Back in August 2005, at the tail end of the housing bubble (but when many VC readers were still berating me for saying [or, more precisely, siding with the many "doomsayers" who were saying] there was a housing bubble), I pointed out one future source of trouble for the housing and mortgage markets:
Just read that 61% of all new California mortgages this year are interest only, no money down. This is especially important because California (like a few other states, but, unlike, say, D.C. area jurisdictions where about 50% of the new mortgages are interest only) has a law requiring that all mortgages be "non-recourse," i.e., if a mortgagee defaults on his loan, the bank cannot attach any of the mortgagee's other assets, but can only foreclose on the house. If prices drop significantly in the next couple of years, as they likely will (given that only 17% of Californians can now afford the median house), thousands of people are going to walk away from their loans and let the bank foreclose, with no bankruptcy consequences. Sure, it will ruin their credit record, but how much is a good credit record worth? Probably not $120,000 (the negative equity on a $600K loan--median single family home price in California--if prices decline a modest* 20%). Anyway, many of the loans are adjustable with "teaser" rates used to qualify the buyers, who understand that in two years they will have to refinance or sell, because they won't be able to afford the new payments. They are counting on interest rates being lower, or on being able to "flip" the house for more money, and using the proceeds to get "back in the game."
A Conspiracy reader who was an executive at Indymac emailed me that the banks were aware of this possible dynamic, but were confident that home buyers would protect their credit rating at all costs, and wouldn't default on their mortgage unless they really couldn't pay their mortgage, regardless of how far "underwater" they were. This is when I first concluded that the banking industry was out of its collective mind. (And of course, as it turns out, even in "recourse" states, "jingle mail" is an ever-growing problem, and banks rarely try to go after any assets that the borrowers may have).
UPDATE: Part of the problem, from what I can tell, is that the mortgage industry was relying on worst-case scenarios based on default rates from past housing busts, such the early 90s in California, and the 80s in Texas. Yet those were totally different circumstances, not least that those default rates were based on borrowers who generally put 20% down, and thus would think really hard before defaulting, credit rating aside.
"A Conspiracy reader who was an executive at a bank, and I think it was Indymac, . . ."
and was changed to
"A Conspiracy reader who was an executive at Indymac, . . ."
presumably because of guest's comment. Isn't this the kind of thing that should be marked as an update, rather than a silent correction?
The fact that many people were wrong doesn't mean you were the only person who was right.
Further, the fact that major beneficiaries of the bubble viewed the situation in a self-serving manner proves very little.
Finally, if you were so clear-eyed, why didn't you make a bunch of money on the debacle (e.g., by shorting the stock of companies with known extensive exposure to these mortgages)?
As for "finally," how do you know I didn't?
If you'd made a bunch of money, I am confident you'd have also made at least a half a dozen posts about it. cf. the endless stream of posts about your own home-buying experience. Care to correct me?
I take it you aren't a very active trader. There's a difference between knowing a situation is untenable and knowing how to time that situation to make money off of it. Here are a couple clues to tell you a sector is due for a heavy correction:
"This time it's different!"
"x never goes down!"
"Learn how to get rich with no money down!"
A cable channel has a show dedicated to making quick money by "working the market."
From here it looks like it's going to get worse before it gets better.
Maybe there is just too much boomer pension money looking for someplace to invest at a better than 2% rate. I think 2% has been closer to the historic norm. But after seeing 8% and 10% and 12% yields in the 70s and 80s people thought they could retire on little money. Now it turns out maybe almost no one can afford to retire (in style).
Don't listen to the naysayers. It's always difficult to argue that there's an asset bubble, because it amounts to arguing that the market isn't, in fact, always efficient -- the constant derision and condescension from free market fundamentalists (who usually have little formal training in economics) is a surprisingly strong deterrent. I remember what the housing bubble debate was like ("vitriolic" I think is the best word for it), and the people who saw the housing bubble coming deserve a few rounds of "I told you so." Too bad all the housing bubble deniers have mysteriously disappeared!
As for my being obnoxious about this (and perhaps generally), guilty as charged. Though it's certainly a case of the pot calling the kettle black.
In any event, you're right, I looked back through some of your other posts and several of them did link to outsider bubble comments. Other posts, I maintain, reflected the same haughty attitude that is in this post.
I'll finish by noting that you have no claim to being especially prescient for predictions made after this (quoting on 7/1/2005 the CEO of Toll Brothers predicting a large drop in housing prices).
Have a good night, DB.
I'm plenty familiar, and this is precisely my point. Look, Greenspan made his (in)famous "irrational exuberance" comments about 4 years before the stock market bubble burst. But ya know what? A lot of centimillionaires and billionaires were minted from 1997 to 2001 (and not all of them just on paper). They're the ones who get to gloat, not the people who sat smugly on the sidelines reminding everyone that water is wet and all bubbles eventually burst or deflate.
Now if DB did get the timing details right on the burst, then kudos to him.
I predict that everyone who has posted a comment on the VC today, will die.
I also predict that every VC contributor (as of day) will die.
Yes, I'm a great prognosticator.
Incidentally, I predicted that the Dow would hit 11,000. After I had made the prediction, the Dow hit 13,000. But today it hit 11,000. Look at me, I'm a genius!
I mean, in a sense I can gloat. But, I was wrong before I was right. And if I had taken a short position after making my first prediction, I would have had my rump handed to me. So how can I gloat?
In the market, if you think your predictions are so great, you get to test them. Simply take a short position. If you don't, how confident are you really with your prediction?
In any event, some people are predicting that the Dow will hit 15,000. In fact, I am now making that prediction.
I'll be sure to gloat when those events occur.
Mike, I'll predict that the Dow will never hit 15,000. In fact, I'll predict that it monotonically decreases until it gets to 6,000, at which point China decides we're so crippled it can weather a first strike. Seeing as how doomsday prophets are always right, I guess we're pretty screwed now, huh?
If Indy Mac had been able to pursue merger/sale options on its own, there might have been something salvageable. Despite its problems, it still had capital. But, receivership equals fire sale, and FDIC is notorious for negotiating poorly in these situations. As it is, some commentators say, this may cost the FDIC insurance fund upwards of $12-13 billion (out of total reserves in the range of $52 billion). That would bring the FDIC reserve ratio (already low at 1.19%) down below 1%.
Hoqw does it affect you? It is unlikely that there would be a taxpayer-funded bailout of the insurance fund, but assessments on bank deposits will go up tremendously -- that will affect interest rates and loan availability. In the end, the money comes out of the pockets of the depositors and borrowers, and, indirectly, consumers.
Thanks, Chuck. Of course, Chuck blames the regulators -- there was no run, he says, and if there was, it wasn't his fault. But it was -- he took a bad, possibly salvageable, situation and made it worse.
Thus, just as with the savings and loan scandal in the early 90s, the problem is separating reward and risk. If you are lending your own money, you'll be sure the borrower has the ability to met the terms and conditions he agreed to. When you get paid to pass the risk on to some big bank/institution, what do you care about a questionable loan?
The potential damage now comes from efforts to bail out the parties, the flawed borrowers, the greedy lenders and the dumb bundlers, all of whom ignored the risks. Lots of folks saw this coming and LOTS of people made money on that vision, they bought puts and sold short on the house builders (too much existing inventory), banks and anyone holding the bundled securities. Simply look at Citigroup (C) to see what could have been made by buying puts in the first quarter.
This falsified the monetary signals being sent within the economy and resulted in malinvestment. People thought they were doing better than they actually were and were overinvesting in long term projects like housing and internet companies that would not pay out in the end.
All the signals of monetary inflation predicted by the Austrians to occur are with us. Low savings, overextended borrowing, commodity price inflation, trade imbalance. The Austrian theory not only tells you why this happens but they also have a clear mechanism by which it happens. Unlike the theories that inspired the creation of the FED it doesn't work by "magic".
The bad thing is that the hurt is not over yet. The damage has been done and is being hidden by low interest rates. Problem is that that damage is going to have to be exposed and dealt with at some point. The correct thing for the Fed to do now is to neither increase nor decrease the money supply. Unfortunately they have not only interferred in the money supply but in the mechanics of the fractional reserve system.
They have allowed us to become overleveraged. This means that instead of having to deal with an economy that is like a cherry resting inside the bottom of a upright bowl, the natural outcome of free markets, we are dealing with an economy that looks more like a cherry resting on the top of an inverted bowl. On one side is deflation and the other inflation.
The government itself has no assets so it's "guarentees" are pretty much worthless in and of themselves. They can only "fix things" by distributing the errors they have collectivized. Yes, screwing with the money supply causes us humans to all make bad economic decisions in synchrony. But if most everyone is now in error about their economic condition then even taxation isn't going to pull economic prosperity out of the hat.
If the Fed "does nothing" that will be deflationary and the people who have been getting rich quick off of asset inflation will be harmed along with those who lent them the money if they go bankrupt. Problem is that's pretty much everyone. Plus the government owes lots of money to foreign entities so they will, in fact, try to avoid this outcome. The cherry will not quickly this way but it will be pushed this way as banks and other institutions that are leveraged collapse.
The FED can just let them collapse for this reason. The problem is that any "fixing" that is done will be highly inflationary. The problem is that these things are leveraged. So to pay the person who invested or lent to a bank 100% of his money back one must increase the currency by the leveraged amount.
If you lent $100,000 to your bank by depositing it and then lent out $90,000 to others to invest in housing that is now worth only $45,000 then then in order to inject enough "liquidity" into the system to pay you back they are going to have to cough up $45,000 and sell off the asset to someone. That's if you want your cash back and you have it in a short term deposit account.
In other institutions like Freddy and Fannie the leverage is far worse. There is leverage around fifty to one.
Trying to correct all this is highly inflationary. You think the commodity price rise has been large so far, well wait till the consumer prices start to kick in. Yes, that is another prediction of Austrian economics. Commodity prices go up first then consumer. I could explain why all this happens but frankly I don't have the time.
Instead of repealing Glass-Steagall, it should have been expanded.
Only sense I could make of it was that the lenders were just convinced the realty bubble was never going to pop, so that the most foolish loan would still pan out.
Glass-Steagall was passed because of the 1929 crash. 25 years ago I remember bankers like Citibank pushing and pushing and pushing to lift all those Depression era restrictions on them saying "this time is different".
I hope this works out, but I suspect that far too many people have been asleep at the switch. Just hope the most disadvantaged do not bear the brunt of the pain for once.
Best,
Ben
Too specific for a doomsday prophecy. You must be vague. For example, Bernstein had long said that we were in a housing bubble. He never got anymore specific, e.g., by saying when the bubble would burst. Well, as prices tend to rise and fall, someone saying we're in a bubble will of course eventually be right.
But so what? What does that prove? It certainly isn't evidence of special insight. It's just the type of tricks psychics use every day. It's no different from the oracles telling the Athenians to put their faith in their "wooden walls."
If you can't get the distinction, I'd encourage you to pick up a copy of a book on cold reading from James Randi's site. Here's a primer on how to be vague enough that you'll always and eventually be "right."
If you want to say, "One day the U.S. will not be a world superpower," then of course your prediction will come true.
The question is: Does that tell us anything about your predictive abilities?
If you can't be specific, then your "prediction" is per se a guess at best, and a ruse at worst.
That's correct, and our high interest rates (relative to other nations) have devalued our currency. We're now at $1 = 0.50 Pounds and 0.63 Euros. This is not a good time for vacationing in a foreign land. Our devalued currency also is responsible for most of the recent oil cost rises. If our currency was as strong as it was 3 years ago, those $130 per barrel oil prices would be around $95 per barrel.
One of the downsides of economic interdependencies is that a relatively small group of people acting like greedy sheep (Lender A is giving out no money down, 2% adjustable rate mortgages and making money, so we should do the same!) can disrupt the entire national economy. And some people thought Enron was a big deal. I'll take 50 Enrons over the mess we have today. Any bets that all the irresponsible executives at the lending companies and remortgage companies either keep their jobs or walk away with bonuses or golden parachutes?
Professor Bernstein was right about the bubble. Us old unreconstructed New Dealers were on this way before that. Big blocks of money attract crooks. An ideology that says locks are bad is just looking for trouble.
Glass-Steagall was repealed during the first Clinton administration.
I bet Phil Gramm feels like an idiot. He always was one, but he picked a poor time to speak up for the robber barons, didn't he?
Are you trying to claim that this is a "big business" issue? If so you are sadly mistaken. This is all about corruption of free market processes, just like the Enron example. ... and yes we need judicial processes to maintain a free market, so I'm not advocating "anything goes".
Laissez Faire isn't "anything goes". It's "leave us alone" and it's quite clear that the government hasn't "left things alone" here. Forcing interests rates down to around 1% (not letting the market seek its price) is not leaving things alone.
This is the same kind of governemental meddling that happened pre-Great Depression, and pre-70's inflation. In addition the government has come up with new way to create bad incentives in the economy.
I haven't followed the IndyMac situation closely, but I don't understand this comment. If the bank were solvent but illiquid why cut off the borrowing?
Isn't it more likely that it was insolvent but there was hope of recovery in asset values?
1) your OWN comment in which you claimed to have predicted in April 2005 that the end of the bubble was coming within months because of "end of bubble" evidence like condoflip.com. (Clearly referring to this post.)
2) my response to that comment (in which I made not a single personal remark), pointing out that, not only was that assessment made in June 2005, but that it was made one week after The Economist said, "PERHAPS the best evidence that America's house prices have reached dangerous levels is the fact that house-buying mania has been plastered on the front of virtually every American newspaper and magazine over the past month. Such bubble-talk hardly comes as a surprise to our readers. We have been warning for some time that the price of housing was rising at an alarming rate all around the globe, including in America. Now that others have noticed as well, the day of reckoning is closer at hand. It is not going to be pretty."
I don't think that kind of editing of the discussion is fair or reasonable.
Well, I don't think your constant, obnoxious attacks are fair or reasonable either. Go away, troll.
Everything else I've said has been in response to follow-ups from him and other commenters. Yes, he, along with many many others could see that the end was nigh in the spring and summer of 2005. As he acknowledged in his post above, that and a quarter will get you a bag of chips.
My last quibble is that he took the opportunity of subsequent bad behavior on my part to paper over his own misrepresentations about his predictions. (Indeed, I made a mistake above, he deleted one of his own comments and edited another.) I have no doubt that he made his condoflip.com comment in good faith, but when someone calls you out on a mistake (as Professer Bernstein himself is wont to do), pretending like you never made it -- and editing out the record of it -- is, in my very humble opinion, lame.
Now the real question is this. If Schumer shorted IndyMac before he brought it down, was he selling on inside information? What if he told his aides the day before he brought up the subject and THEY sold IndyMac short?
I have a banker friend on whom I want to play a practical joke.
Interestingly, the significance of a "bad" credit record varies inversely as to the person with the bad credit and his bank.
If only one person has a bad record, it would be devastating to be that one person. On the other hand, if EVERYONE is defaulting, driving a bank toward collapse, a bad credit record doesn't mean much at all. Who else can a bank lend money to if everyone has a bad credit record?
The more important bad credit records collectively become to a bank, the less important they individually are to any single credit holder. The more you are desperate for folks to pay their debts, the less likely they are to do so.
I have sympathy for those who foolishly thought they could afford the loan for the house they bought to live in, just because the mortgage broker, et al. told them they could. I have no sympathy for those who thought they could make money buying houses to rent out. If people could afford rents that would cover mortgages, taxes, and insurance, they would be buying houses, not renting them.
For anyone wanting to buy a house: Plan on spending at least five years in it. This will bridge any normal dip* in the real estate market since WW II. And get a fixed rate mortgage, so you never get surprised by the amount of the monthly payment.
*Don't buy in towns with declining industries, or one-company towns, unless you can afford to pay cash.
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