Eating Fair Traded, Shade Grown, Free-range, Crow

One unfortunate feature of being an economic gadfly is the the field of economics is fraught with prediction, most of it coming from the third bend in an economist's colon.  At the Institute For Economic Reality, the convocation of macro-economic realists strives not to source its predictions in the same manner.  Even so, reality often intrudes in the most obsene fashion for those of us trying to politely cajole the mildly curious out of the dark arts of economic superstition and down the marble colonnade to economic reality.  Even the IER's predictions did not take into account the serialized criminal actions by the financial elites in this country to prevent the collapse of the debt-fueled consumption binge of the last 20 years.

That's a fancy way of saying that we didn't think the FED and US Treasury would resort to freebasing several trillion dollars worth of economic crystal methamphetamine to keep the party going. 

The IER's predictions of an 80% (minimum) peak to trough decline in sexy, bicoastal residential real estate by the end of 2010 is a bust.

Yes, the IER was wrong.  You heard it here, first.  The homes of the vainglorious twits (the ones that drone on endlessly about how valuable their homes are and how they are special and immune from the macro economic forces that subjugate the rest of us) only collapsed 30-40%, which is 80% lower than where said twits thought they would be.

As one of my favorite hockey players, Grant Marshall, would say when the Dallas Stars would lose a hockey game, "They didn't beat us; we just ran out of time."  He was implying that the Stars were better, but didn't get enough time to demonstrate it.

The same is at work here.  2010 has come and gone, but the game isn't over.  The only part of "20 cents on the dollar by 2010" that isn't true is the time element.  Make no mistake - we are going to 20 cents as soon as the FED runs out of ammo, and they are running out of ammo.

There is no better time to gun the financial markets higher than in the low volume trading days surrounding Christmas.  Even with this, the debt markets are getting crushed, and equities aren't exactly rebounding like they should.  With the FED now holding in excess of a cool trillion in US debt, they are very, very sensitive to the value of that debt.  Some students of this phenomenon have predicted that the FEDERAL RESERVE is going to be frozen solid if the 10 year US Treasury hits 4.5%.  Absent some flood of money hitting the debt auctions over the next few months, we should be there by Spring 2011.

How would you like to sell a home in a market that doesn't have loans available at any price?  If the FED freezes up, we get to find out.

Just as any tweaker knows, once you start meth, you have to keep on it to get the same high, while at the same time, your brain's ability to manufacture its own "happy drug" is essentially detroyed.  That's the situation with the Treasury and the FED.  13% of GDP is borrowed money, and that gets us a 2% growth rate.  Think about that and what happens when the government can no longer borrow 40% of what it spends.

The economy is just reacting to government spending, rather than to a genuinely expanding manufacturing base.  The deficit spending is killing off the private economy because the risk/reward is distorted.

So, for the record, and so everyone on "Rain City Guide" and the detractors on "Seattle Bubble" can rub my face in it, "20 cents on the dollar by 2010" is dead. 

Recipies for crow are being accepted.  In the interest of the sensitivities of those living on the southern 7 miles of SR-305, the crows must be fair traded, shade grown, and free range.

Is QE 2 Really The Titanic?

As the vast and loyal readership of Clearcut Bainbridge already know, the Institute For Economic Reality has been a pretty good fade for calendar year 2010.  The IER predicted a rising US dollar and falling "everything else."  This wasn't lost on the senior fellow level of the IER, and I had a short, but prosaic posting where I would be eating large helpings of corvus brachyrhynchos.  The mighty US dollar was the Pee-Wee Herman of Venice Beach, and the equity, debt, and commodity markets were Rambo on a 'roid rage.  Capping off all that was the two weeks prior to The FED announcing yet another asinine program to prevent the price discovery of banking assets (Quantitative Easing 2.0, or QE2), I took an unfortunate spill body surfing and spent my fortnight's leave in Hawaii lying in bed with a shattered shoulder and bombed on pain meds.

Just as I was going to press with my "101 Ways To Eat Crow" article, I placed a call to the IER's Great Lakes Associate Fellow to see what she had to say, and she told me to stand down from admitting defeat and check out the European bond spreads in the more dysfunctional economies (that's everyone but Germany).  Apparently, after a few liters of Irish single malt, things get a little foggy on the concept of actually paying back money you borrow to live beyond your means.

Sure enough, Ben Bernanke's idiotic plan to thwart the normal restorative properties of a free market and credit based hard currency system has blown up in his face almost as fast as a dumb insurgent tinkering with a roadside bomb.  Stocks are mixed, but the bond market appears to be treating Ben the same way the American voters treated Nancy on November 2.  Everything in Bondville is getting sold, especially closed ended mutual funds (hattip to Karl Denninger of the "Market Ticker").

Ostensibly, the entire idea of Ben issuing credit to buy debt in the amount of $100B/mo for 6 months, is to keep Treasury rates from climbing and continuing the charade of deficit spending papering over the contracting economy.  He also needs to keep prices of assets held by member banks high, and his member banks hold a trainload of Treasury bonds.  If those sell off, there aren't any accounting games you can play with those, like you can on mortgage-backed-securities.

Ben either continues to buy everything, or Ben's buddies go BOOM.

The problem is for the past few weeks, Ben's bluff has been getting called.  Check out these graphs.

10 Year Treasury Yield
(click to enlarge)

This is the 10 YEAR US Treasury bond as viewed from a yield point of view.  This is one of the biggest things driving mortgage rates on Bainbridgeislanddreamhomes.  Ben and the Boys announced the second round of "QUANTITATIVE EASING" on the low tick of this chart.  Since then, the interest rates have gone straight up.  That's pretty cool, but the object of QE2 is to keep rates LOW by the FED creating credit ex nihilio and purchasing these securities.  Rates move inversely, by definition, from price.  It would seem that the overall demand for this kind of debt is drawing down.

That's not good.  Not good at all.  Granted, Ben isn't going on his buying spree for a few more weeks, but normally bond traders front-run large purchases by the FED to sell to Ben at higher prices.  The real test is when he actually starts buying.  If rates still go up, he's done.

Why would Ben be so obsessed with buying US government bonds at the short duration?  The reason is that he has been stuffing the Federal Reserve wholesalers (called Primary Dealers) with government debt all during these bailouts.  It's an easy way to get money via the taxpayer, and since they get to keep the money that is the difference between the rate they bought in for, and that of ex nihilio credit, why not?  What is the downside?

10 Year Treasury Price
(click to enlarge)

This is the downside.  This is how Ben sees the bond market.  Those of us in the Great Unwashed only see the bond market in terms of how much it costs to borrow money to buy goodies, baubles, and Bainbridgeislanddreamhomes.  Ben and the banking cartel see the bond market in terms of price, which is what you see to the right.

Pretty ugly, huh?

Someone had better plug that hole STAT! or we are going to have a full-on bond collapse which will seriously imperil the government's ability to function.  Remember, Barry, Harry, and Nan have been spending almost twice what they collect via the thuggish IRS, which means that the Tax Cheat-in Chief (Geithner) has to borrow almost half of all federal expenditures.

Ben has been stuffing the PDs with US Treasury debt and as long as the coupon pays enough to keep things liquid, it works.  It also works as long as the price of the debt is high enough to sell into the market to raise cash.  When the price of debt falls (yields rise), those PDs holding the debt can't sell because they will take a capital loss, and believe it or not, all that ex nihilio credit creation needs to be paid back, or The FED blows up.  The banks find themselves in the same predicament they had when they were holding tons and tons of worthless mortgage backed securities, that were backstopped by the never ending rising of residential real estate.

Oops.

Ben has to keep the market price of US debt high enough to keep his wholesalers liquid, otherwise it's TARP:  The Sequel, which would go over about as well as a disabled Iraqi War veteran marching in the 2004 Grand Old Fourth parade.

The Yankee Lira has been marching around in circles, looking for direction, and the contest is between Ben driving the currency into the ground (collapse of demand), and the circulation drop as debt defaults and the economy delevers (collapse of supply).  I am still firmly in the latter camp, and believe most of the hype around the impending doom of the US dollar is a bunch of nonsense.

The dollar has been tanking because of a bad risk-reward environment brought on by the FED using ex nihilio credit to keep the price of asset classes high as return on investment shrinks.  This elevates risk against declining reward, which can only find relief in abandoning dollar denominated assets en masse.  Ben ends up as the buyer of last resort, rather than the lender of last resort.

In fact, if any of the vast readership is still investing "for the long haul," you need to know that the only thing you are investing in is getting out of your assets before The FED does.  If you think you can hit the exits before the guy that actually knows when to exit does, you are one brave and foolish man.  That is all you are doing - betting you can get out before Ben does.

Good luck with that.

Being short isn't much better.  You need to be able to meet margin with real money and you are fighting a man with the ability to generate ex nihilio credit.  The only thing you have going for you is that your money can outlast Ben's credit-from-heaven.  Yeah, right...

That being said, if those charts of interest rates don't turn soon, the shorts will clean up.

[EDIT:  In order for Ben to get yields down and prices of bonds up, he must be able to generate ex nihilio credit faster than it is being destroyed in the private sector.  Failing that, he must generate some form of financial panic to drive money out of certain asset classes and into short term US bonds.  Look at Aug-Nov 2008 to see what that looks like.  Stock prices would come apart to foment such buying in short term Treasuries.  Equities are at eye-popping multiples and margin compression, brought on by rising commodity prices via dollar selling, will also bring in multiples.]

As the bottom falls out of dollar denominated asset prices, the risk of holding them goes down, and the rate of return on those assets rises.  This brings risk/reward back into balance, and the dollar will rise rapidly.  This is essential for the formation of capital to start the new economic cycle, and hopefully it won't be us flipping assets back and forth to one another and calling that wealth production.

The IER has been a pretty good fade for 2010, and that realization is a swift kick to the crotch.  It took several trillion dollars borrowed from our children, but the FED and US taxpayer made a monkey out of the IER...

...for now.

This isn't over.  Nothing has been solved.  Couple that with a narcissistic disaster on the verge of a nervous breakdown in the White House, 2011 should be an E-Ticket ride.

Local NAR Hints at Housing Time Bomb???

Today's Kitsap Sun had a great article by Rachel Pritchett discussing the direction of Kitsap's troublesome home resale market. It was surprising, not because Pritchett did some fine journalism (as that is her baseline), but that the real estate professionals seemed to be telegraphing an ominous development in real estate.

While December’s numbers were encouraging, it’s too soon to say the market has bottomed out, said Mike Eliason, association executive of the Kitsap County Association of Realtors.

“The big issue in the pond is the foreclosures,” he said.

I'd rather say "A" big issue... rather than "The" big issue... because there are scads of problems bearing down on real estate. Among these are: rapidly rising interest rates, discontinuance of government life support, rising unemployment, falling stock market, adverse demographic changes, and acceptance that "real estate can, AND DOES, fall in price."

Let's talk about foreclosures. On that score, Eliason probably doesn't know how correct he is.

The Market Ticker , by Karl Denninger, is one of the best sources for the play-by-play of this horrific debt implosion we are all witnessing. Earlier this week, he noticed that the US Treasury is lobbing a financial nuke into this year's housing resale market.

Come the spring selling season you're going to see the inventory of homes that were "HAMPd" and failed for whatever reason hit the market.

This is not a trivial number of houses - there are close to 750,000 homes currently under trial modifications, and only a tiny number of them - something like 30,000 - have converted to permanent payment changes.

Thank Treasury for not telling you about this until the "selling season" had ended and we were in the middle of the winter months when sales are slow - and timing the "required start" date for April 1st, right into the maw of the spring selling season.

If you need to sell your house in the next year this is something you need to take into consideration. A flood of nearly 3/4 of a million houses appear poised to hit the market as short sales and "deed in lieu" sales beginning in April.

It appears that the US Treasury is going to do something prudent, which is to force the market to clean up this mess, and not allow "extend and pretend" programs to continue as institutionalized denial.

The resale market is likely to get hit with an avalanche of low priced sales, which will overwhelm the bid and crush prices. This doesn't include houses that were not subject to HAMP, but are distressed nonetheless.

Rumors are floating around that Bank of America will push 600,000 foreclosures into the market in 2010, up from 100,000 in 2009. I guess they saw that Treasury release. You can bet if BoA is going to disgorge 6X what they did in 2009, other banks will as well.

Remember from ECON 101 - Supply isn't just the number of units for sale, but the eagerness of the owners of those units to sell at the current market price. He who sells first, sells best. Put another way, "sell now, or be locked in forever."

If you bought a home in the past few months thinking you were really getting a good deal because rates were low, prices are "at the bottom," and you got $8000 of free government cheese, you are going to realize how expensive that $8000 cup of financial hemlock was when you find the homes in your neighborhood are dropping 20% below your price in very short order.

Eliason continues:

Eliason said bankers are warning his organization that the number of foreclosures and short sales is expected to grow locally in 2010 and 2011, working against a market that otherwise is attempting to recover.

Eliason estimates that 25 percent of homes selling now have been foreclosed on, are short sales, or are selling for less that what was owed on them.

Yup. Looks like Eliason got the memo. Remember, our market is one of the "healthiest" in the nation, which is to say we are in the last car on the roller coaster. Those 25% are with all the government backstops, and enormous financial engineering being done at the Federal Reserve, and being the "last car on the roller coaster." The backstops are going to end when interest rates rise and the US Treasury can't roll its debt. The Institute For Economic Reality is predicting rising rates as money comes into short supply and deflation sinks its talons into the flesh of the productive economy.

Here is a thought experiment: ask yourself how many of your acquaintances are holding their homes off the market until housing recovers? What is the ratio of that number to those you know equally well that are facing forced foreclosure or distressed sales? Extrapolate from the 25% that Eliason is quoting and see what is really out there UNDER CURRENT CONDITIONS.

Now expand that with local unemployment rising another 5-8% and home mortgage rates pushing 7% for short term loans, or 9% for 30yr fixed?

“Yes, it will still pull down the prices because of the appraisal problem,” agreed Heather Holmen, an agent with Windermere Real Estate of Silverdale. She explained that a homeowner who wants to sell will have to adjust the asking price based on homes that have recently sold in the neighborhood, which likely includes distressed properties with low prices.

Appraisals are the least of our problems. Sure, the outright fraud that was foisted upon us during the go-go years is over, with Realtors and lenders no longer being able to twist arms to get appraisers to "hit the number," but the real problem with prices will not be in the appraisal. It will be in the inability of people to find the money to pay. Appraisals will trail the market as prices will continue to fall due to lack of liquidity. Remember, appraisals are a lagging indicator. They tell you what HAS happened, not what IS happening or WILL happen.

Holmen continues:

Holmen is among many local professionals who believe that continuing tax credits and low-but-rising interest rates will help the market hobble along this year, especially for homes in the $200,000 range in Silverdale and East Bremerton, the most active segment of the market.

“We’ve actually had some multiple offers,” she said.

She expects interest rates to approach 6 percent by mid-year.

Delusional. The tax credits are not indefinite and only go through the end of April. The Congress is in the process of foisting upon us the largest tax hike in our history, which will certainly weigh on our ability to scrounge up money to buy Bainbridgeislanddreamhomes. However, the most glaring evidence that Holmen is under the influence of "hopium" is that "low but rising interest rates will help the market hobble along this year."

Excuse me? How do interest rates rising off a low base "help" home prices? I'd like for Holman to chime in, with her HP 12C in hand, and 'splain that to me. I realize that I went to Port Orchard schools, but the math on that is elusive.

If the county median home price is in the low-mid $200K range, and the most active $200K range is slightly below the median, that screams two likely possibilities: first time buyers are using the free government cheese and VHA backstop to buy homes they can't afford, or that flippers are descending on homes in that range. Rising rates will scare off the flippers like soap scares off hippies. Without flippers, or first time buyers, those foreclosures and distress sales are going to have an increasingly difficult time finding suitors.

Holmen continues:

It may take up to a decade, she said, for the market to genuinely return to normal, when homeowners can expect a modest-but-steady 3 percent to 5 percent annual rise in home values.

Source? Why a decade? Why would homeowners expect 3-5% What drives that return? (something must) I'd like to see the basis for such a fanciful prediction.

Additionally, I'd like for someone from the NAR to clarify what "normal" means. Was 2006 normal? I hardly think an unending torrent of brain-dead Californians armed with truck loads of money that was borrowed into existence against the self-delusional hope of ever rising home prices is "normal."

Holmen starts to find reality:

Even then, the days of easy home loans are gone forever, she said, and consumers need to be ready.

This is undoubtedly true (at least for our lifetime). If easy loans are a thing of the past (thank God), then home prices are about to revert to a very short orbit around declining disposable incomes. Consumers are not the ones that need to be ready - homeowners need to be ready. Their home isn't going to recover anywhere near the 2007 peak. That is not an opinion. That is a mathematical fact every bit as valid as AxA+BxB=CxC.

“People are going to have to get used to the fact that it’s not going to be as easy to get a loan,” she said.

Banks will take longer to check out prospective borrowers. Would-be homeowners will have to clean up their credit and do away with multiple loans on boats and RV’s, for example.

I guess lending based upon the premise of being paid back with good collateral as a backing will replace the 20 year old paradigm of lending against anticipated future appreciation and refinancing. Yup, that will leave a mark. Loan officers are going to actually have to do homework and learn to say "no." They will no longer be able to securitize their ineptness and greed.

In the go-go years, you borrowed more on your home to finance your his/her Sea-Doo, Disney Cruise and Whistler weekends. Soon, those boondoggles will cost you the ability to buy a house. Ironic, isn't it? Imagine the stories you can tell your grand kids.

Grandpa: "Well, back at the turn of the century, we used to borrow money against our house to buy lifestyle toys and bling without ever having to worry about paying it back."

Grand kid: "That's insane! Are all old people as dumb as you? Is that why I'm in debt beyond my comprehension and our standard of living hasn't improved in 40 years?"

Here is the money quote (no pun intended)

And most of all, homeowners from now on will have to plan for a down payment, she said.

This is going to be the killer for home prices. If we are paying down debt, and our debt service is pretty close to our disposable income, there simply won't be any savings worth mentioning. There can't be in that scenario. If banks won't lend without a substantial down payment, and the lunatic practice of borrowing the down payment, or buying PMI (an even dumber idea), is a relic of a fool-laden era, how do you get rising home prices?

You don't.

If banks settle on 20% down (and we would be lucky if they stopped there), you can borrow 4x your savings. Think about this. How many people have, as liquid and disposable assets, $40K? Seriously, how many people do you know that could have 400 Ben Franklins in their hands by the end of the week? We are not discussing lines of credit, but actual cash they have saved over the years. Not many, and those that can are likely living in the upper tier of real estate in Kitsap County. Under this metric, that upper tier is worth $200K, provided you can get the loan and are content to blow your entire life's savings on your down payment.

Good luck with that.

How about $25K? That pencils out to $125K house.

What do you think a "first time" home owner has as savings? Let's review: these people need to get $8000 from Obama's Stash and VHA loan to buy their home. They don't have squat. If they have $10K in real cash savings, I'd be surprised.

Think about this some more. Every house in Kitsap County would necessarily be valued at 5X the cash savings of the occupant (on average), and that presupposes they can service the debt on 4X their savings with no reserves of any kind.

There is no recovery coming in housing. Prices are going to continue to fall until debt burdens are relieved such that disposable incomes can rise to create savings and enough to service debt at 2-3X income. That's an awfully tall order if we consider where we are in this cycle and the FACT the government remedies for all of this have just piled on even more debt in a failed attempt to prevent the market from clearing.

It actually breaks my heart to see so many friends and family continue to buy into the insane notion that you have to own a home at these prices. Many have had the great fortune of being able to sell their homes in this environment, only to blow it by rushing in to buy something else.

The people that have bought in the past few months are going to be very P-Oed. 2010 is going to be a year people won't soon forget.

I still hold to my prediction of "20 cents on the dollar by 2010." I have 359 days left on that, and it is going to be tight, but I still like my chances.