I posted this on Bill Cara's site
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I am still of the mind that it is dangerous to compare market malady similarities from year x to year y, largely given that the N is so small, there can be no real confidence in either the correlation or the timing of such events. Weather people have the advantage of having vastly more data points, and accordingly, can assign some better probabilities to observable conditions. Therefore, we heed their warnings when they call for a gathering of ominous clouds along with a falling barometer and the blowing of ill winds. And though they bear our watching, they may not lead to bad weather.
I've being reading quite a bit, and I don't pretend to understand it all. But something that repeatedly strikes me is that most market downturns occur not due to failure in the economy, but rather the failure in the credit system. (The Depression was a credit failure, not an economic failure). Economy does well; market does well; increased liquidity encourages investment and suddenly you have asset prices that have gotten ahead of themselves—but it’s not recognized as that, but rather people point to “it’s different this time”.
There can be NO argument that there is a real estate bubble. When an asset class is priced out of the reach of the average profile of a homeowner, as opposed to speculators, then there is a problem—an incontrovertible one. For that reason, and that reason alone, I believe that there has been too much emphasis placed on “subprime” mortgages as being THE problem. It’s the symptom of the larger bubble—it’s not just real estate, it is treasury markets, with artificially low rates because the system is awash with money and will look for a home, despite its providing a paltry return. It’s commodities, though we may be seeing some cracks there. It’s emerging markets.
I’m left to wonder ,then, that it isn’t the stock market that accurately forecasts the demise in the economy, but rather it is the fallout from these excesses that doom the economy. Maybe that sounds stupid, but it has some merit. An over-leveraged system when it receives a shock clamps down. A clamped down credit system has no juice to lubricate the economy, and the gears wind creakingly down.
So if excessive speculation, which leads to excessive leverage, is the root of all financial market evil (and I'm beginning to believe that it is), then the question really isn't whether or not we'll have a hard or soft landing. Rather, it is whether or not market participants will continue to have confidence in the underlying financial structures. Currently, it looks like money is falling out of one asset class into another (e.g. commodities, into tech). But when there is a stumble and a scraped knee, the other side of liquidity, as Bill reminds us, is the debt that is created. And once the perception of the asset is one of declining value (whether stocks, bonds, real estate, commodities), then that debt is going to get satisfied to maintain appropriate debt/asset ratios. To be satisfied, the asset class must be liquidated, and prices must come down. And that is the prick in the balloon. So the question is not a hard landing or a soft landing. The question is whether or not it is a pop or a hiss. If we get a pop, we will have a hard landing. If we get a hiss, we’ll get a soft landing.
But I don't know a thing, and all of this represents a view rooted in ignorance and inexperience. But this is how I make sense of the incomprehensible.
8 comments:
"There can be NO argument that there is a real estate bubble."
Wow. A woman of your smarts taking a fall like that. Just glad it wasn't me.
*wonder if she meant housing bubble? she'll no doubt wonder why I am splitting hairs*
The other 4 sectors of real estate are doing great and only the new-home builds of the residential sector is the one that has been slammed so far.....
Absolutely a fair point Larry.
The extent of housing price inflation is for both new and existing homes, so I'll stand by that for both of those asset classes. The fall in prices of the new will drag the existing with it. I'm also leaning toward the view that commercial real estate may not be far behind. But I'm just watching, not making any prognostications.
Commercial construction work leveled off in the 4Q 2006. There was a shift toward government work away from the private sector. Government work is about as lagging of an indicator as it gets. But architectural billings are up so any big commercial downturn that may occur is not that likely to show up in the numbers until next June.
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"most market downturns occur not due to failure in the economy, but rather the failure in the credit system".
That is an odd statement. The credit system is so integral to the post medieval western economies that is very unclear how you could make that separation. Pay-as-you-go gets the economic vibrancy of a 200 year Cathedral building plan or South Carolina highway construction.
You do not need an over extension of credit to get an economic downturn. Credit collapses may make downturns sharper, but downturns do occur without a run up in prices. As we discussed earlier, a very large percentage of world manufacturing job losses are due to productivity increases. That has nothing to do with over extended credit.
Russell...I agree that the credit system and the economy are inextricably linked. I'm talking about inflection points (or rather stress fissures)--not normal course of business. It's excess credit and excess speculation that drives up asset class prices that I'm making my generalization for. Accordingly, I do not think that it is difficult to parse them out.
An asset class (real estate, stocks, commodities) attracts attention, speculators jump in. The juice is available credit--it turbo charges the momentum behind the rise in the asset class prices. Yes, that stimulates the economy, but I'm just positing that the credit (up or down) comes before the economic effect.
It's when the momentum slows (due to credit drying up and or saturation of the market of buyers that now there are net sellers that cause prices to fall). That inflection point is where people come to their senses and the concept of risk (and "why the hell did I buy, finance that?" questions start)sinks in. Credit curtails. Buyers curtail.
The Great Depression was a credit shock, that caused a stampede of selling. The S&L crisis, due to the real estate boom, was a credit shock. LTCM/Russian bond crisis was a credit shock.
An over extension of credit is generally part of a bubble situation. But not always. And bubbles are not present prior to all downturns.
The great depression had a huge number of banks go under within the US. But there was a lot going on besides bank collapses. The economic downturn started before the stock market collapse with its margin calls.
A very large part of the savings and loan scandal was a combination of poorly thought out regulation, and out right theft/corruption. The over extension of credit was to a large degree an outgrowth of very poorly thought regulation.
LTCM was an example of our financial firms being very foolish. It should also be noted that it was not the collapse of the Russian debt that caught them out, but the fact that their positions were illiquid and they could not cut their losses by selling.
It is the inability of businesses to predict future requirements, combined with the lag time between various business inputs and their outcome, that causes much of the business cycle. Credit requirements simply work into the mix.
Russell.. I'm not quite sure what point we are debating. I think that I'm discussing extenuating circumstances, and you are excepting my comment noting extenuating circumstances--so I think that we are really talking about the same thing.
WE are in agreement that credit and the economy are inextricably linked. But I'm specifically excepting hyperextensions of credit (due to poor policies/regulation as you note) and am denoting their failure as causing shocks to a system that precipate declines far greater than a "normal" decline that we would expect to see in an economy that breaths in and breaths out.
There is no bubble near me. Not when I can purchase a three bedroom home in decent condition for 15g as a rental.
The coasts are another matter. And they have always had peaks and valleys. I have a son and his spouse who can't sell their Hallandale, FL condos.Inland, I have a daughter and son in law who just bought a brand new spec home. loaded with extras, of 2400 sq. ft. near Dayton, OH for 207g.
Leave the coast and join our predominately red states. We know how to live cheap. And very well.
Being involved in real estate ventures, there is always excess somewhere. And there are always tremendous buying opportunites everywhere else.
A large part of the credit problem is financial institutions having to lend to poor credit risks because of the "diversity" rules being forced down their throats.
T, this is not a red v. blue issue, and it is really unbecoming to paint every issue in partisan colors.
"A large part of the credit problem is financial institutions having to lend to poor credit risks because of the "diversity" rules being forced down their throats."
This statement is patently untrue.
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