When is the drink going to run out?

As the flying party that is the debt-fed US economy and the super-special Seattle housing market experience more and more turbulence, I feel that the following quote from Douglas Adams’ novel Life, The Universe, and Everything (third book of five in the must-read Hitchhiker’s Guide to the Galaxy trilogy) is even more pertinent than it was when I first posted it a year and a half ago.

I guess you could look at the flying party as being either the national (or worldwide?) economy, or more specifically the Seattle real estate market. Either one could work (if your mind is as twisted as mine is, anyway).

The longest and most destructive party ever held is now into its fourth generation, and still no one shows any signs of leaving. Somebody did once look at his watch, but that was eleven years ago, and there has been no follow-up.

The mess is extraordinary, and has to be seen to be believed, but if you don’t have any particular need to believe it, then don’t go and look, because you won’t enjoy it.

One of the problems, and it’s one which is obviously going to get worse, is that all the people at the party are either the children or the grandchildren or the great-grandchildren of the people who wouldn’t leave in the first place, and because of all the business about selective breeding and regressive genes and so on, it means that all the people now at the party are either absolutely fanatical partygoers, or gibbering idiots, or, more and more frequently, both.

Either way, it means that, genetically speaking, each succeeding generation is now less likely to leave than the preceding one.

So other factors come into operation, like when the drink is going to run out.

Now, because of certain things which have happened which seemed like a good idea at the time (and one of the problems with a party which never stops is that all the things which only seem like a good idea at parties continue to seem like good ideas), that point seems still to be a long way off.

One of the things which seemed like a good idea at the time was that the party should fly — not in the normal sense that parties are meant to fly, but literally.

One night, long ago, a band of drunken astro-engineers of the first generation clambered round the building digging this, fixing that, banging very hard on the other and when the sun rose the following morning, it was startled to find itself shining on a building full of happy drunken people which was now floating like a young and uncertain bird over the treetops.

Not only that, but the flying party had also managed to arm itself rather heavily. If they were going to get involved in any petty arguments with wine merchants, they wanted to make sure they had might on their side.

The transition from full-time cocktail party to part-time raiding party came with ease, and did much to add that extra bit of zest and swing to the whole affair which was badly needed at this point because of the enormous number of times that the band had already played all the numbers it knew over the years.

They looted, they raided, they held whole cities for ransom for fresh supplies of cheese crackers, avocado dip, spare ribs and wine and spirits, which would now get piped aboard from floating tankers.

The problem of when the drink is going to run out is, however, going to have to be faced one day.

The planet over which they are floating is no longer the planet it was when they first started floating over it.

It is in bad shape.

“Floating over the treetops” = magical growth, unsupported by fundamentals.
“Looting and raiding” = ever-increasing, crushing personal debt (followed now by increasing foreclosures).
The time “when the drink is going to run out” = the point at which debt (both personal and national) reaches critical mass.

I admit, it’s not a perfect analogy, but I think it works.

In a lot of ways, the artificial economic high we have been on the last ten years (the dot-com bubble followed by the housing bubble) could indeed be described as “the longest and most destructive party ever held.”

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About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market. Tim also hosts the weekly improv comedy sci-fi podcast Dispatches from the Multiverse.

75 comments:

  1. 1
    Wade Young says:

    I am concerned about a third bubble — unused credit. If a consumer has credit card debt of $10k and total lines of $50k, that leaves $40k sitting out there to be accessed if times get tough. Yes, the banks can lower credit lines but perhaps not in time. People are already stretched so far that another financial shove could result in a popped credit bubble — trouble for the banks and all of us.

    “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

    ~~Ludwig von Mises

  2. 2

    TIM, SOMEONE WENT TO 7-11 AND PICKED UP A TRUNK LOAD OF BOOZE FOR YOUR PARTY

    The Fed just announced another rate cut in the 0.25-0.5 range Next Week.

    Someone just put another Black Sabbath CD on and everyone’s rocking again.

  3. 3
    Jonny says:

    well, we don’t yet know what the cost is, but it might be right up there before it’s all over.

    the build-up to the great depression took about the same amount of time (the “roaring 20’s”). the 20’s also included a really large real estate bubble (florida).

    the south seas bubble took around a decade as well. when it burst, it nearly took out england’s whole financial system (one of the few cases where not having democracy can be an advantage!) and resulted in stock certificates being outlawed for more than a century afterwards.

    around the same time, john law’s unregulated economic ideas pretty much put an end to already-ailing france as a world power during the mississippi bubble. that took a number several years as well.

    this bubble may or may not end up topping the world history of bubbles, but it’s certainly a good possibility that it will put an end to american economic dominance. and in any case, the dollar may no longer be the defacto world currency. hell, i pointed out to a cashier the other day that i shouldn’t give him a canadian penny since they are now more valuable.

    what’s driving all this is out-of-control monetary inflation driven by malfeasance in the management of our banking system (al greenspan being chiefly responsible). the reason the dollar is sinking is because they printed too many of them (as john law did in france). debasement of a currency is a great and subtle way to steal large amounts of money from naive and uneducated people (the majority of people in the US).

    anyway, this is not the longest such party by much if at all and it remains to be seen whether it is most destructive. we were probably closer to destroying the entire US financial system in the late 1700’s (don’t recall the dates) and the 1930’s than we are today. things are very different today and it would be almost impossible to compare bubbles. some things are far better. our economies and systems are probably more resilient. some things are unconceivable. nobody actually knows how all these financial instruments work or what it all adds up to. apparently someone had to educate our new fed chief recently as even he doesn’t understand this whole “risk management” casino. and nobody has any idea what the outcome might be if a portion of the system collapses. the linking is very tight and extremely complex these days. during the south seas bubble, the problem was large, but simple enough that a king and a parliament could just put an end to it. today, if the problem gets out of control, it may be very unclear what to do about it.

  4. 4
    Jonny says:

    “TIM, SOMEONE WENT TO 7-11 AND PICKED UP A TRUNK LOAD OF BOOZE FOR YOUR PARTY

    The Fed just announced another rate cut in the 0.25-0.5 range Next Week.”

    Oh boy. We may really be the next Japan.

  5. 5
    B&W Nikes says:

    nice one softwarengineer – “spiral city architect, I build, you pay” is last line of last track on Sabbath Bloody Sabbath – crank it up, it’s going to be another all nighter bro!

  6. 6
    Buceri says:

    And the EU is raising their prime tomorrow, making the peso less desirable. What will China do? They are holding paper that is less and less valuable; but if they sell their pesos, we’ll sink faster and WalMart sales will go down and they will buy less from China….Oh, what to do??

  7. 7
    Brian says:

    The Chinese will not play hard ball with the US until they have fully industrialized their country. They’ll buy all our debt until then because it is in their better interest to do so. The Fed is a joke every time they decide to listen to the Jim Cramers of the world crying for the sakes of the Goldman Sachs of the world. The money supply needs to shrink for the dollar to regain it’s strength and the Fed needs to realize they can’t cut rates our way out of this mess. A lot of the problems we are facing today have nothing to do with the Fed or government – they have to do with irresponsible citizens that spend well in excess of what they can afford.

  8. 8
    deejayoh says:

    And the EU is raising their prime tomorrow, making the peso less desirable. What will China do? They are holding paper that is less and less valuable; but if they sell their pesos, we’ll sink faster and WalMart sales will go down and they will buy less from China….Oh, what to do??

    Not so fast. Read Roubini today. Canada lowered their rate yesterday, looks like England is going to, and the pressure is on the EBC. Market Ticker makes a compelling argument that this is recipe for WW deflation.

  9. 9
    Chris says:

    People are looking at the the declining yields in the ten-year and thirty-year and seeing that as a sign of deflation, yet at the same time deflation would result in lack of credit which should make credit more expensive (higher rates). Yet higher rates would make the yield curve right itself, which would not seem make sense…..where is my logic off here?

    On a related note, can someone smarter than I explain to me how the yield curve is inverted in the private debt market while it is not for govt bonds?

  10. 10
    rose-colored-coolaid says:

    I love that chapter, and I think it’s a great analogy Tim.

    That said, there’s one very strong reason why a total meltdown today won’t be as painful as it would have been in the past. People are just so much better off.

    Think about how far we’ve come since the 1930s. Everyone has a car today, and most have many cars. You can get fresh fruit and veggies in any season. You can communicate on this blog (and others) with people you’ve never actually met, all for the price of a little electricity and some unlimited bandwidth broadband internet. You can fly anywhere in the world that is populated in less than a day.

    In most wide spread economic crashes, people live not just beyond their means, beyond their times. The 20s were roaring because they happened 20 years too soon. The crash pushed society back perhaps 20 years. Yes it was painful, but if you took people from the 1820s they probably would have thought it wasn’t too bad.

    I just want to put this into perspective. We’ve outlived our means, and payback will suck, but how far back will we really fall? I suspect that in many regards quality of life will still meet or exceed what was seen in the 1970s or 1980s. Yes, it will seem worst because it will be less predictable for a time, but those are the times we live in.

  11. 11
    biliruben says:

    Wow. Great books. I just made the same analogy over at on the St. Joe thread at RCG yesterday, coincidently, which was mainly met with deafening silence. It has some fun numbers, so I’ll share here:

    Yes, Tim. I know. I guess I meant that the party is coming to an end, but I realize that the bottle of Jaeger still has a few shots left in it.

    Unlike those in Seattle, Portland, Charlotte and a few other miscellaneous burghs, people in cities that have already begun to decline are rapidly losing their refinance ability.

    IIRC, over the last several years somewhere around 7-8% of our consumption spending was coming straight out of our homes. Given than something like 70% of our GDP is conspicuous consumption, the loss of even a portion of that 7-8% spending is going to hurt our economy. Bad. And that’s ignoring foreclosures.

    Declining home prices are going to give us a serious push towards recession by taking away the home ATM, even if everyone were somehow able to stay in their homes.

    A few rough (inexact) statistics, because that’s the kind of dweebish fellow I am:

    We have 110 million (M) households in US.

    Around 75M households are owner occupied (I speculate at least 5M of those have no business being homeowners, based on historic ownership rates).

    Around 50M have a mortgage.

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

    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.

    20M of the 50M, 40% of mortgage holders under water, with a strong incentive to mail in their keys.

    Even is we only see 20% decline (and some parts of the country are already down 15%, and we are just getting started), that’s 13M under water.

    If that doesn’t scare the bejezus out of you, and cause you to start doing things maybe a little bit more proactive than burying statutes of saints, you have a stronger stomach for risk than I do.

  12. 12
    NostraDamnUs says:

    NEWS ALERT
    from The Wall Street Journal

    Dec. 5, 2007

    The Bush administration is expected to announce Thursday an agreement with the mortgage industry to freeze interest rates for certain subprime mortgages for five years. In addition, the plan includes a provision to fast track some borrowers toward refinanced loans and allow state and local governments to use more tax-exempt bond programs to fund refinancings. The plan comes amid concerns about rising home-foreclosure rates.

  13. 13
    deejayoh says:

    People are looking at the the declining yields in the ten-year and thirty-year and seeing that as a sign of deflation, yet at the same time deflation would result in lack of credit which should make credit more expensive (higher rates). Yet higher rates would make the yield curve right itself, which would not seem make sense…..where is my logic off here?

    I don’t think so. The risk free interest rate (commonly assumed to be the Ten-year treasury) is a combination of the real interest rate and the rate of inflation (Risk free rate = [1+r]x[1+i]) – so in a deflationary scenario, you would expect to see low yields (as we are).

  14. 14

    HI NOSTRADARNUS

    That’s old news to us Bubble Brains, the problem with the up-coming Paulsen Plan is its apparently [see the Roubini URL on a blog above] will only apply to teaser rates of 7.5% going to 11%; it will only apply if you can afford to keep going at 7.5%.

    Seattle’s down the tube irrespective [what good is 7.5% teaser rates going to 11% in Seattle], Bush’s apparent 7.5% Christmas present is “joke coal” when applied to $200K condos or $400K homes in Seattle.

    The Paulsen details may prove Roubini wrong, I doubt it.

  15. 15
    on topic says:

    yeah, the housing/credit problem is gonna suck and i’m beginning to think we’ll go the way of Japan, 0% interest rates and all.

    for this to happen, all we need is for it to become more expensive to give the house back to the bank or for the rate of house price depreciation to become slow enough that people are never so far underwater that they give up hope.

    the easiest way to do this is by lowering the reserve rate, increasing inflation. a 5% fixed rate loan on a depreciating asset doesn’t look so bad when inflation is 6%.

    the $600k house will sell for $600k 7 years later, never mind the fact that the $600k will only be worth $300k real dollars.

  16. 16
    Tom says:

    *Home price drop biggest in 25 yrs-Freddie Mac*

    from Reuters, comments:
    “A plan supported by Treasury Secretary Henry Paulson that aims to freeze rates on many subprime loans will do little to slow the housing downturn, analysts said.

    “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!””

    (from here):
    http://www.reuters.com/article/bondsNews/idUSN0460475820071204

  17. 17
    b says:

    Do not be afraid of the Paulson “plan”. In order to actually save a large part of these underwater homes it would have to completely destroy our credit markets. Since they will not be letting this happen, we can safely assume its a lot of hot air which will do nothing in the end except waste some more of our tax dollars.

  18. 18
    jon says:

    The fact that the US has been running massive trade deficits is the only evidence we need to know that the dollar has been massively overvalued for a very long time. We allowed other countries to lowball their currencies because it benefited us to keep their economies strong. We can do that no longer, so the dollar is falling. So far I have heard only Sarkosky complaining about the falling dollar, whereas you would expect every foreign leader would be screaming if they thought a falling dollar could be stopped.

    What is the effect of a falling dollar? More expensive imports and an easier time exporting. How is that bad for us? Just some inflation, which happens to be what we need to keep borrowers from going underwater. We will also have to make do with fewer Chinese toys and suffer with Detroit cars.

  19. 19
    TJ_98370 says:

    Since we are being pensive and sophistical relative to popular culture, the Eagles new song Long Road Out of Eden provides some caustic commentary about American society. The following are some selected lyrics:
    .

    …..music blasting from an suv
    on a bright and sunny day
    rolling down the interstate
    in the good ol’ usa
    .
    having lunch at the petroleum club
    smokin’ fine cigars and swappin’ lies
    he said: “gimme ‘nother slice o’ that barbecued brisket!”
    “gimme ‘nother piece of that pecan pie!”
    .
    freeways flickering, cell phones chiming a tune
    we’re riding to utopia, road map says we’ll be arriving soon
    captains of the old order clinging to the reins
    assuring us these aches inside are only growing pains
    but it’s a long road out of eden……
    .
    ……weaving down the american highway
    through the litter and the wreckage and the cultural junk
    bloated with entitlement, loaded on propaganda
    and now we’re driving dazed and drunk……
    .
    ……behold the bitten apple – the power of the tools
    but all the knowledge in the world is of no use to fools
    and it’s a long road out of eden.
    .

  20. 20
    on topic says:

    there are no detroit cars in my future, I’ll promise you that right now.

    I drive a Pontiac Vibe, a nice American-made Toyota, built in Fremont, California.

    American cars are crap, the cheap ones (Ford Focus) are built badly in Mexico and the big expensive ones have the greatest exposure to rising energy costs both in manufacture and operation.

    A falling dollar points towards Honda Jazz’s and Toyota Yaris’s, not Chevy Suburbans and Ford Excursions.

  21. 21
    AndyC says:

    Looks like they are about to tap a new keg! Rather than letting the party end with a thud, the Bush Administration appears to be getting close to a deal that would freeze ARMs for the next 5 years. What a slap in the face to all fiscally responsible American’s.

  22. 22
    EconE says:

    The drink has run out.

    Now, everybody is sucking on the citrus at the bottom of the empty sangria bowl hoping to keep their buzz going.

  23. 23
    on topic says:

    I’ve decided that the ARM talk is just a way to convince people not to worry so much, to go out and max the credit cards, get back in the stock market.

    This way the rich financial folk will be able to sell their positions at higher prices and leave the middle class holding the bag with depreciating houses, shrinking retirement funds, and stagnant or declining real incomes.

    There is no way, legally or otherwise that anyone can prop up the national housing market. It is just a question of how fast it will fall, how much it will over- or undercorrect, and who will pay how much for it.

  24. 24
    TJ_98370 says:

    Tim,

    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?

  25. 25
    biliruben says:

    Well… He died in May of 2001, so probably not.

    He wrote the series between 1979 and 1992.

  26. 26
    WestSideBilly says:

    We’ve been meddling with the Middle East since the 70s. Wine merchants = OPEC?

  27. 27
    TJ_98370 says:

    biliruben

    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.

  28. 28
    Garth says:

    Where are all the Washington the foreclosures? 60% higher than a historic low from a year ago is still nothing.

    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. . .

  29. 29
  30. 30
    Scotsman says:

    Gonna be a lot of nasty hang-overs come Spring…

  31. 31
    whats my name says:

    “The risk free interest rate (commonly assumed to be the Ten-year treasury) is a combination of the real interest rate and the rate of inflation (Risk free rate = [1+r]x[1+i]) – so in a deflationary scenario, you would expect to see low yields (as we are).”

    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.

  32. 32
    deejayoh says:

    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…

  33. 33
    whats my name says:

    “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…”

    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.

  34. 34
    what goes up comes down says:

    whats my name said, YOU know the future? Cool, can you tell me when the Seahawks will win the Superbowl so I can reserve my seats now?

  35. 35
    Scotsman says:

    Sorry boys, the 10 year bond is increasing in value because demand is high- probably the result of a “flight to quality.” Consequently the effective rate (i.e., NOT the coupon) has dropped. However, this indicates neither inflation or deflation, as it is a single incidence of supply and demand at work, nothing more. You both should know one can’t extrapolate price movements in a single “commodity” to the economy as a whole. Again, it indicates neither inflation or deflation.

    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. ;-)

  36. 36
    economist says:

    yeah, the housing/credit problem is gonna suck and i’m beginning to think we’ll go the way of Japan, 0% interest rates and all.

    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.

  37. 37
    Buceri says:

    All I know is the FED will drop the rate next Tuesday, and as it’s often the case, Wall Street will celebrate. I will sell most of my stocks (in savings account) in late December probably prior to the Santa C. rally. The first trimester of ’08, when we get the winter blues….it will be interesting.

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

  38. 38
    Angie says:

    biliruben says, A few rough (inexact) statistics, because that’s the kind of dweebish fellow I am

    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!

  39. 39
    Buceri says:

    November retail numbers are out.
    “According to a tally by Thomson Financial, 19 merchants beat sales estimates, two met, and 22 missed expectations. The tally is based on same-store sales or sales at stores opened at least a year. Same-store sales are a key indicator of a retailer’s health.

    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.”

  40. 40
    deejayoh says:

    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.

  41. 41
    what goes up comes down says:

    Angie, good to see you are back and hoping fairy tales do come true.

  42. 42
    AndyC says:

    If I remember my college economics, conventional wisdom is that lower interest rates reduce savings and increase spending, which leads to inflation.

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

  43. 43
    Scotsman says:

    We won’t be seeing inflation in spite of lower Fed rates and a falling dollar. Asset liquidation to reduce debt, and the sharp contraction of liquidity, which reduces the number of dollars in circulation, will overwhelm efforts by the Fed and Gov. to ease the economy. Like Japan 20 years ago, we will begin a long period of contraction/stagnation until long-run viability is restored. We’ve come to the end of the cycle- the U.S. consumer has no more to spend, there is nothing left for the government to tax despite its looming SS/Medicare/Etc commitments. Time to reset, and start over.

  44. 44
    Buceri says:

    “We’ve come to the end of the cycle- the U.S. consumer has no more to spend”
    Amen.

  45. 45
    b says:

    Angie,

    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.

  46. 46
  47. 47
    rose-colored-coolaid says:

    Ah, a “Black Swan” event. Here’s the wiki article on black swan events

    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.

  48. 48
    deejayoh says:

    On the subject of HELOCs and Homeowners Equity, by way of Calculated Risk

    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.

  49. 49
    Buceri says:

    Ah, the economy. Let me quote that great philosopher Donaldus Rumsfeldus:
    “there are things we know we know; there are things we know we don’t know; and there are thing we don’t know we don’t know.”

  50. 50
    Ballard Boy says:

    I was wondering if anybody has been reading Dean Baker’s thoughts – especially his own to rent plan?
    http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=12&year=2007&base_name=subprime_solution_to_mortgage
    http://www.cepr.net/content/view/1274/45/

  51. 51
    biliruben says:

    Angie – I got much of the numbers from this article at Calculated Risk. If you don’t read them, I can’t recommend them too highly. The best, unbiased numbers, commentary and detailed explanations out there.

    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.

  52. 52
    NolaGuy says:

    From Herb Greenberg at Market Watch:

    “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

  53. 53
    TJ_98370 says:

    NolaGuy,
    .
    Good article. Well worth reading IMHO. If Mr. Hanson is right, we’ve got some interesting times ahead.
    .
    …..Sub-prime aren’t the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered ‘prime’ so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered ‘prime’ or Alt-A……

  54. 54
    deejayoh says:

    Read the comments on the linked article – they are very interesting. Lots of them are of the “career mortgage broker, agree completely” variety. It is the internets, so who knows if anyone is telling the truth – but if industry insiders really feel this way it is telling.

  55. 55
    Angie says:

    Angie, good to see you are back and hoping fairy tales do come true.

    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.

  56. 56
    biliruben says:

    No doubt, Angie. There are many variables. Option Arms – the principal may actually rise. I/O – the principal will stay the same. 30 year fixed or other amortized pay structure – principal will decline – albeit even in your case (and mine) only a small, single digit percent decline over the next few years.

    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.

  57. 57
    Angie says:

    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.

    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.

  58. 58
    The Tim says:

    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.

    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

    Home Loan-ership

  59. 59
    biliruben says:

    Like I said, Angie. You gotta start reading Calculated Risk!

    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

  60. 60
    biliruben says:

    If you take a close look at that 2nd graph, homeowners were ripping more than half a trillion dollars out of there home EVERY QUARTER, pretty much from 2002 until the present.

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

  61. 61
    Angie says:

    See, the thing that irritates me about those articles/graphs is the lack of context for the numbers.

    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.

  62. 62
    NolaGuy says:

    Russ Winter at WallStreet Examiner covered cash out refi’s today. This chart tells it all:

    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

  63. 63
    EconE says:

    Of course the sky’s not falling Angie.

    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!

  64. 64
    Angie says:

    Well, you know, Ben Bernanke himself declined to assess my vast land holdings, so I’m left to make do.

    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.

  65. 65
    Matthew says:

    you can lead a horse to water…….

  66. 66
    deprogram says:

    For some, obviously, the drink is already running out. Care to engage in a little schadenfreude? You know you do. Head over to Salon for this fun little piece on a California flipper (soon to be former flipper, I guess):

    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

  67. 67
    Scotsman says:

    Angie- take some time to study this:

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

  68. 68
    whats my name says:

    “You both should know one can’t extrapolate price movements in a single “commodity” to the economy as a whole. Again, it indicates neither inflation or deflation.”

    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?

  69. 69
    Scotsman says:

    First, it is a myth that the Fed sets interest rates. The free market sets interest rates. In the old days, before unencumbered instantaneous international funds transfers and global economies, the Fed did have some power over rates. But today, they essentially have little power except to smooth short term changes, and their ability to affect short term expectations. If you look at historical charts for the last 25 years it’s pretty clear that Fed rates follow market set inter-bank rates, not the other way around. The Fed can set their rates at zero, and if there is no demand, there won’t be any borrowing, i.e. Japan. Or they can set rates very high, with the result that money from around the world will instantly pour in, moderating and nullifying the hoped for effect. Think of your T-bill example and the flight to safety that started all this. Further, think of the carry trade and how it works to bring parity to rates.

    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.

  70. 70
    wreckingbull says:

    Kindleberger could not have said it better, Scotsman. I often hear from over-extended homeowners that inflation will save the day for them. This is a fallacy.

    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.

  71. 71
    what goes up comes down says:

    Hmmm, How does the government increase spending when tax revenue is down — DEBT, just like the last 6 years.

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

  72. 72
    notabull says:

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

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

  73. 73
    NolaGuy says:

    Well said, Scotsman. Excellent post.

    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.

  74. 74

    […] as a run-down shack in the far-flung suburbs is not always the case. The whole nation threw a giant housing bubble party, and even the very wealthy were […]

  75. 75

    […] reminded of Douglas Adams’ flying party, which I posted about a few times before the bubble burst and the economy collapsed, taking with it all of that imaginary […]

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