It’s been quite a while since I blogged about house prices, or anything to do with the economy at all really. Mostly because not much seems to be happening. Government prints some money, nothing much moves anywhere, least of all house prices which hae remained pretty much stable the alst few months. An odd rise here, and odd drop there but not a lot. Until that is, the Halifx’s latest report indicated a 3.6% drop in asking prices for September. Now, I know these are asking prices and I know it’s a monthly change but this is a pretty awful statistic. The quaterly change incidentally is 0.9%, which is not as awful. I suppose the next few months will be telling. The annual change is now +2.6%, which isn’t great considering inflation is something higher than that!
This post is taken from a Forum I read, the original thread and associated replies can be found here: http://www.housepricecrash.co.uk/forum/index.php?showtopic=53593&st=0
Well, it’s several years since I said “It ain’t a housing bubble it’s a credit bubble!” in these hallowed pages and finally, and by Eris it’s been a long wait, that credit bubble has burst.
There was the Tulip Bubble, the Wall Street Bubble, the Canal Stocks Bubble, the Railways Bubble, and the grandaddy of all credit bubbles: the South Seas Bubble. You should all feel very privileged that you’ve lived through the one credit bubble that’s been bigger than all of them and this planet’s very first global credit bubble.
Better yet: you’ve reserved a ringside seat for the denoument and already it promises to be spectacular. yes folks, this is a once in three generations event. This is the only time this will happen in your lifetimes. For the Longwaves and Kondratiev fans around you, the first snow of K-Winte ris starting to fall thick and fast.
How’s the show so far? Well, entirely as expected, if a little faster than I’d have thought it would be. Naturally the first hole appeared in mortgage credit since mortgage debt is far and away the largest part of the credit pyramid that’s been so carelessly put together over the past couple of decades. Sir Printsalot, Alan Greenspan, must be regretting the day he said that derivatives don’t need regulation, because part of the fun in this giant game of pass the parcel is that nobody even knows where those trillion-Dollar parcels of bad debt are. Worse, since it’s known that there are more credit default swaps insuring corporate debt than there is corporate debt to insure, we can’t even put an upper limit on the actual amount of poison there is still floating in the global financial system. Not unnaturally, pretty much everyone is suspected either of holding some bad paper or of having loans out to someone who is.
Meanwhile, remember that little fuss about how the backroom boys of derivatives trading hired to keep records couldn’t keep up with the action and were sometimes weeks behind? Well, we’ll get to see how they do when the markets get a little excited. My bet is that they’ll fall behind and folks will get even more jumpy when they realise that not only don’t they know where the bad stuff is, but they don’t know either who’s trading in it.
Now of course a normal credit bust would take 16-18 years to play out, though history’s largest may take a litte longer. We can’t expect this sort of mayhem every day for 18 years. There will be days, weeks,months, even years when things seem to be getting back to “normal”, only to fall off a cliff again and catch out the unwary. What I’d expect sooner rather than later is for a gigantic fraud or two to be uncovered. Frauds are easy to hide when everything is booming, but not so easy when folks start nervously counting their money. The great Warren Buffet pointed out that it’s only when the tide goes out that we find out who’s been swimming naked. Needless to say, when these frauds are discovered, there will be a whole lot more nervousness to go around.
Now of course I’ve been absent from the prediction game (other than that it was a credit bubble and it would bust) because if we could predict when a bubble would bust we would be overnight billionaires. Worse, it gets quite disheartening to keep knowing that it’s going to happen and yet see the monster go on and draw yet more people into its maw. I still believe that we would have had a bust and debt deflation in 2003 if it wasn’t for Sir Printsalot and Chopper Ben cutting rates to 1% to prevent the coming debt-deflation. Naturally this simply took a mortgage bubble already on a moonshot and gave it a stardrive. Those guys will yet go down in history as the folks who saved a recession at the cost of a depression.
Still, since we have the above bubbles, plus the 1990’s Japanese credit bubble to crib from, let’s make some predictions about the general structure of what’s comng.
The golden rule of credit bubbles seems to be that whatever assets, or Magic Money Tokens, people use credit to bid up in the bubble, are the main areas of price implosion during the bust. I don’t think it’s any sort of well-kept secret that the main MMT in this one has been housing. The usual margin on a MMT is 90%, that is people put 10% down and borrow 90%. That was certainly true for Wall Street stocks in 1929 and nothing I’ve read of the other bubbles indicates them as having been grossly different. Housing in his bubble has been unprecedented in garnering 100% loans and even 110% or 120% for pretty much anyone who could fog a mirror. Even the South Seas Bubble, the previous largest, brought in only one third of the UK population. The Millenium Bubble (Hell, someone has to name it eh? Any better suggestions?) has typically involved 70% of the population of those countries affected (and in the advanced westernised countries, I see only Japan and Germany not taking part). The price of the main MMT’s will generall fall between 67% and 90% in the aftermath. This fits well with what happened in Japan and it’s what I expect to see happening here.
Another firm rule is that the more debt involved, the more people involved and the longer the bubble goes on, the worse the denoument will be. Remember the old saw:
If you owe the bank a million Dollars, you’re in trouble, but
I you owe the bank a billion Dollars then your bank is in trouble?
Well, we’ve just invented a third line:
If you owe the bank a trillion Dollars, we’re ALL in trouble.
So there’s no escaping that the general economies are going to hit the skids. Pretty clearly the first hits will be in the financial sector. There are going to be swathes of redundancies in banking, stockbroking, estate agencies, builders and petty much anyone else who’s been an intermediary in the game. Worse, since everyone is going to need a svapegoat (nobody blames themselves for their financial stupidity and politicians are adept at finding someone else to blame) some of those folks are going to jail. If you’re an estate agent, or a buy to let landlord, then keep your nose clean and your head down. I’m serious: some of you are going to the pokey simply because someone has to. All folks need is some sort of chicanery which will suffice as a charge. An unsympathetic jury is already guaranteed.
Next up, people who’ve been spending borrowed money for a couple of decades are going to have to relearn how to spend only earned money. That’s going to guarantee a decline in retail sales. Worse, once the severity of what’s happening becomes apparent folks are going to try to pay down debt and save. This will cut retail even further. In western economies, the amount of retail space now is ten times what it was a decade ago. That all got build for the boom and it’s all about to be redeployed back to oher uses. A lot of people who got jobs in retail are going to become redndant, and they’re going to have trouble paying their debts. Inevitably this will lead to reposessions and more property on the markets.
Since two-thirds of US and UK economies depend on retail and related (and it’s close enough for government work elsewhere too) these economies are going to go into recession. In the UK this is going to produce an immediate and interesting result. A whole bunch of people from outside the Uk are here to earn money to send to their families back home to buy or build a house there. When the recession comes and they can’t earn money, they’re going to take the plane out to wherever they can. This is going to hit retail again. It’s going to hit the tax take and it’s going to hit the property rental markets. A great many properties are very suddenly going to find themseves missing tenants. This will drive rents down adn it will produce a large number of landlords racing each other to sell first while there are still any buyers. This will be the point that Charles Mackay called”Devil take the hindmost”.
Needless to say, by this point housing prices will be falling. This will ratchet them down further.
In the US, 40% of loans in the past 2 years were subprime, 12% were Alt-A, and 8% were Jumbos. None of those markets are making loans now because the bond investors won’t buy ’em. Even if someone can find a creditor ready to take a risk, they’re asking 3% per annum on top to compensate them for it. There’s a great deal of difference in the affordability of a mortgage at 8% and one at 11%. I figure that based on that, more than half the US mortgage market has been shut down. It’s time to ask what price properties will sell at if nobody gets credit and everyonme pays in their own cash. The Japanese found this ou the hard way, and we’re now headed implacably to the same question.
In the ratcheting up of property price to income ratios as the mortgage interest rates have been falling, properties have been behaving like a bond where the price acts inversely to the yeild. No doubt at some point the central banks would like to cut the mortgage rate to try to head off the carnage. However what the last fortnight showed is that it’s not the central banks who decide mortgage rates, and it’s not the “lenders” either. Nope, tha pass was sold as long ago as 1998, it’s just taken folks this long to notice. Last week US Treasury rates fell as folks sought security. Those are the rates the central banks can affect. However mortgage rates actually rose while Treasury rateswere falling. The bondholders discovered that they control the mortgage rate by setting the price at which they’ll buy mortgage-backed bonds and the CDOs based on them, if hey’ll buy any at all, which is becoming a less academic question by the day. If property acts like a bond, then as the bondholders raise the interest rate on mortgages, properties must fall in price in response. I estimate that for every percentage point on the rate, prices will fall around ten percent. If the risk premium is to be three percent, we’re loking at a 30% fall from the getgo, though due to erosion of availability of credit, I expect things to eventually go much furthe than that. This is the only time in history that credit has been available to everyone, and by the time we’re through, I don’t think anyone on the planet will be looking to repeat the experiment. Not lender, and certainly not buyer.
Another lesson from credit bubbles past is that they end in “revulsion” (Kindleberger’s term I think). Those whose financial lives have been destroyed by debt will refuse ever to countenance taking it again in their lives, which is fine because there essentially won’t be any offered anyway – revulsion happens to those creditors who lost their all too. Also, they’ll teach their kids not to take on debt. Those kids will grow up and teach their kids the same thing but with the bust becoming history, they’ll probably take it out for serious purposes. Their kids will see it as ridiculously old and fogey to be scared of debt and sooner or later they’ll find their Magic Money Token. It could be a flower bulb (I know of six flower bulb bubbles in history) or maybe flying cars or AI chips, but there will be one, and the credit cycle will be complete. The only real certainty is that it won’t be housing. The token always changes.
So what will the central banks do? Well, they’ll try to stop a deflation. That’s the reverse of inflation. Cash under the bed becomes more valuable over time. The effective value of debt rises because the money it takes to pay it back becomes more valuable. If enough deflation happens, then wages start to fall. f they don’t, as in the 1930’s in the uS, then mass redundancies happen and that has even worse implications for turnng the financial screw tighter. As folks wages fall, it gets harder for them to pay their oustanding debts and more defaults happen. That affects debt paper. Lather, rinse, repeat.
The central banks will try more of what they’re doing now: printing money and showering it liberally upon the economy. Chopper Ben got his name for a 2003 paper on how to stop a deflation by throwing cash out of helicopters.
There are a couple of problems with the idea though. First, you have to shower ever more money out of the helicopters to keep things going and keeping them going will make any eventual burst worse. Eventually the amount of cash needing rained down is going to be enough that you don’t have enough helicopters. Remember those pictures of wheelbarrows in post WWI Germany? That’s the end of that story. Eventually people repudiate the currency, as they did in the Mississippi Bubble in France, and run to gold. Needless to say, that’s even worse than a deflation. The Japanese tried this. It failed because folks took their cheques from the central bank and duly put them in the bank or paid down debt with them. Paying down debt doesn’t cause as much extra deflation as defaulting on debt, but it does cause some.
The second problem is that the more usual way for central banks to shower people with money is to let them borrow it at ultra cheap rates. The Japanese cut heir base rates to zero for a decade (they’ve only just raised them to half a percent in the last month and some folks think that’s too much). Japanese house prices still fell 50% to 90% and the deflation still went gaily on. You can offer people cheap loans, but if the last thing they ever want to see again in their lives is a loan, then it just ain’t gonna help.
What might happen with all this money printing is that inflation will rise. Then the bondholders will simply raise their interest rates to compensate them for the inflation risk and property prices will take another large step down.
I expect the central bankers to try it though, so we’ll get an inflation, then a deflation, which will almost certainly destroy mre people’s wealth than if we cut out the middleman and go straight for the deflation. The great thing about deflation is that it’s self-curing. Once the price of money and assets returns to a sustainable level then it stops. Sure, that’s likely to see property. art, vintage cars, collectibles etc drop 90% or so in value, but in fact it will be a good thin g that people don’t have to go into hock their whole lives to get a roof over their heads. Sure, some people with current mortgages will be in debt for the rest of their natural, but more and more they’ll find that their neighbours won’t. It will be a far healthier society.
Remember the end of the 1989 housing bubble (interesting that housing bubbes are 18 years in length in the UK, we now have a housing bubble and credit bubble peaking, and busting, at the same time – exciting or what?) where prices fell 50% in real terms but only 25% in nominal terms? That was because we got 25% inflation over the 4-5 years of the bust and that sheltered nominal prices from a larger fall. In a deflation though, nominal prices fall further than real prices because the effect is reversed. Thus a 50% fall in real prices again, plus a 40% deflation (say over 18 years that’s not a huge amount per year) and you get a 90% all in nominal values for houses only going down 3% per annum in a 2% deflation.
So enough of the economics. What else will change? There’s the famous Hemline Indicator where hemlines go up in good times and down in bad. We can safely assume that they’ll be going down and sadly we’ll see the demise of the bare midriff and other forms of fleshly exposure. Modesty will make a comeback. People will be more worried about keeping their jobs and social conservatism and conformity will return. People will have less money and so will move from expensive to cheaper pursuits. They’ll move away from reality TV to escapism and fantasy (the Potter mania may be an early indication). Romance, Westerns, SF and Fantasy and so on will be back in vogue. People don’t like reality when it’s grim and want to get away from it in their leisure time. People will mend and make do rather than junk stuff when it’s broken. They’ll also speak to their neighbours again. People need to know there are other people to help when they’re in trouble and so individualism will wane.
In short, times will change, but not all the changes will be bad ones.
Certainly the future just got a lot more interesting and as I said, you have a ringside seat for the most spectacular financial event in this planet’s history.
Bought some shares in a mining company, Sunkar Resources. They have a large phosphate deposit in Kazakhstan which was previously mined by the USSR. Currently it’s being developed to provide fertiliser. So far, they’ve doubled in price from when I first bought them, and hopefully will continue on upwards as more positive news comes out.
WMH are doing rather poorly, I’d have thought more people would be gambling in a recession, seems a few large places have shorts on them though. Hmm.
Not investment advice!
I’ve started trading shares now. I’ve been following Robbie Burn’s excelent blog and commentary over at the Naked Trader, bought his book and have begun to take baby steps into the world of shares. I seem to be doing ok so far. I’m not sure if it is due to luck or judgement however. I suppose time will tell and the market will no doubt make a fool of me, as it has many others. Remember, the market can stay irrational longer than you can stay solvent!
Bradford & Bingley, the nationalised mortgage lender, has laid bare the dire state of its loan book and said that a rising wave of fraud dragged it to a £160 million loss for the first half of the year.
The figures came the Council of Mortgage Lenders warned that the economy remained fragile and predicted that repossessions and arrears would continue to climb this year.
The CML has forecast that 65,000 people will lose their homes this year, up from 40,000 last year and just under 26,000 in 2007.
B&B, which was the UK’s largest lender to landlords before it was broken up and its mortgage book nationalised last September, said yesterday that 40 per cent of its mortgage book was in negative equity, up from 30 per cent at the end of 2008.
Impairments on bad loans ballooned from £75 million last summer to £328 million.
B&B has 60 per cent of its book in buy-to-let and 20 per cent in self-certified loans, sometimes called “liars’ loans” as borrowers did not have to provide proof of salary.
B&B, which flagged up a spike in fraud last year, warned that the trend was rising, and increased its provision by almost £100 million between January and June.
That brings the total provision for fraud and professional negligence to £271 million, a figure described by an industry insider as “extraordinary”.
As well as some customers apparently lying about their income, there is evidence of cases of property valuers and solicitors falsely inflating the value of properties, B&B said. Some of the fraud-related loss may be reclaimed on insurance policies, it added.
Customers falling more than three months behind on repayments rose to 5.88 per cent of the book, from 4.6 per cent at the year-end.
Richard Banks, a mortgage industry veteran who joined B&B as managing director three months ago, attempted to strike an optimistic note by echoing the sentiment of Lloyds last week that the worst was over. “Arrears appeared to have peaked and started to go down modestly in the past two months,” he said.
The Government sold B&B’s £21 billion of deposits to Spain’s Santander but could not find a buyer for its £41 billion mortgage portfolio and was forced to nationalise it.