Housing Bubble Accomplices Preparing for Death: Caroline Baum

this clip is made for this great piece from caroline baum. if you havn´t seen it yet ..this is a must see!!!!!!!!!

dieser clip ist wie für diesen bericht von c.baum gemacht. wer den noch nicht kennt ....ansehen!

I first used this analogy in 1999 in writing about the bubble in Internet and technology stocks. The paradigm seems equally applicable to today's burst housing bubble.

First came denial: It isn't a bubble. Banks don't have any exposure to mortgages. Housing is a small sector of the economy. Subprime mortgages are a small segment of the home-loan market.

Then came the Feb. 7 double time-bomb from HSBC Holdings Plc, Europe's biggest bank, and New Century Financial, the No. 2 subprime lender in the U.S., that they were setting aside more money as a cushion against rising loan delinquencies. New Century filed for Chapter 11 bankruptcy protection on April 2, one of more than 40 lenders that have ceased operations or sought buyers since the start of 2006, according to Bloomberg data.



Accountability
Soon the anger set in. Delinquency and foreclosure rates rose. Everyone was shocked, shocked to learn there was risk in risky loans. The press bombarded us daily with tales of shady lenders preying on victimized homeowners who would soon be out on the street for non-payment of mortgage interest.

No one was more upset than our elected representatives. Congress wants blood. Whose is irrelevant.


``Members of Congress want someone to be accountable for sensible lending,'' says Andy Laperriere, a managing director at the ISI Group in Washington.

Let the bargaining begin. With the homeownership rate at 68.9 percent in the fourth quarter, just shy of the all-time high, the potential audience for congressional hearings and potential market for invasive action is huge.
Unfortunately, Congress comes up with some really loopy ideas.

``Ideas that seemed out of the mainstream today may become mainstream in the future,'' Laperriere says.

Options Open
On Tuesday, Bloomberg News reported that the top Democrat and Republican on the House Financial Services Committee, Barney Frank of Massachusetts and Spencer Bachus of Alabama, respectively, said that mortgage-bond investors should be liable for deceptive lending practices.

..Let's hope the committee calls some mortgage-bond investors to testify. If they can be sued for someone else's actions, they aren't going to buy any mortgage bonds. Period.

Higher yields may compensate an investor for increased risk, but they don't offer adequate protection against class- action lawsuits.

Precedent
Chairman Frank might want to call some folks from the state of Georgia, where the enactment of a Fair Lending Act in 2002 rocked the mortgage industry.

The law assigned liability for predatory lending to everyone along the food chain, from lender to securitizer to investor.

The reaction was predictable. Many lenders pulled out of the state, the rating agencies refused to evaluate the pools of home loans and the secondary market dried up.

The law, which took effect in October 2002, was amended the following March ``to address a number of unintended consequences'' and to limit assignee liability.

New Jersey's Home Ownership Security Act of 2002 had to be amended in 2004, too, because ``the market shut down,'' according to Robert Levy, executive director of the Mortgage Bankers Association of New Jersey. The amended law put limitations on assignee liability.

Liability ``does apply to high-cost mortgage loans, which carry more than 4.5 percent in points and fees and an interest rate greater than 8 percentage points over the comparable maturity Treasury,'' he says.

Aligned and Assigned
There is no market for securitized high-cost loans, Levy says, and not many loans originated. Which is probably what Congress is getting at. The common theme to the hearings on subprime lending has been that Wall Street is ``eager to securitize, rate and buy as long as the originators feed the beast,'' Laperriere says. ``Many members of Congress want the major players in the secondary market -- holders of mortgage-backed bonds and the investment banks -- to have their interests more aligned with homeowners.''

It would seem a lot easier to fix the problem at the source, tightening regulations on the lenders themselves.

But hey, we still have two final stages of dying before the bubble is fully exorcised: depression and acceptance. If Congress follows through on its legislative reforms of the subprime market, the housing recession may turn into a depression. If that happens, can the rest of us find acceptance?

disclosure: unlike nowitzki i hate david hasselhoff :-)

The Plankton Theory Meets Minsky / pimco on ponzi schemes

well done! it looks like the principle of economics havn´t changed over time despite lots of innovation. this is a long but very good read!

fundamentals matter....maybe a bit delayed due to financial innovation or "intervention"......

mal wieder extrem gutes von pimco. gut zu wissen das die grundsätze der wirtschaft doch nicht wie oft suggeriert durch innovationen ausser kraft gesetzt sind. es lohnt sich das lange posting durchzulesen.

fakten zählen....evtl. heutzutage ein bisschen verzögert dank der finanzinnovationen und einiger "interventionen".....

Watching the on-going meltdown in the sub-prime mortgage market, which is triggering a sharp tightening of underwriting standards to these dicey credits, I was reminded of prescient writings by two serious thinkers: Bill Gross and Hyman Minsky. Both narratives go back a long ways, with something that Bill wrote in August 19801 – 27 years ago! – particularly poignant:

“The Plankton Theory, like life itself, begins and ends in the ocean. Plankton, of course, are almost microscopic organisms that serve as food for higher life forms. Without plankton almost every fish and mammal in the sea could not survive, since most species depend upon other fish for their existence and plankton are the initial building blocks of the entire process. Logic would suggest, therefore, that in attempting to forecast the well being of the Great White Whale, Jaws, or even Jaws II, that one of the factors to consider would be the status and future outlook of the plankton. That, in one hundred words or less, is the Plankton Theory.

Now, what possible significance could this have for the investment world? Plenty. Take for example, the area of real estate, especially that of single family housing. We’re all familiar with the rapid escalation of home prices over the last 10 years. For most Americans, their homes have been the best and in many cases the only investment that they have made in their entire lives. Some have gone so far as to invest in several homes and have endured ‘negative carry’ on the cash flow in anticipation of leveraged capital gains a few years down the road. But where does it stop? Can housing continue to increase at twice the Consumer Price Index for the next 10 years?

One way to measure might be via the Plankton Theory. In the case of real estate, the plankton would be the first-time buyer (perhaps a young married couple) with a desire to own their own home but with very little capital to carry it off. When the time comes that they can’t pull it off – either through an inability to come up with a down payment, or to service the monthly mortgage – then the ‘plankton’ would disappear and the rapid escalation in housing prices would ease as well. For, unless the current homeowner has someone to sell his house to, he’ll be unable to afford the house with the view or that extra bedroom, and the process would continue into the echelons of Beverly Hills and Shaker Heights. In the end, the entire market would wither on the investment vine and home prices would stop increasing at the same rapid rate. So to gauge the health of the housing market, look first at the plankton. ”

Bill’s call was a good one, as displayed in Chart 1: home price appreciation tumbled in the first half of the 1980s, as the homeownership rate fell: the Plankton Theory at work! Draconian Fed tightening at the beginning of the 1980s had something to do with it, too, of course, as the Plankton were priced out of the market by high interest rates, independent of the availability – or underwriting standards – for home mortgage loans.

But the theory held: it’s the first-time buyer, stretching to buy, that is the life’s blood of vibrant property markets. ....

But the human condition is inherently given to the Mae West Doctrine that if a little of something is good, more is better, and way too much is just about right. ....
Minsky, who passed away in 1996, was the father of the Financial Instability Hypothesis, providing a framework for distinguishing between stabilizing and destabilizing capitalist debt structures. He first articulated the Hypothesis in 1974, and summarized it beautifully in his own hand in 1992:

“Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified. how would you label this...? / wie würded ihr das bezeichnen...? :-)

Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit.

Speculative finance units are units that can meet their payment commitments on ‘income account’ on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to ‘roll over’ their liabilities – issue new debt to meet commitments on maturing debt.

For Ponzi units, the cash flows from operations are not sufficient to fill either the repayment of principal or the interest on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stocks lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. (another ponzi scheme........)

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system.

..... The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.

In particular, over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make positions by selling out positions. This is likely to lead to a collapse of asset values.” (just look at new century....)

Clearly, the explosion of exotic mortgages – sub-prime; interest only; pay-option, with negative amortization, et al – in recent years, as shown in Chart 2, have been textbook examples of Minsky’s speculative and Ponzi units.

And as Bill Gross explained long ago, such mortgages have been the food of the Plankton, the first-time homeowner, driving the homeownership rate to record highs, as displayed back in Chart 1, while also fueling accelerating home price appreciation. But as Minsky had forewarned, eventually this game must come to an end, as Ponzi borrowers are forced to “make positions by selling out of positions,” frequently by stopping (or not even beginning!) monthly mortgage payments, the prelude to eventually default or dropping off the keys on the lenders’ doorstep.

That is happening. And true to form, Ponzi lenders are now recognizing their sins of irrational exuberance, repenting and promising to sin no more.....

And in this cycle, it’s not just the first-time homebuyer – God bless him and her! – that is trapped, but also the speculative Ponzi long: borrowers who weren’t covering a natural short – remember, you are born short a roof over your head, and must cover, either by renting or buying – but rather betting on a bigger fool to take them out (“make book”, in Minsky’s words). Thus, the supply of plankton is twice drained.

Which means that the bigger fish in the domestic and global economic sea are going to be living on leaner diets. It also means that any given level of central-bank enforced short-term policy rates will become ever more restrictive with the passage of time. That is nowhere more the case than in the United States, where mortgage originators’ orgy of Ponzi finance stifled the Fed’s ability to temper irrational exuberance in housing with hikes in the Fed funds rate.

More specifically, as long as lenders made loans available on virtually non-existent terms, the price didn’t really matter all that much to borrowers; after all, housing prices were going up so fast that a point or two either way on the mortgage rate didn’t really matter. The availability of credit trumped the price of credit. Such is always the case in manias.
It is also the case that once a speculative bubble bursts, reduced availability of credit will dominate the price of credit, even if markets and policy makers cut the price. The supply side of Ponzi credit is what matters, not the interest elasticity of demand.

Bottom Line
The ongoing meltdown in the sub-prime mortgage market would not matter, except for those directly involved, except that it marks the unraveling of Ponzi finance units that, on the margin, were the plankton of the bubbling property sea of recent years. As the bubble was forming, riding on first-time homebuyers with first-time access to credit on un-creditworthy terms, and first-time speculators riding the same with visions of bigger first-time fools to take them out, all looked well. But as Minsky warned, stability is ultimately destabilizing, as those who require perpetual asset price appreciation to make book are forced to sell to make book. Such is reality presently in the U.S. residential property market, which has flipped from a sellers’ market on the wings of buyers with exotic mortgages to a buyers’ market of only the creditworthy.


This state of affairs need not produce a U.S. recession. But it does unambiguously render any given stance of Fed policy more restrictive: a tightening of credit supply based on underwriting terms means that any given policy rate will elicit reduced effective demand for credit. And that’s the stuff of seriously easier monetary policy to come. Just as mortgage demand seemed inelastic to rising short rates when availability was riding relaxed terms, so too will demand seem inelastic to falling short rates when availability faces the headwind of restrictive terms.

It may be a while before the Fed accepts and recognizes this, waiting for these Minsky style debt-deflation dynamics to become evident in broader measures of the economy’s health, notably job creation. But make no mistake: A Minsky Meltdown in the most important asset in most Americans’ asset portfolio is not a minor matter. Bill Gross’ Plankton Theory ain’t just a theory, but a reality.

Once the Fed begins easing, it will be a long journey down for short rates.