontinued altogether.
Additionally, the banks are no longer able to bundle loans into
securities and sell them to investors. In fact, the future of
"securitization" of mortgage-debt is very much in doubt now. An article
in the Financial Times shows how this process has slowed to a trickle:

    "Only $9.9 billion of home equity loan securitizations have come to
market since July 1---A 95% DECLINE FROM THE $200.9 BILLION IN THE
FIRST HALF OF THIS YEAR AND A ROUGHLY 92% DECREASE FROM THE SAME PERIOD
LAST YEAR."

Also---and perhaps most importantly---many potential buyers are now
finding that they no longer meet the stricter standards the banks are
using to determine credit worthiness. This is especially true for jumbo
loans, that is, any home loan that exceeds $417,000. The banks are
getting increasing skeptical (some believe they are hoarding capital to
cover bad bets on mortgage-backed derivatives) in determining who is a
qualified mortgage applicant. Understandably, this has thrown a wrench
in sales figures and slashed the number of September closings in half.

In other words, the credit meltdown on Aug 16 changed the basic
dynamics of home mortgage-lending. Decreasing demand and mushrooming
inventory are only part of a much larger problem; the financing
mechanism has completely changed. The banks don't want to lend money.
And, when banks don't lend money---bad things happen. The economy goes
into freefall. Despite the valiant efforts of the Plunge Protection
Team in engineering a late-day turnaround to the August rout; the
damage is done. Tighter lending will put additional downward pressure
on a housing market that is already in distress speeding up an
unavoidable recession. The economic storm clouds are already visible on
the horizon.

Treasury Secretary Henry Paulson has finally admitted that the slumping
housing market is now the "most significant risk to the economy". Fed
chairman Ben Bernanke agrees and adds that he believes that housing
would be a "significant drag" on GDP. The troubles at the banks and the
news from California have put the "fear of God" in both men. But
there's little they can do. Millions of people are "in over their
heads" living in homes they clearly can't afford. They'll be forced to
move in the next year or so. Foreclosures will soar. That can't be
avoided. Also, the industry has a 10 month backlog of existing homes
that must be reduced before new sales have any chance of rebounding.
That takes time. Construction and construction-related industries will
suffer substantial losses.

The problems facing the banks are much more serious than anyone cares
to openly discuss. The banking system is over-extended and
under-capitalized. The Fed has provided more than $400 billion in repos
since the August meltdown, and yet, the troubles persist. The Treasury
Dept has joined with Citigroup, Bank of America and JP Morgan Chase in
an attempt to repackage bad debts and sell them to wary investors via
"Super conduit" mega fund. The desperation is palpable and these latest
shenanigans are only adding to rising stock market jitters.

There's a myth that the Fed chief can wave a magic wand and make things
better. But that is not the case. Bernanke's decision to cut to the
Fed's Fund Rate last month did not affect long term rates and,
therefore, did not make it cheaper to buy (or refinance) a home. The
rate-cut was really just a gift to the banks that are currently buried
under $500 billion in mortgage-backed debt and CDO sludge. The increase
in liquidity hasn't made these toxic securities any more sellable or
solvent. Nor has it increased the banks willingness to provide new home
financing to mortgage applicants. That process has slowed to a crawl.
All the Fed's repos have done is buy more time for the banks while they
try to wriggle out of reporting their true losses.

The banks serve as a key conduit for the transferal of credit to
consumers. That conduit has turned into a chokepoint due to defaults in
the mortgage industry and the banks own humongous debt-load. The Fed
cannot get money to the people who need it and who can keep the economy
(which is 70% dependent on consumer spending) growing. This is a
structural problem and it cannot be resolved by merely cutting rates.

We've already begun to see signs of a slowdown in consumer spending at
Target, Lowes and Walmart. If that deceleration continues, the economy
will slip quickly into recession.

American consumers have withdrawn over $9 trillion from their home
equity in the last 7 years. That spending-spree has kept the economy
whirring along at a healthy clip. Now that housing prices have
stabilized"and in many cases, gone down---that easy money is no longer
available setting the stage for shrinking economic growth, slower home
sales, and declining demand. Deflation is the Fed's worst nightmare and
will be fought with every weapon in their arsenal.

Regrettably, Bernanke does not have the tools to fix this problem and
he is likely to destroy the currency if he keeps cutting rates. The
recent cuts have already sent oil and gold to new highs while the
dollar continues to nosedive. (The euro stands at $1.42 per dollar"up
63% since Bush took office) The weak dollar and the persistent credit
problems in the markets, has sent foreign investors scampering for the
exits. August was the biggest month on record for the withdrawal of
foreign capital from US securities and Treasuries---$163 billion in
capital flight. (Japan and China led the way) Confidence in US markets,
leadership and integrity has never been lower. Investors are voting
with their feet. They've had enough.

With capital fleeing the country at the present pace, the US will not
be able to maintain its $800 current account deficit, which means that
prices will rise, the dollar will fall, and consumer spending will dry
up. No amount of financial tinkering at the Federal Reserve will make a
damn bit of difference. Barring a dramatic change in economic
policy"which seems unlikely---we appear to be quick-stepping towards a
system-wide market-busting break-down.

THE MESS THAT GREENSPAN MADE

The ruinous effects of Greenspan's housing bubble can't be fully
appreciated unless one spends a bit of time studying some of the charts
and graphs that are now available. These graphs are the best way to
dispel any lingering suspicion that the housing bubble may be some a
left-wing conspiracy theory. It's not, and these links should provide
ample evidence to the contrary.

http://www.bubbleinfo.com/statistics-2007/2007/3/15/arm-reset-schedule.html

http://static.seekingalpha.com/uploads/2007/9/7/amortization_1.jpg

http://static.seekingalpha.com/uploads/2007/9/7/amortization_2.jpg

The first graph is the ARM (adjustable rate mortgages) reset
schedule---totaling hundreds of billions of dollars in the next 2
years. The next 2 are the interest only and negative amortization share
of total purchase mortgage originations 2000-2006. Keep in mind, when
studying the ARM reset graph that "A study commissioned by the AFL-CIO
shows that nearly half of homeowners with ARMs don't know how their
loans will adjust, and three-quarters don't know how much their
payments will increase if the loan does reset. 73% of homeowners with
ARM's don't even know how much their monthly payment will increase the
next time the rate goes up." (Calculated Risk)

The unwinding of the housing bubble is now beginning to show up in
other areas of the economy. Credit card debt has skyrocketed to 17%
annually now that homeowners are no longer able to tap into their
vanishing home equity. Americans already owe over $500 billion on their
credit cards. Now that debt is increasing faster than retail sales,
which suggests that many people are so over-extended they are using
their cards for basic necessities and medical expenses. Industry
analysts now expect an unprecedented wave of credit card defaults in
the next 6 to 12 months. Unfortunately, for the tapped-out consumer,
the credit card represents his last access to an unsecured loan.

We can also expect the downturn in housing to swell the unemployment
lines. Oddly enough, while home sales have declined 40% from their peak
in 2005, construction-related employment has only slipped 5%.That is
really astonishing. It could be that the BLS is fabricating the numbers
using its Birth-Death model. (which magically produces millions of
fictitious jobs) But we know that construction has accounted for 2 out
of every 5 new jobs in the US for the last 6 years, so we are sure to
see a significant rise in unemployment as the bubble deflates. The
financial and mortgage industries have already experienced significant
layoffs.

Similarly, we can expect to see substantial correction in home prices.
Housing prices typically lag 6 months after sales peak and inventory
rises. So far, prices have dropped a mere 3.5%, whereas inventory is at
historic highs and sales have decreased 40%. It is impossible to know
how low prices will go (some experts like Robert Schiller predict 50%
cuts in the hotter markets) but the downward pressure on housing prices
is bound to be enormous. Growing unemployment, o% personal savings,
rising foreclosures, the weakening dollar, and the prevailing mood of
gloominess (a recent poll showed that a majority of Americans believe
we are ALREADY in a recession!) suggest that the impending fall in home
prices will be precipitous.


DEFLATIONARY DOWNWARD SPIRAL

There is a debate raging on the econo-blogs about whether the country
is headed towards hyperinflation or a deflationary cycle. The argument
for hyperinflation is compelling since the Fed has already shown that
it is prepared to savage the dollar in order to keep the economy
running. As a result, we've seen inflation is heating up at a pace not
seen in over a decade.(despite the government's mendacious figures) In
September gasoline costs rose 4%, heating oil soared 9%, food jumped
5%, and dairy products lurched ahead 7.5%. Everything is up except the
greenback which appears to be in its death throes.

Still, there are signs that America's debt-fueled consumer economy is
on its last legs as shoppers and homeowners are increasingly forced to
accept that they have maxed-out nearly all of their available lines of
credit. They will have to curtail their spending and live within their
means. That means less growth, a continuing decline in housing, and a
sharp fall in equities prices. These are all the harbingers of
deflation.

Treasury Secretary Paulson's new "Master Liquidity Enhancement
Conduit", M-LEC---which allows the investment banks to delay reporting
their losses---is particularly ominous in this regard, since it was the
Japanese banks unwillingness to write-off their bad debts which
extended their deflationary recession for 15 years. Can the same thing
happen here?

Probably. An interesting exchange took place last month between the
widely-respected economic blogger, Mike Shedlock ("Mish's Global
Economic Trend Analysis") and economist Paul L. Kasriel. The interview
provides details of the Japanese crisis which offer some striking
similarities to our present predicament. I have transcribed an extended
portion of that discussion:

Paul L. Kasriel: "Japan experienced a deflation in recent years because
the bursting of its asset-price bubble in the early 1990s created huge
losses in its banking system. The Japanese banks had financed the
asset-price bubble. When it burst, the debtors could not keep current
on their loans to the banks and therefore were forced to turn back the
collateral to the banks. The market value of the collateral, of course,
was less than the amount of the loans outstanding, thereby inflicting
huge losses of capital to the Japanese banks. With the decline in bank
capital, the Japanese banks could not extend new credit to the private
sector even though the Bank of Japan was offering credit to the banks
at very low nominal rates of interest.

Banks are an important transmission mechanism between the central bank
and the private economy. If the banks are unable or unwilling to extend
the cheap credit being offered to them by the central bank, then the
economy grows very slowly, if at all. This happened in the U.S. during
the early 1930s.

U.S. banks currently hold record amounts of mortgage-related assets on
their books. If the housing market were to go into a deep recession
resulting in massive mortgage defaults, the U.S. banking system could
sustain huge losses similar to what the Japanese banks experienced in
the 1990s. If this were to occur, the Fed could cut interest rates to
zero but it would have little positive effect on economic activity or
inflation.

Short of the Fed depositing newly-created money directly into private
sector accounts, I suspect that a deflation would occur under these
circumstances. Again, crippled banking systems tend to bring on
deflations. And crippled banking systems seem to result from the
bursting of asset bubbles because of the sharp decline in the value of
the collateral backing bank loans."

    Mish: What if Bernanke cuts interest rates to 1 percent?

    Kasriel: In a sustained housing bust that causes banks to take a
big hit to their capital it simply will not matter. This is essentially
what happened recently in Japan and also in the US during the great
depression.

    Mish: Can you elaborate?

    Kasriel: Most people are not aware of actions the Fed took during
the Great Depression. Bernanke claims that the Fed did not act strong
enough during the Great Depression. This is simply not true. The Fed
slashed interest rates and injected huge sums of base money but it did
no good. More recently, Japan did the same thing. It also did no good.
If default rates get high enough, banks will simply be unwilling to
lend which will severely limit money and credit creation.

    Mish: How does inflation start and end?

    Kasriel: Inflation starts with expansion of money and credit.
    Inflation ends when the central bank is no longer able or willing
to extend credit and/or when consumers and businesses are no longer
willing to borrow because further expansion and /or speculation no
longer makes any economic sense.

    Mish: So when does it all end?

    Kasriel: That is extremely difficult to project. If the current
housing recession were to turn into a housing depression, leading to
massive mortgage defaults, it could end. Alternatively, if there were a
run on the dollar in the foreign exchange market, price inflation could
spike up and the Fed would have no choice but to raise interest rates
aggressively. Given the record leverage in the U.S. economy, the rise
in interest rates would prompt large scale bankruptcies. These are the
two "checkmate" scenarios that come to mind." ("Mish's Global Economic
Trend Analysis")

Well put. Thank you, Mish.

Mike Whitney lives in Washington state. He can be reached at:
fergiewhitney at msn.com