I’ll add that a month ago, I was really worried about inflation as the USD continued to plummet and oil rose. But as this unwinds globaly, I think the dollar will rise, oil will fall and deflation in asset and commodity prices sets in.

The “housing prices will catch up with inflation” comments will be incredibly wrong. We’re experiencing inflation right now in food and oil, but that will go away as this financial crisis unwinds.

Cash will be king.

Of course not. The mission was accomplished. Didn’t you hear? ;)

Currently, the cost of the war is NOT included in the budget.

When a downturn comes, cash is king. Assets are sold for cash to cover postitions. In our case, these assets will be securities, homes, cars/boats, and precious metals. My portfolio is light on all of the above.

How about rising oil/fuel prices, Chinese imports, food, etc? If the consumer is out of money, maxed out, he’s either not buying these items, or is prioritizing them at the expense of other purchases not made. The net result is not inflation as a whole, but stagnation. These are again, individual price increases, not systemic inflation. The consumer’s total expenditures haven’t risen, his market basket of priorities has changed. And the consumer is out of money. Our individual saving rate is zero. See the link in my post above. In fact, the consumer, 70% of the economy, has been able to increase spending only by taking on additional debt. This is where the housing bubble has come in as rapidly inflating home values have allowed spending to increase well beyond increases in personal income. We are now at the point where he can’t service any more debt without an increase in personal income, and international competition, along with a shift in the nature of our economy, has kept personal income growth flat.

Unlike inflation,deflation is a self perpetuating trend that is very difficult to stop. Higher taxes and interest rates grind inflation to a standstill. Deflation feeds on its self, and as the Great Depression and the recent experience in Japan have shown once started it’s very hard to turn around. It is spending that reverses the trend, and who wants to spend when your dollar is increasing in value everyday, and assets are getting cheaper as they fall in value? Think rent, or buy a house that drops in value every year. Japan has had 18 years of falling home values. Buy, or rent? How does the government increase spending when tax revenues are falling, and raising tax rates only puts a further damper on the desired growth?

Why will deflation start now? With consumers, governments, and financial sectors leveraged to levels never seen before, even a small contraction in, say, the housing sector, leads to huge losses multiplied throughout the financial system. Individuals and corporations are poised to lose much more than their original stake due to the current levels of leverage employed. To try and recover, they sell assets. Get rid of the debt- sell your house, sell your portfolio, sell the car, sell the stake in XYZ corp. Put off the new development, lay people off, cut wages and benefits- putting more people in a state where they need to sell stuff to service debt and/or just exist. Given our fractional reserve banking system, for each dollar lost it’s estimated 20 more disappear. A severe contraction of credit occurs, leading to further hardship, and so on, and so on, etc.

This is a complex subject, and not well covered here. Head on over to: http://www.tickerforum.org to read until your head spins. But you’ll find a solid explanation through the threads on how inflation is the last thing we’re going to be seeing. Cheers.

Aye, you caught us, Scotsman, (tip of the hat to deejayoh). But consider the price changes in food, fuel, healthcare, shelter – and soon, Chinese consumer goods. I smell inflation.

I read your subsequent post as well. What is behind your perception that asset liquidation to reduce debt, and the sharp contraction of liquidity will be at a level high enough to overwhelm a substantial Fed easing?

http://homepage.mac.com/ttsmyf/RD_RJShomes_PSav.html

http://www.salon.com/tech/htww/2007/12/05/bakersfield_real_estate/index.html

Looks like the party is starting to come back to earth:

http://www.bakersfield.com/137/story/164483.html

So, if “For some years, cash from a refi *averaged* almost 70% of disposable income!”, then to get an overall equity withdrawal of 5% of disposable income in a given year, that means that on average, 7 out of 100 mortgage holders withdrew 70% of their disposable income.
Which, across the country, means an average dollar value on the order of $10K.

Which, if amortized for 30 years at 6.75%, has to be repaid to the tune of $65/month.

I’m still not feeling the fear here, folks.

All these “bubblehead” charts that come from places like the FED, GS, Credit Suisse etc are just CRAZY! Now Zillow…there’s a chart that I trust! In fact…If you say that Zillow has you have 21% sweet sweet equity in your house! In fact…I’ll bet it’s even more than what Zillow says!

If I use my “anecdata” my Dad’s house just sold for 3X what it Zillowed at when he listed it!

So stop paying attention to that pessimistic Zillow thing because not only is your house worth WAY more than they say…I’ll bet that your pink ponies sh#t gold bullion!

http://tinyurl.com/3593u3

For some years, cash from a refi *averaged* almost 70% of disposable income!

For the entire blog entry, here is the link:

http://wallstreetexaminer.com/blogs/winter/?p=1254

Tim, I saw that graph in the Times today too. Nice and dramatic looking, but so what? Prices (at least locally) have been escalating quickly since the early 1990s. Since that time—but, I believe, not before—it became possible to buy a house with less than 20% down, and more people took advantage of those lower-down loans. How much of that decrease in home equity percentage is from people who have been behaving responsibly, not using their houses as ATMs, but started out with a lower percentage down payment?

And, OK bili, that second graph: half a trillion sounds like a lot, but it doesn’t seem nearly as ferocious when presented as “5% of disposable personal income”. What does an aggrate number like that even mean? Presumably it’s across the entire country–five percent of everybody’s collective “DPI”–but how is it distributed? 50% of mortgageholders withdrawing 10% of their “DPI”? 25% of them withdrawing 20%? 5% of them withdrawing 100%? 2.5% of them withdrawing 200%?

Considering that average or mean “DPI” is probably on the order of $10-20K (presuming a median income across the country of, what 40K, with maybe 30% for housing, 20% food, 10% transportation), I’m just not getting worked up about it.

Surely there’s some distribution. If you can hit that “5% DPI” statistic with 95 out of 100 householders not touching their equity, and 5 householders out of 100 taking out $16K each, well, that doesn’t seem so freaky. Or if 99 out of 100 don’t touch their equity, and 1 out of 100 withdraws $50K. I just don’t feel like the sky is falling here.

That’s a lot of equity spent on Prius’s and 50 inch LCDs.

Freddie Mac Cash-out report:
http://www.freddiemac.com/news/archives/rates/2007/3qupb07.html

In the third quarter of 2007, 87 percent of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts that were at least five percent higher than the original mortgage balances, according to Freddie Mac’s quarterly refinance review. The revised share for the second quarter of 2007 was 84 percent.

Q307 Mortgage Equity Withdrawal (MEW):
http://calculatedrisk.blogspot.com/2007/11/advance-q3-mew-estimate.html

They may not have “imperiled their living situations,” but the data seems to support the thought that the majority did in fact do cash-out refinances: AP: Bit by bit, homes given away

It makes sense to refinance when rates go down. We did, twice.

But I’m still not convinced that the majority of mortgage holders did cash-out refinances, or did cash out to such an extent that it imperiled their living situations. Financial horror stories get a lot of press, but I still don’t think I’ve seen good statistics about it (though I’d love a pointer).

And even if you are underwater, as long as you keep your job and keep up on the payment, it doesn’t really matter what you could sell it for if you don’t sell it.

Yep—and if you keep chipping away at your mortgage, eventually it’ll go away.

The majority of mortgage holders did, alas, refi during the run-up, and the majority of those took cash out of the house when they did. You are in the minority, having left all your equity in your house of 9 years. Most did not.

But people who bought more than a couple of years ago and didn’t cash-out along the way should probably be fine. You are right.

And even if you are underwater, as long as you keep your job and keep up on the payment, it doesn’t really matter what you could sell it for if you don’t sell it. I have a few friends who made questionable mortgage decisions over the last couple years, but they’ll be fine, as long as they keep their job and health, as they ended up with a fixed rate in the end.

Lovely to see you as well. You know, they say every time a bell rings, a pink pony gets its wings.

Thanks for the link to the Calculated Risk article, bili. I read it over carefully and while it is thought-provoking, I think their analysis is still a little simplistic.

For instance, over the time period of the housing price slump, people are going to continue to be paying their mortgages. Market value will vary, but so will debt values.

People with mortgages in the early years of the amortization curve (where relatively less is going to reduce principal) will be more affected than those who’re further along the amortization curve.

As anecdata, I ran the numbers on our two houses, assuming that housing prices declined over 3 years and we continued paying out our mortgage as scheduled.

For the house we bought in spring 2006, based on our mortgage principal amount and what Zillow has to say today, we have 21% equity. If the house lost 30% of its value in 3 years, this house would be “underwater”—but less than it would first appear, since we would have also paid down the loan by ~10K in that time.

In contrast, for the house we bought 9 years ago, using the numbers for today, we have 71% equity in the house. If its value declined by 30% and we paid off the principal as expected in 3 years’ time, we’d have…70% equity in that house.

Based on those data points, I’d say that a rigorous analysis of how different scenarios will shake out would have to take into consideration how rates of debt repayment come into play.

b says, with an overall negative savings rate you are going to see a whole lot of people with good credit and high incomes in trouble very soon

Yeah, that’s gonna suck. Lots of people already are getting laid off. The invisible hand of the market giveth, and the invisible hand of the market taketh away.

“Now, with all the exotic programs gone, a household income of $175,000 is needed to buy that same home, which is about 10% of the Bay Area households. And, inventories are up 500%. So, in a nutshell we have 90% fewer qualified buyers for five-times the number of homes. To get housing moving again in Northern California, either all the exotic programs must come back, everyone must get a 100% raise or home prices have to fall 50%. None, except the last sound remotely possible.

What I am telling you is not speculation. I sold BILLIONs of these very loans over the past five years. I saw the borrowers we considered ‘prime’. I always wondered ‘what WILL happen when these things adjust is values don’t go up 10% per year’.”

http://tinyurl.com/2ota6e

They got their numbers from a report by Goldman Sach’s chief economist, Jan Hatzius.

That said, many folks like their house enough to continue to pay their mortgage even if they are under water. If they run into some financial bumps however, sending jingle-mail will become a tempting solution for some.

As for people having to live somewhere – sure. It doesn’t mean they need to, or even should, own where they live.

We are currently at all time record historic inventory numbers, BTW. There are over 5 million homes out there for sale. A would guess a fair number of those will enter the rental market, making homes for those homeowners who probably shouldn’t have been homeowners.

Fed: Homeowner Percent Equity Falls to Record Low

The Fed released the Q3 Flow of Funds report today.

Homeowner equity declined by $128 Billion in Q3 as appreciation slowed (why didn’t assets decline?) and equity withdrawal was still strong.

Homeowner percent equity fell to a record low of 50.4% (this includes the almost 1/3 of homeowners with no mortgage). I’ll have more this afternoon.

I think any predictions based on historical norms are going to look very foolish, because we are looking at a situation which nobody has seen before.

Here’s what we do know. Things got out of control. Nobody cared at the time. Things started to correct. Lots of people care now. We have not seen the bottom yet.

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HELOCs make up a whole lot more of the market than you may think. Several TRILLION dollars worth of equity extraction took place in just the last 2 years (http://www.startribune.com/business/11919516.html for some numbers). The huge majority of that money has been vaporized into consumer spending, which Greenspan says may have made up to 3% of all consumer spending in the last few years. If we removed that spending from the GDP equation, we would have been in a recession since 2004. What do you think is going to happen when that money is no longer there? E-Trade recently got 27 cents on the dollar for their “AAA” HELOC paper, which means Joe Schmoe is not going to be getting a loan like that for a long time and all those folks who did cash out at the top now have mortgages in line with bubble prices and not actual value. While they can probably continue their payments easier than the $10/hr joker with the 500k condo, with an overall negative savings rate you are going to see a whole lot of people with good credit and high incomes in trouble very soon.

But in today’s debt ridden US economy, this conventional wisdom likely goes the way of the dodo.

I have an MBA myself, but the whole world ain’t textbooks. I price off of treasuries into the future, so it’s important for me to know if there is a distortion. You don’t have to accept my argument, but did you follow it? I don’t see where you are doing more than appealing to authority.

probably just being difficult :). After thinking more about it, I think Scotsman probably has it right. The “flight to quality” is in essence a drop in the real interest rate – investors are willing to accept less due to massive market instability, which has nothing to do with inflation or deflation. I do think long run prospects for deflation are not insignificant, but it’s likely “r” and not “i” that is driving ten-year yields.

With Christmas about three weeks away, the retail industry is struggling with consumers’ eroding confidence and a weak sales trend amid mounting problems in the economy. Throughout the year, shoppers have been faced with higher gas and food bills and depreciating value of their homes. Tighter credit has also become an issue in recent months.”

I knew there was a reason I liked you so much. Dweebs of a feather flock together.

I’m curious about the source of your numbers, though.

I’m with you initially. I recognize the first # from those Census Bureau figures I dug up recently, and the second from a story in the Times today about the ridiculous flying home equity party:

Around 50M have a mortgage.

Around 3.5M of those 50M currently owe more than their house is worth.

But I wonder where this comes from, if you’d care to cite or explain:

If what I consider conservative estimates hold true and we see a 30% decline in home values over the next 5-7 years, we could see that number grow to 20M households.

This I find hard to believe. It seems to be based on the premise that 40% of the homes in the country either (a) changed hands in the last say 4 years, and all were bought with super-low down payments, or (b) were bought >4 years ago and stripped of major equity.

Lots of houses changed hands w/ low down loans, and lots of equity was extracted, but really that much? I’d love a source for those numbers.

Also, here’s something to think about: your rough statistics don’t address the financial status of the landlords who own the remaining, non-owner-occupied 35M households. Lots of anecdata on this blog about landlords renting for less than their mortgage payments, and 20somethings with 4 and 5 properties…it’ll be interesting to see how that end of things wash out, too.

In the end, everyone has to live somewhere, and every residence is going to be owned by someone. It’s the Christmas season and It’s a Wonderful Life is on my mind…I hope we end up a little more on the George Bailey end than the Mr. Potter end!

By the way, interesting economic analysis by all of you. Keep them coming.

And just who is going to keep lending the US the +$2 billion/day it needs to keep going at 0% interest?

You have to understand that Japan can set its interest rates anywhere it wants because it has a high savings rate and doesn’t borrow from other countries. The US is the exact opposite. You can’t tell your bank what interest rate it’s going to charge you on your credit card.

For the record, after much analysis I’ve moved from the inflation to the deflation camp in terms of where the U.S. economy is headed. The inflation many predict as the path out of our current predicament will not come to pass. We are headed for several years of deflation throughout the economy, not just the housing sector.

Oh yeah, MBA and economics degrees, with honors, from really good schools. Currently working in a field that has nothing to do with either one. ;-)

I have an MBA myself, but the whole world ain’t textbooks. I price off of treasuries into the future, so it’s important for me to know if there is a distortion. You don’t have to accept my argument, but did you follow it? I don’t see where you are doing more than appealing to authority.

Treasuries are abberantly low based on flight to quality of fixed income investors more afraid of losing principal in private issues or equities than they are of inflation 10 years out. This is too much money chasing too few goods – inflation, not deflation.

I guess you’ll have to direct me to the finance/economics text that says low rates = high inflation. I only have a BA and Masters in Finance. I could have it wrong…

Treasuries are abberantly low based on flight to quality of fixed income investors more afraid of losing principal in private issues or equities than they are of inflation 10 years out. This is too much money chasing too few goods – inflation, not deflation.

“Many government and policy-makers feel this is a subprime problem, which is completely wrong,” said Paul Miller, an analyst at Friedman Billings Ramsey, in a research note. “This is a high loan-to-value and overvalued housing problem!””

Friedman Billings Ramsey is an unprofitable securities firm masquerading as a REIT. Their 52 week change is -65.6%, and that is in their chosen business line. If you think that portends well for their analysis outside their primary business, well good luck to you.

I also have still not seen a reasonable foreclosure public interest story yet, every one is a series of stupendously foolish decisions with levels of risk way outside of their income. The last one I read bought their house for $110,000 in 1990, refinanced several times using subprime loans taking out about $200,000 and now owing $650,000 on their 3/27 subprime mortgage.

I think at this point I just don’t get any of it,, BOA invested in countrywide so they didnt have to sell their CDO assets for 80% value and then etrade goes and sells their CDO assets to Citadel for 27%. Tech in Seattle is booming again, financial companies seem like a real mess. . .

I believe Mr. Adams was being predictive.
.
The Arab oil embargo of 1973 made the West painfully aware of our dependence on oil supplied from the Persian gulf. Nothing much got done about it in the U.S., but that’s another story.

He wrote the series between 1979 and 1992.

I like your analogy. Another analogy that seems to work equally well is that the “wine and spirits” is petroleum. The flying party is supported by our outsized consumption of energy. Note the reference to “tankers”, the fact that the “drink” will run out some day, and the planet “…is no longer the planet it was when they first started floating over it.” He also notes that the “….mess is extraordinary….”, possibly referring to the damaged natural environment as a result of the flying party.
.
I think Mr. Adams was making a generalized comment about our economy and unsustainable consumption of natural resources, which are related.
.

I especially like the way that the drunken astro-engineers armed themselves “rather heavily” in case they got into any arguments with “wine merchants”. Could there possibly be a parallel with this fun little story and the U.S.’s current involvement in the Middle East?