Phil Anthropy

The Fed Stops Spoonfeeding Us: A Great Depression for Housing?

It would be good to have objective data on housing prices and sales by region, since declines in the median sale price without respect to regional weightings are not useful data. In some markets, inventory and time on the market have greatly increased, but prices have not decreased. Other markets have been overpriced for several years, and a correction was to be expected at some point. I am not trying to minimize the large impact of housing price declines on the economy, but its deflationary effect does seem to be part of the Fed's plan to control growth.

The subprime mortgage issue has several major components: decline in real estate prices due to desperation selling, and increased risk to hedge funds owning mezzanine and equity grade mortgage backed securities or other collateralized debt obligations. Neither of these deserves the high level of worry that currently prevails.

Desperation selling and outright defaults are, in my view, largely a product of speculation. As I understand it, the numbers are growing, but the percentage of defaults in terms of total number of mortgages is still extremely low. New bankruptcy laws will assist lenders in holding many borrowers hostage to debt for the rest of their lives, if foreclosures do not bring enough money to repay the mortgage (this depends on state mortgage laws.) I expect the default numbers to level off, not accelerate, since the really bad loans go belly up first, and I think that has been done already. Interest rates are not going up. As long as homeowners have jobs, they will usually find a way to make payments on their primary residence.

In terms of defaults affecting hedge funds owning CDOs, once again I am not concerned. I believe (but could be wrong) that most at-risk portfolios are owned by under-informed and poorly-advised groups with a high greed quotient, such as pension funds, college endowments, foreign investors and wealthy individuals. I don't expect major banks and financial institutions to have risked significant portions of their business on speculative CDO ventures, especially ventures involving leverage or underwriting in return for cash flow. Major institutions that have been in business for decades are not likely to bet the farm on such risk. I expect most of the pain to fall on groups who expected something for nothing (or at least, for no risk) and who indeed made a good profit for a number of years, and probably distributed a goodly portion of it to their members. It is unlikely that many people will be bigger net losers, at the end of the day, than they would have been if they had invested in the stock market during a normal bear market period.

Some worry about the unwinding of leveraged CDO money that has been hedged incorrectly on the short side to misbehaving tracking funds or indexes. Once again, we should keep things in perspective. The loss of a few billion dollars in the global economy is no longer a big deal.

Moreover, there is an economic imperative at work now that has not previously existed in U.S. history. We are a huge debtor. Those to whom we owe money have bet their own economic welfare by recycling dollars into our treasuries to help keep interest rates low so that we will continue to prosper and to buy their exports. They cannot risk major perturbations to our economy, or else their holdings will lose a huge amount of value, and large value has already been lost due to the weakening dollar. Therefore, when push comes to shove, money will become available for major bailouts and buyouts. This won't happen for the small players, because there's not enough vested interest to help them. But if major institutions have troubles, they'll be rescued -- if no one else will do it, the Fed will.

My reasoning is based on the assumption, which I am seeing increasingly validated in recent years, that everything must happen so that the rich will get richer. Using this assumption, all else follows. Recessions and depressions are bad for business. Therefore, in this globally interconnected financial world, business (and governments -- sometimes it's hard to separate the two) won't let them happen, at least not until the big players have their money off the table.

However, when small and medium sized investors decide to play for high stakes with high risk, they usually end up getting punished. Later the high rollers come in and buy up the debris for pennies on the dollar.

This happened during the Savings and Loan fiasco, when developers made money (subsidized by the taxpayers) buying foreclosed property from the Resolution Trust Corporation. Additional taxpayer money went into salvaging or liquidating the failing Savings and Loans. Where S&Ls closed, deposits migrated to nearby banks, which saw profits rise. In retrospect, that "crisis" was barely a ripple on the pond of history. Many younger people don't even know what the RTC was.

I believe the current real estate and CDO difficulties are transient, and that real estate prices will stabilize within the next two years. The cost of construction materials has fallen dramatically. It is cheaper to build a new house today than it was two years ago. That artifact is keeping prices low on sales of existing homes. When the current investory clears, prices should reach equilibrium about 15% lower than they were two years ago, and should thereafter increase at near the rate of inflation, as they usually do.