Duck

[solarbird]

Remember the noises I made last summer and again last fall, about housing? And how I said to watch your 401Ks, given the new "national security" bookkeeping regulations' likely effects on bookkeeping integrity?

I strongly suspect that this would be Shit, meeting what I believe would colloquially be known as Fan. Those of you currently in open-enrollment periods for 401K and similar plans may wish to take whatever actions you may feel to be appropriate - keeping in mind, of course, that I am not an investment advisor and have not here given investment advice.

Comments

[loopback.livejournal.com]

so, pretend I'm someone who hands over his investments to a financial planner to manager. Is this something I should be asking them about, and what are some questions I could ask that wouldn't make me look like king of the morons?

I am getting from the reading that there is some potential badness rolling in fast, but I also note that there are frequent potential disasters rolling in all the time, and few have really come to pass as yet. What makes this one likely to really bear fruit and cause a crash?

[solarbird]

I didn't use the word "crash." But I think I know where you saw that: in the economic press, "hard landing" means "recession," which is to say "economic contraction," where the economy shrinks rather than staying stable or growing. Markets tend to do poorly in initial phases of economic contractions.

This event could potentially be more worrisome than usual because of the combination of scale and economic breadth. There have also been a series of claims over the last several months about how the initial contagion has been "contained;" in each case, the "containment" has been proven nonexistent. Considering just housing, the scale is reasonably obvious; the breadth may not be. The breadth concern is that, given a negative savings rate over the last two years or so now, and given that Americans have been extracting paper equity from their homes to finance their very high level of continued spending, that a major hit to the housing market could force significant cutbacks in consumer spending. Given that discretionary spending is between 2/3rds and 3/4ths of the American economy in recent years, this could be very serious.

What could be significantly more serious is the ... largely not understood massive network of derivative hedge funds, intended originally to reduce risk both by spreading it and creating, essentially, paper upside potentials even for fund losses. The scale of this market is not well understood, but is, in my reading, believed to be in the 15-16T$US range, and much, if not most of it, could be damaged significantly by a major housing downturn. We are now in a major housing downturn that, despite National Association of Realtor proclamations, does not show any signs of improving for at least a year and a half, if not two or three more years, simply from the numbers shown in the articles linked to in the main post. (All the spirit dancing by realtors doesn't make me feel any more confident about the situation, either. But I digress.)

The two Bear Stearns funds collapses are not good indicators of the health of these funds. The housing situation alone could trigger a consumer-spending recession. If the housing contagion spreads to these hedge funds in a more significant way - and despite the lack of coverage, the Bear Stearns collapse is huge - then all kinds of bets are off, and things could get very ugly - a potentially very severe recession and a major market downturn over a period of multiple years. That's what the second article is talking about.

It would be nice if these were the only major economic pressures. Unfortunately, they are not. C.f. my commentaries on oil and my continuing concerns about the US dollar (about which I post less, I admit), for example. You may also wish to note the rising protectionism urge (on both the left and right, I'm afraid), particularly in regards to both China and OPEC, the limits of China, India, and Japan to continue to pay for the US's massive fiscal deficits (plural) and the effect that will have on the dollar, the wind-down of the Iraq war (war aftermath has generally, if not always, produced recessions in the industrialised world) and so on.

And, of course, you are correct: there is always a lot of OMG OMG OMG. Most of the time, such OMG OMG OMG forecasts rely on a series of things going wrong against their dominant probabilities. And it is absolutely possible that the economy and market will proceed to be just fine for the indefinite future. However, at this point, I think that in order for that to happen, a series of things must go right against their dominant probabilities. That's certainly possible, but it's the converse of the disaster scenario that, as you note, mostly fails to come true.

Again, that said, everything could be just fine. But I think of that particular navigation as being a Scylla and Charybdis situation. Getting through that untouched is certainly possible; it can be and has been done. But it's a neat trick. And if liquidity dries up - if the unprecedented current liquidity dries up - I don't think it can be done.

[solarbird]

Oh, but to answer the main question:

so, pretend I'm someone who hands over his investments to a financial planner to manager. Is this something I should be asking them about
Talking to your financial manager is rarely a bad idea.

and what are some questions I could ask that wouldn't make me look like king of the morons?
I would express my concerns about the housing market, and, just as importantly, the hedge/derivatives market, and the effects of a possible significant downturn in liquidity and/or consumer spending, and indicate that you are concerned about your risk exposure to the effects of this potential situation over the next 1-3 years. Then see what they have to say.

[solarbird]

I misunderstood the scale of the total derivatives market. It is much larger than I realised. The $15-16T portion refers only to credit default swaps, and I was also unaware that this number - the most immediately vulnerable portion of the greater market in a high-default environment - has soared to over $30T.

The entire derivatives market is closer to $300T.

[llachglin.livejournal.com]

I'm not sure I buy the idea that the unfolding drop in the housing markets is going to have a significant effect on the stock market. It might just slow growth rather than trigger a recession, and the market has done well weathering recent crises because a lot of the capital and resulting revenue of public companies is overseas and sheltered a bit from problems in the US economy.

In any case, even if the market does dip it's not like there's much that can be done to soften the blow to our 401Ks. A recession will hit most US stocks across the board. That's just the reality of defined contribution retirement funds as opposed to defined-benefit pensions. I suppose you could buy more international stocks, but that comes with its own risks.

Really, at this point I'm more concerned with the direct downside of what's happening with housing. A lot of people with sub-prime loans are about to default and lose their homes. For those of us without sub-prime loans, we're probably OK for now.

[solarbird]

And you are in good company. Unfortunately, thus far, this same good company has been repeatedly wrong regarding the containment of this problem at various earlier levels. Hopefully they will start being right soon!

However, in my responses to loopback above, I note that one of the key issues is that housing valuations have stopped rising and have (overall) been falling outright, rather sharply. Housing valuation-based equity-growth extraction has been the big source of consumer-spending funds over the last couple of years as savings rates turned negative. If consumer spending tanks in response to that resource going away, that will chunk stocks. If the mortgage-based derivative funds are sufficiently damaged - and this Bear Stearns situation makes me go "oh gee, that's not good" - by this, then you could see a broader drop in equity, which will be a double-whammy.

Also, there are other places to put 401K money than stock.

But, you are in good company, and hopefully they are right now.

[king-chiron.livejournal.com]

I'm not seeing anywhere where the national security bookkeeping regulations (which are pretty creepy) has anything to do with the downturn in the mortgage market.

I think there will be some HUGE losses because of investments in the subprime market, but I'm not convinced that it's going to crash the economy. Frankly, I think it's a good thing, because if banks and investment companies don't lose a lot of money on these ridiculous loans, they'll continue with more of the same. My real fear is that, in the name of helping out low-income borrowers (some of who were ripped off and others who simply made stupid stupid mistakes), the government is going to hand a bunch of money to companies that made stupid and risky loans.

[solarbird]

I'm not seeing anywhere where the national security bookkeeping regulations (which are pretty creepy) has anything to do with the downturn in the mortgage market.
They don't, directly. However, they have a lot to do with good ways to hide very, very bad bookkeeping in hedge funds, many of which are based on the mortgage finance market. Criminally bad bookkeeping and lending practices have been endemic to the industry (both housing and mortgage) as of late.

I think there will be some HUGE losses because of investments in the subprime market, but I'm not convinced that it's going to crash the economy.
As detailed above, I did not use the word 'crash.' It's interesting that you are the second person to pick that up, though.

Regardless, I could certainly be wrong about the possibility of the depth of its effects. However, I think you underappreciate the depths to which the standards in subprime fell, and the breadth of the effects of its collapse. You may also wish to note that similarly very poor practices spread out of subprime and into "alt-A"/"near-prime" loans, which are starting to fail at rates only marginally better than subprime. You may further wish to research the percentage of mortgages over the last three years or so which are subprime, and which are subprime and alt-A. (This was one of the subprime contagion containment walls that failed.) You may then wish to consider the impact of a genuinely massive glut of houses on an already cooling market, which, as we are already seeing, leads to stated housing sale values falling at a rate not seen since the Great Depression. Then it is helpful to realise that even these falling numbers are overstated as they do not include most types of 'incentives,' which in many cases literally consist of tens of thousands of dollars in immediate rebates in new properties. (Sometimes in the form of bales of cash. No lie.)

Given all that, you might then consider the impact of a negative "wealth effect" on consumer spending, along with the elimination of the ability to draw cash from paper equity growth (equity growth coming from valuation hikes rather than payment towards mortgage) on consumer spending, particularly in the light of two years of negative savings rates - by which I mean two years of consumers have negative net incomes vs. spending. And remember: between 2/3rds and 3/4ths of the American economy consists of discretionary consumer spending.

Frankly, I think it's a good thing, because if banks and investment companies don't lose a lot of money on these ridiculous loans, they'll continue with more of the same.
If they didn't lose any money on them, there wouldn't be any reason for them not to continue. I mean, profit is good.

My real fear is that, in the name of helping out low-income borrowers (some of who were ripped off and others who simply made stupid stupid mistakes), the government is going to hand a bunch of money to companies that made stupid and risky loans.
Some of the more hard-hit states are already stepping in with state programmes to try to staunch the bleeding in their local markets. Some of the worst areas are seeing houses literally being unsaleable at any price; e.g., in the Detroit area, houses selling 18-24 months ago for $400K-$500K failing to sell at any price in bankruptcy auction now; across the country, there are housing developments filled with new homes that simply cannot be sold. These are, of course, the worst-case areas, but they count.

There is also a delayed effect on commercial construction, as it tends to follow move-in to residential construction. This commercial construction is failing to happen as the residential new-housing areas fail to sell.

Anyway. Sorry, don't mean to rant; I get kind of rambly when sleepy. But I do think you underestimate the extent of the situation.

[king-chiron.livejournal.com]

>Some of the worst areas are seeing houses literally being unsaleable at any >price; e.g., in the Detroit area, houses selling 18-24 months ago for >$400K-$500K failing to sell at any price in bankruptcy auction now

What, no one is willing to pay $50K for these houses? What's more likely is that the seller (the bank or mortgage company) isn't willing to drop the price low enough for the market to clear because they believe if they wait a few months the market will look much better.

I do think in addition to a serious problem there is a lot of hyperbole being thrown around by mortgage lenders and investors that want to make the problem seem as bad as possible in order to convince the government to bail them out. As you note, they're already doing that, and it's not just a bailout plan for subprime borrowers, it's a bailout for lenders who make stupid loans. And it's just encouraging more lenders to seek the same.

When I see that house prices dropped 0.9% in May I consider that a problem, but not the end of the world. We had a crazy bubble and we're having a correction, I think that's healthy. Let's see what June looks like and maybe I'll change my mind.

[solarbird]

What, no one is willing to pay $50K for these houses?
Yes. That's where they stopped dropping the opening bid. Some houses did sell for $50K-$75K in this particular auction. Others did not. No, they were not tear-downs.

[solarbird]

This was, of course - and as I noted - an extreme case. I do not suggest that extremity will be normal for most, or even much, of the country. I am not projecting OMG END OF THE WORLD from this. A consumer-spending recession, one possibility, is not OMG END OF THE WORLD. But again, I do not think you have a good appreciation for the severity of this problem's impact. I do get the impression that you think I have either panicked and/or am underinformed and falling for, as you put it, "hyperbole being thrown around by mortgage lenders," which I find confusing, given that the mortgage-industry spin has been that everything is actually just fine, even as literally dozens of lenders have gone bankrupt and ceased operations, and most of last year's industry leaders in the market segment are no longer operating in the market segment at all.

But this is not directly about the lenders. This is about the cascade effects from the situation as a whole.

Also, as to the realtor spin: the NAR has been declaring consistently that things are actually just fine, that worsening conditions are actually signs of improving conditions, that there's no real correction or need for one, and what there is will be over immediately. At this point it has become rather comedic. The local realtors are, in some areas, freaking out, but it's only this quarter that the national home builders have started saying that this is much worse than they'd hoped and have been downgrading - sharply - their projections.

Had the housing boom broken two or three years ago, I would have agreed with you that this was a minimal-impact situation. (Two and a half years ago, when we bought our house, I assumed the housing spike was near its peak, made a guess at how much we had probably overpaid based on that, and bought anyway. This despite the fact that Seattle sat out much of the boom, due to the locally longer-lasting effects of the post-2000 technology recession.) I did not expect two more years of pure bubble.

As I said above, it is perfectly possible that everything will be just fine. The first quarter growth recession (0.7% year-to-year growth, which is to say, a per-capita shrinkage; the economy grew, but not as fast as population) will be the bottom of it, and the economy will bounce happily along all year. Hopefully, you are right. But my opinion of this situation is neither ill-considered nor uninformed, and I consider that outcome regrettably unlikely. Hopefully, I am wrong.

This is not advice.

[solarbird]

This is merely a pointer or three.

Negative housing data pile up

Sea of Change discusses the downturn in credit, and in particular credit psychology, found linked to from:

this, which is is the sort of thing you'd start seeing if this situation were to unfold badly. This does not, of course, prove that it is unfolding badly. It's just the kind of thing you'd see if it were.

Oh, and Bear Stearns, by the way, had to cancel several of its recovery auctions on its imploded funds because they weren't getting 10c on the dollar. (Note the relationship between this ratio and that seen in the Detroit auction I referenced earlier.) These were A-rated funds a few months ago.

Just, you know, sayin'.