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You can't reconcile these two views
Thursday, March 06, 2008
On the one hand, an increasing number of observers are coming to the increasingly unpleasant conclusion that real estate prices have to come down before order can be restored to the U.S. financial system and an economic rebound can take hold.
On the other hand, an the increasing number of observers are coming to the increasingly unpleasant conclusion that real estate prices can't be allowed to go down if order is to be restored to the U.S. financial system and an economic rebound is to take hold.
You can't reconcile these two views.
Is anyone even trying?
Shouldn't someone be trying?
A couple examples from earlier today help to frame the issue. Writing in the Washington Post, Robert Samuelson notes:
Offering the opposing view, Boston Fed President Eric Rosengren comments:
Home prices are tumbling. We're bombarded by somber reports. But wait. This is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall, the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last.
...
From 2000 to 2006, median family income rose almost 14 percent, to $57,612. Over the same period, the median-priced existing home increased about 50 percent, to $221,900. By other indicators, the increase was even greater.
But home prices could not rise faster than incomes forever. Inevitably, the bust arrived. Credit standards have been tightened, and the (false) hope of perpetually rising home prices -- along with the possibility of always selling at a profit -- has evaporated.
The closest we've come so far to reconciling these two views is the idea above - where lenders reduce homeowners' principal so that as home prices go down, they'll be a little less eager to walk away from the property because they'll be a little less upside-down in their mortgage which, of course, will only forestall the inevitable market-based correction.
"As long as housing prices continue to fall, the decline increases the risks to borrowers, lenders, markets and the economy," Rosengren said in prepared remarks to the South Shore Chamber Economic Breakfast in Quincy, Massachusetts. "Significant further declines in home prices could greatly complicate efforts to resolve current problems."
Rosengren joined Fed Chairman Ben S. Bernanke this week in warning about the rising threat of negative home equity, where property prices drop below mortgages.
...
"Lenders could write down the loan amount to the current home value, cap losses, avoid the costs associated with foreclosure, and receive a share of any future home appreciation," Rosengren said.
It would be nice to hear more observers ask, "You know, we really can't have an entire economy that is based on blowing one asset bubble after another because, once the bubble pops, the asset prices drop like a rock causing all sorts of problems. How do we fix that?"
5 comments:
there will never be a bottom in housing. During this recession, people are losing their jobs, then they will sell the house becuase they need to move to find other or work or simply can not pay the mortgage for lack of money. Thus, the increase in supply of homes further depresses the market causing more underwater mortages which in turn causes more defaults which leads to more unemployment. Thus, it is a vicious circle.
The only remedy is for the Federal Govt to buy the properties for vacant housing and demolish them. It could create a land bank. Thus, the excess supply of homes is removed from the marke and prices can go up again.
To be frank, we are in this mess because the Fed/Govt tried to apply fixes for every small problem and eventually made a big problem requiring even bigger fix. The free market fix would be to run the downturn run its course, let some financial giants to fall (like DEC of 1990s) and let house prices fall in line with incomes. Since we got used to freebies (getting oil from everywhere, always checking asset prices so that we can get rick by not working etc.), the best the govt can do is to declare foreclosure moratorium. The debt can never be paid any way (then money goes to 0). By design, all the parties have to pretend that they are going to to pay those obligations when we clearly know it is not possible. Let us just make it explicit by just adding outstanding interest to the loan balance and not expecting a single penny.
They are not really different viewpoints, rather just different goals. Implicit in Rosengren's statement of "resolve current problems" is "resolve to the situation where the economy can be in a debt-fueled deficit-spending unstable bubble again". He's absolutely correct: decreasing housing prices moves the economy farther from that goal.
On the other hand, if your goal is the stabilization of the economy and the correction of the asset bubble condition which caused the current "crisis", Samuelson is correct. The sooner everyone absorbs the real losses from creating and propagating the bubble, and the still solvent companies and individuals integrate those hard lessons into future investment and risk analysis, the better we can get to a stable, non-bubble situation.
It's not that they're opposite views, just opposite goals.
The issues you ID in this post and comments are reflected at the highest levels and explain why there is so much doom and gloom around.
Graham
Vicious spiral haunts debt markets
By Gillian Tett
Published: March 6 2008 22:08 | Last updated: March 6 2008 22:08
This weekend the Group of Ten central bankers will convene in Basel for one of their regular pow-wows. The discussions will be fraught.
Almost three months ago, a similar gathering paved the way for an unprecedented bout of collective action in the money markets that was supposed to halt the sense of financial panic.
But three months later, the grisly truth is that market anxiety is seeping back with a vengeance. Thus the crucial question confronting the central bankers this weekend, as they fly in to snowy Switzerland is twofold: first, are we on the verge of a new downward lurch? And second, is there anything the G10 bankers can actually do to stop this?
A downward lurch does look a real danger now, not least because the central bankers themselves are looking increasingly impotent when it comes to tackling the fundamental reasons why sentiment is so fragile.
The western financial system is caught in a trap. On the one hand, there is an urgent need for clearing prices to be established for impaired assets to restore confidence; on the other hand, if this is done in a mark-to-market world, there is a risk that some banks will run out of capital. Policymakers are in the unenviable position of knowing almost any step they take risks denting sentiment further.
First, a bit of background. History suggests a crucial component for ending a financial crisis is to establish some sense of clearing prices. Once goods look cheap – and it does not seem they will soon become cheaper still – buyers tend to rush back in. This, after all, is Economics 101, and it applies as much to houses and cars as collateralised debt obligations.
Now, in theory, there are plenty of reasons to expect investors to start rushing into the credit markets soon, in a manner that could stabilise sentiment. After all, many credit prices have slumped dramatically. And while banks may be capital constrained, plenty of investors are sitting on pots of free cash, such as sovereign wealth funds and even mainstream asset managers and pension groups.
But these groups are notably not buying credit yet, either because they are still paralysed with shock or, more realistically, because they have a nasty feeling that while a leveraged loan, say, looks cheap, it could be cheaper in the future.
How can you combat this? Fifteen years ago, the US government devised a clever trick in the aftermath of the savings and loans crisis, by conducting firesale auctions of S&L assets. This was brilliantly effective in establishing clearing prices and turning sentiment around, because as soon as investors saw some assets being sold at knockdown prices they starting jumping in, meaning that within a few months, prices were rising again.
But these days the US government faces a crucial impediment to repeating this trick. Back in the days of the S&L crisis, US banks were not forced to mark their books to the firesale prices. But now the mark-to-market creed has taken hold. And it is a fair bet that if US banks were forced to mark their books to the initial clearance price for a CDO squared, say, some would run out of capital. Hence the trap: in the modern financial system, you can have mark-to-market accounting systems, or quick action to establish clearing prices, but probably not both, without blowing up some banks.
Of course one way to exit this trap would be to abandon the mark-to-market rules for a while, or loosen capital adequacy standards. Some furtive discussions between policymakers along these lines are already occurring.
But I would be surprised if any action occurs soon. So the risk now is that we will remain trapped in this climate of grinding fear for months – at best. Few institutions have much incentive to voluntarily create clearing prices. However, hedge funds are now being forced to make asset sales in an ad hoc, opaque manner that is adding to the sense of fear. This is forcing the banks to mark books lower and pull in their horns, sparking even more hedge fund sales and fuelling concern about banks. It is a viciously unpleasant spiral.
Let us all hope the G10 have some amazing new tricks up their sleeves; if not, we are moving into dangerous waters.
gillian.tett@ft.com
Copyright The Financial Times Limited 2008
Awesome idea on government buying houses and demolishing them. In fact, your idea is so excellent that it should be applied to unemployment as well.
Frickin' moron!
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