NYC Housing - A Brief Update

I am sure very few of the NY real estate cognoscenti out there missed the Wall Street Journal Online's "They'll Take Manhattan -- For Less" article on Friday. For those who did, the article quotes the Corcoran Group real estate brokerage firm saying that inventory in the NYC market is rising and that prices are flattening. It cites third quarter data from Radar Logic, Noah's friend Jonathan Miller's firm indicating that the median Manhattan apartment price fell 3.4% quarter-to-quarter in Q3, but was still up 2.3% year-over-year. Sales volume reportedly declined 11.2% compared with the prior quarter, but was still up year-over-year. Properties were lingering on the market for 123 days, up from 94 days during the 2005 boom period. If you have been reading Urban Digs, this is probably not a surprise. Christine Toes broke the story of proliferating developer incentives - a leading indicator - here a few weeks back, which is also highlighted in the Wall Street Journal Online article. Of course you have heard Noah and me ramble on about the strong and insidious macro headwinds that are proliferating and seem destined to at least dent, if not break, the unstoppable NYC housing boom. So what about activity thus far in Q4? Now that Urban Digs has real time data to look at, I thought I would bring it to everyone's attention......in hopes of keeping some content flowing while Noah is getting some R&R in Jamaica. The data have been available here for a few weeks due to Noah's recent re-design of the site and collaboration with Street Easy, who has cleaned up the data to Noah's exacting standards (once a trader, always a trader). We will eventually have a regular piece highlighting the data as the set gets longer and we learn a little more by tracking it over time relative to other indicators. Understand, this is only a couple of weeks worth of data. This piece is not intended to be an indication of how we will utilize or feature this data in the future, just a reminder that it's already here on the site for your use.
As is evident from the graph, there was a spike up in activity in late November, but we have seen a steady decline since. My guess is that people wanted to get their apartments listed and or get contracts signed before the holidays and we are now in hibernation mode through the holidays....it will be much more interesting to see how the market starts coming back after the New Year's holiday. By then we will have a data series that actually could reflect a trend. As you can see from the second chart however, it would be hard to characterize Manhattan apartment inventory as busting out.

The price cuts, notable in our final chart, coincide pretty well with the increase in both listings and closings...again I would speculate it was due to attempts to move apartments before the holidays...and it looks like it worked.

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Data Dump

In the interest of keeping folks up on some of the data Noah has focused on the last number of weeks - and correctly so - I am giving Urban Digs readers a little real time data dump. There's no way I can duplicate Noah's graphics arts mastery so I'm not going to try. This dump will mostly be sans charts.

LIBOR to Treasury Spreads - This is the difference between yields on "riskless" short-term U.S. Treasuries vs. the short-term rates banks lend to each other at...and which they price various loans off of. These spreads continue to rocket higher as banks are scared to lend to each other and charging each other ever higher interest rates. Thi is because they can't assess each other's risk with regard to holdings of toxic sub prime paper. At the same time they are buying up "riskless" U.S. Treasuries as a safe haven as are all the other market players. This is driving a continued widening of spreads. As the old saying goes, "if you don't need to borrow money (or you can print your own) it's easy to get a loan".

More Blow-Ups - A short-term fund run by the State of Florida as a place for various Florida municipalities to park their cash and earn slightly better than money market fund rates has experienced a flight of capital by city governments that invested in it due to fears about its holdings of SIVs. Montana and Connecticut reportedly have similar problems with state funds and speculation is there are others yet to step forward.

More Poorly Thought Out Intervention - First there was the SIV masterfund plan, which was to bring together large banks to buy SIV overnight paper and keep these vehicles alive and off bank balance sheets. These SIV funds run by banks made the oldest mistake in the banking book, borrowing short and lending long or failing to "match maturities". So the government was going to get these same banks together to try to put together a fund to help these vehicles hobble through the crisis in overnight funding because longer-term the paper that the SIVs hold is supposedly not really that bad off. Tell me another! HSBC nixed this idea and went ahead and owned up to being responsible for its SIVs and took a big write down. I have not been hearing any new positive developments about the super SIV plan since.

ARM Freeze - So now we have a new novel government idea, freeze the interest rates on sub prime ARMs. Andy Laperriere who works the Washington beat for Fast Eddie Hyman (the famous Morgan Grenfell economist of the 1980s) at ISI Group wrote a great Op Ed piece in the Wall Street Journal Tuesday on why this idea is preposterous in terms of implementation and morally hazardous to the point of being laughable. He also points out that most sub prime paper has been going tapioca before the first interest rate increase....these people never had the money to pay back these loans, reset or not. My twist is this. Even after having done some work on the Myrtle Beach vacation home market, which I learned has historically been driven by speculators, I was still shocked to find out that "half the subprime loans made in 2006 were for homes that are not the owner's primary residence" what's worse these speculators had way higher median incomes than the local Myrtle Beach folk. You want to freeze interest rates for these knuckleheads..... please!....NEXT!

ABX Index - This index of sub prime paper caught a brief short-covering rally on the news of the potential freeze on interest rate resets. It was the biggest one day up move the index has ever had....that's what happens in bear market rallies, they are short, sharp and designed to punish bears that are feasting too aggressively on a sell-off. But the ABX started to give back today.

We are not out of the woods and this asset meltdown is following my asset cycle script pretty closely. Later in the week I will have some juicy tidbits from NYC developers....who are starting to get downright negative.

From The Internet & Blogosphere

All Major Central Bank's Should Cut Rates Now

Losses Stack Up

Defining Delinquency Down

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Mortgage Bailout Plan / Subprime Rate Freeze

A: Back to work. What do you do when free markets take advantage of ultra cheap money and a booming housing market? You have gov't step in of course to clean up the mess! However, I caution anyone from interpreting this Bush sponsored subprime rate freeze as anything more than political window dressing. While the full plan has yet to be unveiled, major parts of the plan were and from what I can tell, this is nothing more than putting 2 or 3 band-aids onto a gunshot wound. I'll explain why.

First off, this subprime rate freeze plan does NOT affect all subprime borrowers about to be dealt with higher resetting mortgage payments. That is the most important thing you need to know. It is not a fix-it-all plan and it will not stop foreclosures and defaults from rising in 2008! Sure, it may help a little, but the most I get out of this is a stab at restoring confidence into the credit markets that the gov't will be there to help if things get hairy.

What's unusual here is the grand scheme of things is the proactive measures that both our gov't and the federal reserve have been taking lately! Is anyone else noticing this or viewing the situation in this light? I mean, if it wasn't for rate cut hopes via a fed governor speech or a Super SIV bailout plan that will ultimately be half as big as once thought, or now gov't intervention to freeze some subprime mortgage rates, where would be right now? There is an awful lot of action being put in place beforehand to soften the hit that is obviously expected to come later on. I digress.

Back to the mortgage bailout plan. Here is who the plan will work for:

a) ONLY loans made at the start of 2005 through July 30th, 2007
b) ONLY loans that will reset to higher rate between Jan 1st, 2008 through July 31, 2010
c) ONLY owner occupied borrowers (primary residence borrowers)
d) ONLY those borrowers who CAN afford 'teaser' payments & CAN'T afford resetting payments
e) ONLY those borrowers who CAN PROVE they cannot afford resetting payments
f) ONLY those borrowers who are making payments ON-TIME

So, completely eliminate speculative borrowers who used these teaser mortgage products to keep costs ultra low while they flipped their properties! Also eliminate any borrower who...

1) already had their teaser rate reset to a higher rate
2) already are missing payments
3) was savvy enough to avoid a teaser mortgage product but now pays a higher 30YR fixed rate

Obviously, those in dire need are not going to qualify for this plan! You must also understand what most subprime borrowers deal with. Since they are subprime, or poor credit borrowers, even their teaser rate is much higher than a 30YR fixed rate that most of us take for granted. Most subprime mortgages start at teaser rates of between 7% - 9%, only to re-adjust to about 9% - 11% or so after the teaser period is over. This is the price you pay for having poor credit and buying a home during a real estate boom where lenders didn't care whether you could actually afford the house or not!

The fault lies partly to the borrower & the lender. As painful as it is for anyone to lose a home, fact is way too many people bought a house they couldn't afford in an attempt to ride the real estate boom bandwagon. They were just poor investment decisions that went through because the lenders allowed them too. In the eyes of the lender, it was more about getting the deal done, collecting their fees, and packaging the loan up into a mortgage backed security that could be resold to some other investor to deal with! Well, the game is over and now we are paying the price with an illiquid secondary mortgage market where no investor is putting a desirable price on these mortgage backed securities.

I wonder how the ABS (asset backed securities) investors are handling all of this now that they will take a costly hit here as they will not get their higher resetting rates for some holdings; which is the whole point of dealing with these types of borrowers in the first place, to get that higher rate. I'm sure you'll hear more on this side effect as the full plan is unveiled.

This subprime rate freeze plan will not fix the problems we face in the housing downturn cycle or the crisis to the credit markets & secondary mortgage markets that happened as a result. It may install some confidence for a while though and it may help some struggling borrowers, but it won't nearly be enough!

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MBA: Rate of Deterioration Increases

A: In mathematics, a derivative is the rate of change of a quantity. A derivative is an instantaneous rate of change: it is calculated at a specific instant rather than as an average over time. In the real world of analyzing foreclosures and delinquencies, the second derivative will tell us whether the rate of change is increasing or decreasing. As confirmed by the Bankers Group, the rate of deterioration of foreclosures & defaults is increasing! What does this mean? Things are getting worse, faster!

MBA: Delinquencies Increase in Latest MBA National Delinquency Survey

DELINQUENCY RATE CHANGE FROM LAST QUARTER

Prime Loans ---> Increased 15 basis points (0.15%) from 2.58% to 2.73%
Subprime Loans ---> Increased 105 basis points (1.05%) from 13.77% to 14.82%
FHA Loans ---> Increased 43 basis points (0.43%) from 12.15% to 12.58%
VA Loans ---> Decreased 34 basis points (0.34%) from 6.49% to 6.15%

Facts people, if you don't like it than I am very sorry. I try to be unbiased here and as many of you know I have no qualms about telling it how it is, even if the news is not good. And yes, I derive 75% of my annual income from real estate transaction commissions in an industry where sales skills is the name of the game. Obviously, I'm not a good salesman so I will never be a mega-performer in this game; something I have no problems with.

Back to the news. According to Bloomberg's article, "U.S. Mortgage Foreclosures, Delinquencies at Record, MBA Says":

The number of Americans who fell behind on their mortgage payments rose to a 20-year high in the third quarter as borrowers were unable to refinance or sell their homes. The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, the Mortgage Bankers Association said in a report today. New foreclosures hit an all-time high for a second consecutive quarter.

"These are the first numbers we've seen that combine the meltdown of the credit markets with the drop in home prices," said Jay Brinkmann, vice president of research and economics for the Washington-based bankers trade group. In the quarter, 3.12 percent of prime borrowers made their mortgage payments at least 30 days late, up from 2.73 percent in the second quarter, the report said. The subprime share of late payments rose to 16.31 percent from 14.82 percent.

The Bloomberg article didn't touch on the actual RATE of increase I was looking to point out here. The CNN Money article, "Record Rate of New Foreclosures" does:

The rate of home owners going into foreclosure hit a record high in the third quarter, while those late with their payments were at the highest level since 1986 - the latest signs of the meltdown in the mortgage and real estate markets shaking the U.S. economy. Mortgage delinquencies and foreclosures became a serious problem during the quarter, as investor demand dried up for securities backed by mortgages, particularly subprime loans made to borrowers without top credit scores.

That meltdown in the mortgage market made many major lenders pull back from making subprime mortgage loans, which in turn helped send home sales, prices and new construction sharply lower, raising the risk of a recession.

The troubling item of this report is that the rate of delinquency is rising & that it is starting to infect alt-a and prime loans. Overall, most loan categories experienced rising rates of defaults. All part of the downturn cycle. Expect news to get worse before it gets better.

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Toes' Predictions for 2008

My buyers have been asking me where I think the real estate market is heading. Please keep in mind when reading this post that 90% of my buyers are first time buyers and are purchasing in the $300K - $2M range. Most of them have been sitting on the fence for the past 2 - 3 months waiting for the predicted impending doom & hoping that prices would come down. The NY Times front page article this weekend titled, "Stalemate," was pretty accurate. However, when an apt comes onto the market even $5K-$10K below market value, buyers pounce on it, it goes into a bidding war, and it is gone in 2 open houses at above the asking price. I've seen it happen on several occasions in the last three weeks.

Since Thanksgiving, I have seen a significant increase in what I perceive as the level of seriousness of the buyers that I am currently working with. I think they have realized:

1. Manhattan is probably not on the brink of a 15% drop in sales prices.
2. The wintertime is frequently slow and can be a good time for "deals." Sellers who want to get out by the end of the year finally dropped their prices right around Thanksgiving.
3. Anything terribly overpriced has come back down to some semblence of reality.
4. My buyers know that they are at least not buying at the absolute "top of the market."
5. First time buyers just want to get into the market somewhere. "Time in the market is more important than timing the market."
6. I suspect they are also getting sick of looking by now, since they have seen 30 properties in the last 2 - 3 months. Basically they have seen everything on the market in their price range and are comfortable picking their favorite property or jumping on something they like when it first comes onto the market. You can only spend so many Sundays at open houses before you fall in love with something.
7. They are looking for somewhere to spend the next 3-5 years, so they aren't as concerned with what "might" happen in the next 1-2 years.
8. They have been renting for 2-3 years in their current apartment and are tired of renting & ready for a change.
9. They want to get in somewhere so when they get married, etc., they can trade up to something larger because they have been building equity instead of spending money on rent.
10. Their income is finally getting to a high enough level where they could use the tax deductions.
11. Sellers are finally waiving the mortgage contingency.

So what are my predictions for 2008? Unfortunately I do not have a crystal ball. However, I think that the entry level market ($300K - $1M) is going to be fairly level from January 2008 to January 2009. Why do I think this? There are always people in NYC looking for their first home, pied a terre, or small investment. Studio sales remain strong and developers aren't building enough of them. Permits for new condo developments are down 50% so the predicted "condo glut" is just not going to happen for the smaller units (studios, one bedrooms) although the larger units will take longer to move. (Side note: I do think there are a lot of new developments / condo conversions in far west Chelsea and also now in the Financial District, and I don't see how all of it is going to be absorbed. But other areas in Manhattan below 96th street seem to have more of an inventory shortage than a surplus). A million people are expected to move here by 2025.

So my thoughts are: The sky is not falling. Noah is going to disagree with me here, but as someone out on the streets:

1. There are a good number of buyers at all of the open houses I have attended in the past 2 weekends.
2. One of my listings just had a bidding war and sold over the asking price in just a few days on the market.
3. I do a lot of work in the Village/SoHo, the UES and the UWS and prices have come down just enough to make buyers feel comfortable taking the plunge.

Looking forward to hearing everyone's comments:) Noah, if I am wrong, I owe you dinner!

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Fed Time Again: 25 or 50 Bsp?

A: It's the day before the next decision on fed funds rates. Everyone gather round and huddle up. What should be done?

Arguments For 1/4 Point Rate Cut: The more likely option. Since Fed vice chairman Donald Kohn spoke a few weeks ago, the equity markets have translated his words (backed by a Bernanke speech the next day) into a rate cut induced party burning the shorts and resulting in a nice recovery after a very dangerous selloff. Now that wall street has undoubtedly 'priced in' a 1/4 point rate cut, the question is will there be any surprises?

The argument for a 1/4 point rate cut remains the same. The downside risks to the economy are clear, even though at this point in time the economic data continues to show some strength and moderating inflation; giving the fed some room to cut. Flawed or not, this is the data the fed looks at. The credit markets are still in distress, the housing market is getting worse at a faster pace, the future with ARM resets is cloudy at best (even with this gov't sponsored private sector rate freeze plan), and even Stevie Wonder can see the red flags waving that could hurt the consumer and the US economy in the months to come.

As a result, the fed will cut at least by 1/4 point to forestall the adverse effects to the economy. With pipeline inflation still a concern and the US dollar still very weak against other major currencies, the argument for a 1/4 point rate cut gets stronger. Plus, by cutting only by 1/4 point, the fed can save some ammunition for later use should things get real hairy in 2008; something that can prove to be vital to help restore some confidence without over-stimulating the economy or presenting a moral hazard for all those that made bad bets again.

Arguments For 1/2 Point Rate Cut: The main arguments for a 50 basis point rate cut is a combination of the fed being behind the curve already, the street already pricing in 1/4 point cut, and that the macro data shows a seriously slumping housing sector that will inevitably bleed into consumer spending. We know that there is a lack of liquidity in the secondary mortgage markets, but fed rate cuts do little to reverse that. We know that the credit markets are in distress, but that has to be worked out on corporate balance sheets (hey there, UBS with another $10 Billion in write downs; how are you doing?) first before normalizing.

And we also know that the housing market will get worse before it gets better and the side effects of that on the consumer, in my opinion, is the biggest argument for the fed to be aggressive and cut rates by 50 basis points.

For now, lets enjoy the free round of tequila shots that the fed has provided us via speeches by its members, as it almost makes it look like things are getting better. Beware not to confuse rate cut induced rallies for confidence & certainty returning to the marketplace. While subprime has taken all the headline blame for what is going on right now, let us NOT forget that there are plenty more loans out there that are waiting to go bad: option arms, hybrid I/O loans, cosi & cofi loans, alt-a (already starting), second mortgages, HELOC's, credit cards, and prime loans (already starting).

THIS IS NOT A SUBPRIME PROBLEM! This is a complete mortgage/lending mess that has yet to fully reveal itself and explains WHY the fed is taking aggressive proactive measures to soften the blow expected to come.

MY BET

65% ---> 1/4 point rate cut fed funds, 1/4 point rate cut discount window
30% ---> 1/2 point rate cut fed funds, 1/2 point rate cut discount window
5% ---> some combination of above
0% ---> NO CUT; that would be a shock

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NAR: Lifts 2008 Housing Outlook; "...local markets seeing increases"

A: When will they learn? The NAR, a trade group for real estate agents, said today that the clobbered housing market is on the verge of stabilizing and inched up its outlook for 2007 & 2008 home sales. Um, isn't 2007 pretty much over?

Before I get into what Lawrence Yun said, NAR chief economist, lets check in on the NAR's track record for the past 9 months or so.

The NAR has unsuccessfully predicted housing trends for 70% of 2007! For the past 9 months, count 'em NINE MONTHS, the NAR had to downwardly revise their housing predictions; which were unsurprisingly too bullish. This is the same trade group that was once headed by David Lereah, you remember, the poster boy for 'everything is OK' as the national housing market went into free fall. In Mr. Lereah's own words, "It's a great time to BUY & it's a great time to SELL"! That one was the best. Hmmm, a great time to buy and a great time to sell is what the head of a real estate agent trade group is telling us! Talk about losing credibility as head of a group of people that earn their salaries on transaction commissions.

BubbleMeter's History of Calling out David Lereah

Even Jonathan Miller of MATRIX gets into the NAR groove: NAR's Temporary Housing View

Not a month goes by that Larry doesn’t say housing is getting better and that mortgage problems are temporary:

"Lawrence Yun, NAR chief economist, expected the sluggish performance. "As noted last month, temporary mortgage problems were peaking back in August when many of the sales closed in October were being negotiated. We continue to see the biggest impact in high-cost markets that rely on jumbo loans," he said. “Mortgage availability has improved as evidenced by much lower mortgage interest rates and a sharp jump in FHA endorsements for home purchases."

I was wondering what mortgage data Larry is referring to? I don’t believe its part of his research but is a primary basis of rationalization for glowing market conditions, despite the fact that inventory tracked by NAR is at its highest level since 1985 and has continued to rise despite temporary mortgage problems.

I yearn for the day when NAR finds that perfect moment and decides to inform the public and the consumer what is happening in the housing market, rather than assume we are illiterate. I know many, many brokerage firms and agents that agree with this. PR driven quotes like this don’t move markets so what is there to be afraid of?

It's just so sad, it really is. JM is dead on and I just don't get why the NAR is so afraid to be unbiased and acknowledge what is really going on in the world of real estate. This is one very big reason why real estate agents have a bad reputation!

Anyway, here is what the NAR stated today according to Yahoo Finance:

The revised monthly forecast from the National Association of Realtors, which followed nine straight months of downward revisions, calls for U.S. existing home sales to fall 12.5 percent this year to 5.67 million -- the lowest level since 2002. Last month, the association predicted 5.66 million existing homes would be sold this year. The Realtors' group also forecast sales will rise slightly in 2008 to 5.7 million, up from last month's prediction of 5.69 million.

Numerous other economists, however, are far less optimistic than the trade group. They predict weak sales and falling prices through next year and beyond and emphasize that those problems could worsen if the economy sinks into a recession.

Let us not forget the real data showing delinquencies rising at a faster rate, inventory of unsold homes at record levels, a mortgage market that is in distress, tighter lending standards, and fewer loan options.

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Converting MORE Rentals to Condos in FiDi!

I just saw this article in the NY Sun about Rockrose converting their 400+ rentals at 99 John street to condos.

I don't quite understand what they are thinking. There are SO MANY new developments and condo conversions in the Financial District right now! Off of the top of my head, they are still actively selling units at William Beaver House, 88 Greenwich, 90 William, 75 Wall, District, 159 John, the South Star, 20 Pine, the Setai, 25 Broad... There are 800 rental units on John Street ALONE being converted to condos!

Although the Financial District was a darling of mine for a while, I am going to have to cry "glut, glut, glut" after this latest announcement. I'd love to have a chance to pick the brain of whomever ran the numbers to make that decision...

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Today's Credit Crunch

A: It still amazes me how hopes over rate cuts can cloud investors bets' and make them ignore news. Consider this just a brief overview of what news came out today pertaining to the ongoing credit crunch. I'll leave it up to you to decide whether its getting better or worse.

First: UBS To Take Further $10 Billion Write-down

Swiss banking giant UBS (NYSE: UBS) warned that it will write down the value of its subprime mortgage holdings by a further $10 billion, leading to a loss in the fourth quarter and potentially wiping out all its profits for the year. It also detailed an $11.5 billion capital injection from Singapore and the Middle East. In a bid to soothe the bad news, the bank also announced plans for a capital injection of 13 billion Swiss francs ($11.5 billion) from the government of Singapore and an unnamed investor in the Middle East. The plans would give Singapore a roughly 9% stake, making it the Swiss group's biggest shareholder.

"Conditions in the U.S. mortgage and housing markets have continued to deteriorate, and we have updated our loss assumptions to the levels implied by the current distressed market for mortgage securities," said CEO Marcel Rohner in a statement. "In the last several months, continued speculation about the ultimate value of our subprime holdings -- which remains unknowable -- has been distracting," Rohner added. "In our judgment these write-downs will create maximum clarity on this issue and will have the effect of substantially eliminating speculation."

With the latest announcements, UBS has recorded $13.7 billion in write-downs, more than any European bank.

Second: Bank of America Closing Money-Losing Fund

(NYSE: BAC) According to The Wall Street Journal, the fund was worth $40 billion several months ago but has dropped to roughly $12 billion. The fund, a short-term investment pool for investors willing to put in at least $25 million, was closed after several clients took out their money.

The fund was a so-called "enhanced cash fund," essentially a version of a money-market fund that puts its money in riskier investments. The Journal said a rapid decline in the price of the fund's mortgage-backed securities led to clients taking out their money.

Third: Washington Mutual Cuts Dividend, Slashes Jobs, Sets Capital Infusion

Washington Mutual (NYSE: WM) , the U.S. savings and loan slammed by slumping mortgage markets, on Monday said it would slash its dividend, cut more than 3,000 jobs and announced a $2.5 billion capital infusion.

The Seattle-based bank also said it expects to report a net loss in the fourth quarter after recording non-cash write-downs.

Ahhh, sounds like all is fine & dandy in creditville! Looking good Big Ben! Feeling Good Mr. Paulson!!!

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Fed Cuts Funds Rate + Window By 1/4 Point

A: Before everyone out there bashes Big Ben for not acting aggressive enough, lets take a step back at what the fed probably accomplished here; given the disappointment in action & in the issued statement. In my opinion, this move was the fed's way of regaining control over the tradable markets by not delivering what was hoped for, while at the same time taking some action. This makes it more likely that the ultimate recovery will be pushed back. I admire this move because it removes a level of expectation from the markets and could set up a surprise move down the road; when it may be needed more.

According to Yahoo Finance:

The Federal Reserve cut a key interest rate by one-quarter of a percentage point Tuesday, trying to keep the country out of recession.

The reduction in the federal funds rate to 4.25 percent marked the third rate cut in the past three months. Fed officials signaled that further cuts were possible if a severe downturn in housing and a crisis in mortgage lending get worse.

And here too:

Investors had been expecting policymakers would cut rates for a third straight time, though there was debate over the size of the cut. Most economists had been expecting a quarter-point cut in the benchmark federal funds rate to 4.25 percent -- but some investors were hoping for a half-point cut in the Fed's last meeting this year, and their disappointment took the market lower.

The Fed as expected also cut the discount rate. The Fed cut the rate it charges to lend directly to banks by a quarter-point to 4.75 percent. Fed officials signaled that further cuts are possible if a severe downturn in housing and a crisis in mortgage lending worsen. Investors had sent stocks higher in recent weeks as they grew more confident in the Fed's openness to loosening its policy again.

The fed did NOTHING today that they could later be blamed on! They cut rates. They just didn't cut them as aggressively as the street hoped, and some economists had hoped. Cry me a river. I can sense a Cramer outburst coming.

The fed acknowledged the worsening housing & credit crisis. They acknowledged inflation risks. They acknowledged the weak dollar. And they disregarded the street's hope. They also told the street that they won't always give them what they want and at the same time, saved some precious ammunition for later on should it be needed to jolt the markets with an injection of confidence if things get real hairy.

This move may help HELOC rates a bit but prob won't bring lending rates any lower, since that market is more tied to credit quality & risk appetite these days.

It was a boring, disappointing, solid move. It was like an NFL team drafting a top rated left tackle with the 2nd pick in the NFL draft, to shore up their O-line for the running game and quarterback protection. Sure its not as exciting as drafting a star Quarterback or Running Back, but it will prove worthy later on. Sorry, its the best analogy I can think of given its playoff time in fantasy football.

What do you guys think of this move? I say the markets have more reason for rallies down the road with more rate cut ammunition at the fed's disposal.

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Fed Action Coming; LIBOR Targeted?

A: Breaking news to be released soon. As I said yesterday, I admire the move the fed did yesterday to regain control over the tradable markets' expectations, and to setup a situation that will allow for more surprising action with the saved ammunition. It seems a co-ordinated effort with International central bankers is underway to help the credit markets and specifically the LIBOR rates which have drifted to a 85 basis point spread from fed funds rate. That widening spread is a clear signal of distress in the credit markets showing that banks are risk averse in their lending habits. By now, most know the importance of the LIBOR rate (which has surged in the past 4 weeks while the credit situation deteriorated) as that is the rate many adjustable mortgages reset to. Getting LIBOR back in line, within 10-12 basis points of fed funds rate historically, should be a top priority to soothing the pain in the credit markets and ultimately for consumers.

Yesterday, in my post I stated:

In my opinion, this move was the fed's way of regaining control over the tradable markets by not delivering what was hoped for, while at the same time taking some action. I admire this move because it removes a level of expectation from the markets and could set up a surprise move down the road; when it may be needed more.

Today, the tradable markets are waking up to this concept and the breaking news soon to be released confirms it. As for LIBOR, here is what the credit sensitive rate has done in the past few weeks compared to the fed funds rate:

Notice how 3-Month LIBOR remained above 5% while the fed funds rate was cut down to 4.25%! The spread between the two right now is about 86 basis points! Historically and in normal credit conditions, this spread is about 10-12 basis points. It rises when credit markets are in turmoil and banks become risk averse in their lending. It's a clear sign that a credit crunch is underway; but you don't need me to tell you that.

I think the fed is working on a solution to target LIBOR and sooth the credit distress that is evident by rising LIBOR rates. Keep an eye on this as news unfolds!

Related: Credit Crisis Hits Libor Rate

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Manhattan Real Estate Update

A: I have to admit that I have been spending more time on urbandigs than on the streets of Manhattan real estate the past month or two, especially after that vacation in Jamaica. But, that doesn't prevent me from seeing how quiet the market is. There is just no real urge to jump in from buyers that I am sensing. But I am hesitant to report on it here because I am not out there as much lately. So, lets check in with what Doug Heddings over at TrueGotham is seeing as he is definitely more in touch with 'right now' than I am.

According to TrueGotham's "How's The Manhattan Real Estate Market?" article:

It's SUPER quiet right now! Buyers and sellers alike are indeed digging in their heels. Having said that, I'm seeing more motivated sellers on the market right now than those who "test" the market to see if they can get their price (inflated usually). The best article that I have read lately that most accurately portrays the current market is Between Buyers and Sellers, a Stalemate written by Christine Haughney for The New York Times (and I'm not just saying that because I was quoted in the piece).

" Manhattan is apparently full of sellers who think foreign buyers, or bankers who might still get big bonuses, are ready to pay full price for their apartments. These sellers do have recent history on their side. For the first three quarters of this year, Manhattan apartments over all continued to sell at record prices.

Now, brokers say, they see a stalemate developing between buyers and sellers in Manhattan, especially for apartments in the $1 million to $5 million range. Sales in this range made up more than half of the total dollar volume in the market in the third quarter of this year, according to data tracked by Radar Logic.

Brokers say it is the buyers in this sector of the market who are now growing concerned about the impact of the weak national housing market and the effect that Wall Street losses might have on Manhattan apartment prices. So they’re lowering their bidding or stopping their searches altogether until they have more confidence in the market. "

I'll be getting much more active with buyer clients come January and will start reporting more of what I am seeing on the front lines a few weeks after. Keep in mind that these reports are highly individual! Those brokers who put 10 hours a day into their business with buyers probably will report seeing a very healthy and active market. While those that deal mostly with sellers, will report its a bit on the quieter side. For me, I like to focus more on buyer psychology & confidence as a leading indicator of what may be ahead of us; and that is something I openly discuss with my buyer clients.

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Everything Works in Reverse - Asset Cycle II

It can be very hard for investors to adjust their psychology to new market conditions - I have the scars on my back to prove it. For one thing markets tend to go up over the long-term. If you are a true investor and have a holding period of 10 years or more -Warren Buffet has been quoted as saying his favorite holding period is "forever"- over any ten year period the worst that usually happens to you is you get bored. Obviously if you are not properly diversified, if you buy the most speculative areas...when they are hot, trade in and out, or use leverage, a lot worse can happen.

Looking at these longer-term charts, I am sure you can see how in the long periods of appreciation in different asset classes you can get pretty "long-term" optimistic. In fact since businesses can't trade the markets and have to gear themselves to their long-term competitive positions, they almost have to adopt the "long-term bullish" mentality. Of course this is where the seeds of down cycles are planted. Imagine that you were a large mortgage lending entity...say Freddie Mac....and you were losing share to many alternative sources of financing. Meanwhile real estate prices were marching inexorably higher and competitors were figuring this appreciation trend into their calculus for loan to value ratio requirements. It is likely that you would respond, even just to maintain market share. In fact according to the CFO this is exactly what happened "The underwriting standards declined," said Anthony Piszel, chief financial officer of Freddie Mac. "That was across the board." This according to a Floyd Norris article in the Times Herald Tribune, he writes "A kinder way to look at it is that competition forced the company to lower its standards. Either way, Freddie this week released data showing how its standards eroded. None of the loans on its books from 2003 or earlier call for payments of interest only. Almost a quarter of the loans it bought this year had that characteristic."

So these days Freddie is no longer buying the NINA (no income no asset) loans they were before the credit crunch - and they are raising capital to butress their balance sheet. So what's my point? In order to adjust to the transition from bull to bear market you have start thinking in reverse....once you start doing it, its actually pretty easy. Just think about all the things that people did and realize they will do the opposite when the market turns down. Think about all the positive data and how it underpinned the decisions of appraisiers, lenders, rating agencies, buyers and sellers and realize the bad data will have the opposite impact.

This month's Real Deal has a cover article on "The Commercial Slowdown - How Deep Will the Dip Be" in New York City. Interestingly, it parallels the Freddie Mac example. According to Adrian Zuckerman, the head of the real estate practice for Epstein Becker and Green P.C. and head of the firm's Real Estate Steering Committee. "Lending standards over the past few years were speculation-based, not performance-based". Now although the headlines are coming out now, I have been hearing for at least 6 months about how difficult it was to be a commercial real estate investor/developer and acquiring property in NYC - "Going long the market". But folks were doing it anyway...why? They are in the business of buying and developing real estate and prices usually go up. Zuckerman comments further in the article "There's still a relatively strong leasing market in New York, but if the leasing market drops , or even remains stable, the projected rents won't be there - estimated performance projections won't be met". The article goes on to talk about an increasing number of commercial buildings that are in technical default....they have not stopped paying their mortgages, but they don't have the required interest coverage ratios and other measures of financial health that banks insist they maintain. We have many projects particularly in the boroughs that are coming out of the ground to beat the 421A expiration and I have heard about several deals that are already having financing issues. The current stalemate of buyers and sellers may be broken, when banks join the ranks of sellers. This is a particular risk in the boroughs.

Things working in reverse...thats why they say you can't un-pop a bubble. Pervasive declines in underwriting standards...we are now finding out that they were not just in loans to individuals for residential real estate, they were in loans to developers and commercial real estate buyers to. It is the natural cycle of things - like in the bible 7 fat years...

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Pipeline Inflation: Here Already?

A: When the fed announced its actions on Tuesday, some were wondering why the previous bias towards focusing on growth suddenly seemed to disappear. In its place, was more wording about inflation. I've discussed pipeline inflation plenty here on urbandigs.com over the course of the year, and it's clear that with today's economic data it will begin to take headlines once again. Think to yourself sarcastically, ..."you mean, record high energy prices, higher commodity prices, and higher food prices are inflationary?". Yes, they are.

Forget the whole argument about headline vs core for a moment (read my recent post, "Fake OR Real Inflation?", back in mid November - Search Results for ALL "inflation" articles), today's CPI data came in hotter than expected all around. According to Yahoo Finance:

The Labor Department said the consumer price index rose 0.8 percent in November amid a spike in gasoline prices. The 0.8 percent increase in consumer prices topped the 0.6 percent rise economists had been expecting. The report also showed core inflation, which excludes often-volatile food and energy prices, rose 0.3 percent, the biggest increase in 10 months. The report also found large increases in the cost of clothing, airline tickets and prescription drugs.

The report raises questions about the Fed's plans for priming the economy.

This is important because it will change the roadmap of policy actions by our fed. It will also bring treasury yields up & strengthen the US dollar; all part of the system correcting itself and certain markets reverting back to the mean (treasury's & currency's). If the fed either doesn't ease as much or is forced to consider rate hikes sooner rather than later, it will strengthen US dollars. Think of how many traders are short US dollars and will ultimately need to cover those positions!

Barry Ritholtz over at The Big Picture provides this chart on the year-over-year changes of the CPI Headline & Core #'s showing the sharp uptick since July:

The 0.8% gain was the largest since Hurricane Katrina's boosted CPI in September 2005. That was obviously a weather induced number, and you need to go all the back to January 1990 to find a comparable CPI price increase. And the so-called Core? 0.3% gain was the most since June 2001.

So, what do these inflation figures really mean?

Well, you can forget about a half point cut anytime soon -- at least until the Fed has gone from nervous to scared $#@tless. That's how you know they are in full blown panic mode.

Pipeline inflation (as I like to call it), the buildup of inflation from the past 6-12 months that is yet to trickle down into higher prices for consumers and be reflected in economic reports, is very real. While we may see short term rate easing as the fed tries to stave off any slowdown from the credit crunch, we are probably in for a medium-longer term period of rate hikes. It's just that this credit crisis needs to show signs of normalization, and the housing market needs to stabilize before the fed can risk raising rates; so we have some time and maybe even another rate cut or two in the near term as recession fears remain.

As for lending rates, I would expect them to tick higher on this report. However, you must keep in mind that these days there is less and less relation of fed action and bond yields on lending rates. The reason is the credit crunch, the risk that comes with mortgage lending, and the risk aversion of the banks to this type of lending. Add that all together and you get:

a) higher cost of debt
b) tighter underwriting
c) fewer loan options

...so yes, the credit crunch is related to real estate on a macro level. The time it takes to hit local markets will lag. My thoughts on our fed? I think they will still act in the near term (lower rates) as the credit crunch lingers, but that longer term we will see the lagging effects of global inflation leading to a more sustained campaign of rate hikes in the years to come.

Related:

Inflation in the Euro Zone Climbs (AP)

Inflation in the 13 nations that use the euro surged to 3.1 percent in November versus a year earlier, its highest level in more than six years, the European Union's statistics agency Eurostat said Friday. It is now well over a guideline of just under 2 percent that the European Central Bank looks to when it decides whether to raise interest rates to boost borrowing costs.

But the ECB is now under pressure to keep rates on hold to encourage reluctant banks to keep lending out money to each other in the wake of a credit crisis where they are worried about taking on extra debt.

Inflation: Hot & Getting Hotter (BusinessWeek)

A larger than expected pop in the November consumer price index may temper the Fed's willingness to loosen policy any further. As if the Federal Reserve didn't have enough headaches these days, inflation appears to be on the march after a long period of relative quiet. Case in point: The release of the U.S. consumer price index for November on Dec. 14. The headline CPI surged 0.8% on the month, while the core rate, which excludes food and fuel, rose 0.3%. Markets expected tamer rates of 0.6% and 0.2%, respectively, according to S&P MarketScope.

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Housing Forecasts For 2008

A: Calculated Risk updates us on what some of the experts and organizations think about 2008's existing home sales volume. Surprisingly, the NAR is most bullish.

NAR, Dec 2007:

Existing-home sales are likely to total 5.67 million this year, the fifth highest on record, rising to 5.70 million in 2008, in contrast with 6.48 million in 2006.

From AP:

Patrick Newport, an economist at Global Insight, forecasts that home sales will drop from 5.66 million this year to 4.7 million in 2008

Goldman Sachs:

Back in August, Goldman Sachs forecast existing home sales would fall to 4.9 million in 2008. However, since then, Goldman has becoming even more bearish on housing.

Thanks to Bill over at Calculated Risk for always being on top of this!

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Moving To Halstead

A: Just a heads up to readers that I will be switching brokerages and moving to Halstead. This will not change anything on the site.

While I finish up the paperwork for the switch, I wanted to let you guys in on the move. It was something I was planning on for a little while now, but wanted to wait until UrbanDigs.com went through its full site upgrade, integration of Streeteasy data, charts, real estate chat section, etc.. Now that the site is getting to where I would like it to be, I have more time to focus on my real estate business again. I certainly feel like I have become a bit out of the loop of what is going on in the streets of Manhattan real estate over the past few months. I blame that on site upgrade, vacation time, and holidays. Now, I'm getting ready for 2008!

Since I focus on sales, Halstead is a very good fit for me. They have a wonderful brand, a great vision, a focus on quality over quantity, a solid base of highly successful agents whom I've met over the years, and a great 'sales' reputation. They are the sister company of BrownHarrisStevens, which I consider one of the best of breed brokerages in Manhattan high end real estate. I am extremely excited about the move as I focus on building my sales business moving forward, learning about new development marketing / condo conversions, and servicing of higher end transactions. My philosophy for servicing buyers & sellers will not change, other than to incorporate new learning experiences into what I already have learned.

For Buyers: I focus more on buy-side consulting, rather than finding listings. In my mind, the internet has become transparent enough where the prospective buyer can easily search what is available on the open market in Manhattan real estate. However, knowing how a product's pricing compares to its group, whether the product has features that will retain/rise in value with the market, analyzing past/active comparables, devising a bidding strategy, negotiating, and guiding the buyer through the transaction process is where I like to focus my efforts.

For Sellers: Marketing, Marketing, Marketing! In my mind, the best service a selling broker can do is to pro-actively market a property above & beyond the tools provided by the employing brokerage; to reach as wide an audience as possible. In addition, prepping the property for sale by taking advantage of some low cost renovation options can go a long way in getting top dollar on the open market. Going out of your way to accommodate every showing request, being educated on the product/building/neighborhood/ and market itself, and negotiating the highest & best price for the seller is where efforts should be placed. Knowing how to handle all types of personalities doesn't hurt either as I believe there is a lot of psychology involved in this aspect of the game.

The only thing that changes is that I feel I will be with a highly regarded brand with exceptional marketing tools for sellers. For buyers, its all about the agent's knowledge & strategy than it is about the employing brokerage! So, I feel this is a great move for me all around!

The move also means starting fresh with a new webpage, no listings right now, changing email, and a new internal brokerage system and culture. I will use the remaining weeks of the year to get set up so that in January I can be back in full force. Once I get back, I will start reporting on what I see in the Manhattan real estate market again on a more frequent basis. As you now know, if I'm not on the streets, I don't like to comment on the market; and will report on macro instead! So I look forward to getting back to the game and my old schedule.

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ECB Takes Action, Injects Massive Liquidity

A: This credit crisis is just as much a liquidity crunch as it is a credit one. To break such a complex environment down to its core, there just isn't the liquidity in the secondary mortgage markets as their used to be; and that means trouble for those holding big time mortgage backed securities assets in their bag. While the problem stemmed from the spike in defaults of subprime borrowers leading to lack of interest for the securities backed by lower quality mortgages, one solution may lie in providing sufficient liquidity to corporations that need to raise capital but can't by selling their assets into a healthy marketplace; because the marketplace isn't functioning properly. In comes the European Central Bank with solid action.

I think this is fairly big news on the credit front given the deal that is being offered (low rate) and the time that it is being offered for (two weeks). Lets get right into it.

According to Bloomberg:

Money market rates tumbled after the European Central Bank injected an unprecedented $500 billion into the banking system as part of a global effort to ease gridlock in the credit market.

The amount banks charge each other for two-week loans in euros dropped a record 50 basis points to 4.45 percent, the European Banking Federation said today. The rate had soared 83 basis points in the past two weeks as banks hoarded cash in anticipation of a squeeze on credit through the year-end. The ECB loaned a record 348.6 billion euros ($501.5 billion) for two weeks at 4.21 percent today, almost 170 billion euros more than it estimated was needed. Bids were received from 390 banks, ranging from 4 percent to 4.45 percent.

I bolded what I thought were some of the more important points. In my view, one of the clear signs of distress in the credit markets lies in the LIBOR rate, which is the rate at which banks participating in the London money market offer each other for short term deposits. The action by the ECB brought relief to rising LIBOR rates.

According to Financial Times (via Calculated Risk):

"This is basically Father Christmas to those who have access," said Erik Nielsen, economist at Goldman Sachs. "They are bailing out people who have not really adjusted their balance sheets to the new reality."

But Julian Callow, economist at Barclays Capital in London, said the funds injected today would later be "mopped up" by the ECB, which was "simply doing their job at being lender of last resort".

Last week I discussed this in my post, "Fed Action Coming; LIBOR Targeted?" where I stated:

"It seems a co-ordinated effort with International central bankers is underway to help the credit markets and specifically the LIBOR rates which have drifted to a 85 basis point spread from fed funds rate. That widening spread is a clear signal of distress in the credit markets showing that banks are risk averse in their lending habits.

Getting LIBOR back in line, within 10-12 basis points of fed funds rate historically, should be a top priority to soothing the pain in the credit markets and ultimately for consumers."

I also put a chart up showing you the widening spread between the Fed Funds Rate & the LIBOR rate since August 1st, about the time when this credit crunch hit mainstream media.

So, if I were a central banker and knew that rate cuts in a pipeline inflation world may not be the best thing, why not try some reverse thinking. We know LIBOR is disconnecting from fed funds rate because of distress in the credit markets. We also know that tons of adjustable rate loans (ARM's) are tied to this LIBOR rate. So, we know we need to get LIBOR back in line. Hmmm, how do we do this when banks themselves set this rate and its clear there is anxiety about lending right now? Perhaps we should provide MASSIVE AMOUNTS OF LIQUIDITY to the banks in need who can't raise enough capital because of the distressed state of the secondary markets where billions worth of mortgage backed securities holdings are traded! That way, banks can tap into this liquidity to raise capital from us, rather than from a fire sale of distressed assets! That should help the liquidity problem & confidence at the same time!

That is exactly what is happening and as a result, LIBOR and other money market rates have been heading lower!

According to Forbes:

Interbank lending rates in the euro zone fell today in the wake of a liquidity injection by the European Central Bank.

The three-month euro London Interbank Offered Rate (Libor) fell almost 10 basis points, the largest drop in six years, to 4.85 pct from 4.95 pct yesterday.

This action has been a TARGETED ACT towards the credit markets and getting LIBOR back in line to a more normal spread with the fed funds rate.

You can look at it like I just described OR you can break it down further and see some acts of desperation. You can also look at it as "geez, look how many banks tapped into this cash injection; that can't be good!". Time will tell whether this action eases the crisis we are in, but all in all, I think its a very solid move by the European Central Bank. Now, will it be enough, will banks get too used to this act of kindness and not bother to clean up their books, or will it prove to be too little too late?

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Manhattan Inventory Declining?

A: Well, I'll feel much better talking about this in another 4-6 months when we have a nice baseline of data collected from the Streeteasy tool. But hey, that's way too far out and I hate waiting (like Enigo Montoya who couldn't wait for the man in black to climb the cliffs of insanity!). Anyway, the chart shows a fairly noticeable decline in total active inventory for the island of Manhattan so why not discuss this a bit.

Before sellers get all giddy that inventory is down 5-7% or so in the past three weeks, please know that these systems are in BETA, we are constantly tweaking collection methods and fixing bugs to ensure better accuracy, and that we only collected about 2 1/2 months of data so far! Also, its DECEMBER!

The seasonal aspect of Manhattan real estate kicks in during the tail end of November and most of December as those sellers who do not have to sell REMOVE THEIR LISTING from the open market to freshen it up for a normally more active selling season in the first few months of the year. I think this is the biggest reason for the decline in total active inventory from about 5,300 total units to about 4,950 units or so it is showing now. The market is generally slow in the month of December and most sellers try to enjoy the holiday and their shopping rather than dealing with prospective buyers & brokers. So, we must take this well known trend in mind!

With that said, I expect inventory to rise as we get closer to February & March; right in the middle of the bonus season. Sellers normally re-list their properties, and new sellers usually try to time their marketing with the bonus season to take advantage of the activity so lets see what happens this time around with the data tools & charts clearly displayed!

Any active buyers out there care to back up the decline in inventory OR question it? Would love to know what you guys see.

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Making Money Out of Thin Air

Every once in a while you read an article that makes you say "aha!" The information imparted satisfies a gnawing question lurking deep in your mind that you couldn't even put words to. I felt just that way after reading The Global Money Machine, an Op Ed piece in Friday's Wall Street Journal by David Roche, President of Independent Strategy, a London-based investment consultancy. Now I have the question and the answer.

The question is....Why do I have this feeling that the US sub prime debacle is just part of a larger breakdown of underwriting standards that goes farther than most in the mainstream media have really given voice to, and won't the sudden tightening of lending standards, driven by the sub prime mess initially, have a significant negative impact to the economy beyond just low income borrowers and speculators in residential real estate?

The answer is yes, there will be wide ranging ramifications of this "increase in risk premiums", as there always is. The unwinding of what some people have called the debt bubble (which I think is overly sensational, but not so far off the mark as to be ignored) will have a wide reaching impact globally and it's not just because of tighter underwriting standards. The squeeze is coming from a significant shrinkage in money available to lend, well beyond the traditional bank lending downturns that have historically taken place. This is because of the partial unwinding of a new source of financing that has taken control of the money supply out of the hands of banks and government central banks. I want to use this piece to elaborate on the Op Ed piece, and its implications and why I think its so important to the outlook for the markets and ultimately New York City real estate.

Back in the early 1980s, when inflation was the driving force in financial markets, Wall Street economists used to follow the "money supply", as many "monetarists" believed that inflation was strictly a monetary phenomenon - a result of central banks making credit too easily available. At that time even the Fed paid a lot of attention to money supply and at times even targeted its policies to manage the supply of money. For a variety of reasons, which Fed governors discussed in later years, traditional measures of money supply M1, M2 and M3 seemed to become less accurate. Check this link for a great primer on money. The reason the M's became less accurate was financial innovations that allowed the creation of money that couldn't be captured in even the widest basket called M3.

I am getting to a point here. One of the ways that money is created is by the leverage of lending. Central banks make money available to banks. Banks can borrow from the central bank and lend the money out, but they must keep a "reserve" level of funds (equity or capital) in case any of their depositors want their money back on a given day. Old bank collapses happened when all depositors wanted their money the same day...a so called "run on the bank" - I digress. As long as the bank kept its reserve levels high enough it could lend as much as it wanted....but these reserve requirements ultimately limited the amount by which the bank could multiply the money created by the central bank. The central bank had several ways of controlling money supply. They could change the rates they lent at, which made it more or less profitable for banks to borrow from the central bank and lend (thus multiplying money); they could change reserve requirements (the amount the banks could multiply the money by) or they could tighten bank inspection standards and pressure banks to lend only to the best borrowers, thereby rationing money based on credit worthiness. This last method was also called "moral suasion" or "jawboning", where the fed effectively just tells banks to lend more or less - but this only works to a point - which we will talk about later.

David Roche points out that Wall Street's financial innovation circumvented the reserve requirement system temporarily. This allowed money supply worldwide to grow faster than central banks could measure. A recent Barron's article called Wall Street "a place where people who shouldn't lend are introduced to people who shouldn't borrow"...HA. I love it, but it's exactly true. By allowing banks to "securitize" debt and sell it off of their balance sheets, reserve requirements were effectively circumvented as new lenders beyond the Fed's ken were introduced into the system. (There was another fancy way of keeping loans from impacting reserve requirements called synthetic securitization, where banks eliminated credit risk through default swaps and interest rate risk through interest-rate swaps). Banks could multiply money as many times as they wanted as long as they could find new sources of capital. New lenders who traditionally lent by buying bonds, not by making bank loans, became sources of such funds. These included money market funds, bond funds, insurance companies and hedge funds, foreign sovereign funds etc. The latest innovations like SIVs and CDOs allowed the bank loan products to be packaged into bond-like pieces that accommodated the investment restrictions on these varied lender types. Now many of these funds have their own ability to leverage...or in my parlance....multiply money. These funding sources are not new - though some have grown exponentially in recent years like hedge funds and sovereign funds - and their ability to leverage and lend was expanded significantly by packaging innovations.

PUNCH LINE - We are now going back to basics. The game is temporarily over. Because of the failure of some of these packaging techniques to deliver the risk levels expected and because of the lack of transparency about who owns what paper and how toxic it is. Transparency was much better when banks owned all the debt and bank regulators had the last word on lending standards. Think of it as many small banks going under. These new lenders are all pulling back from lending and likely won't ever be able to come back with the leverage levels or appetites they once had. All those dollars that were created out of thin air and central bank control are going away. Now central banks can lend to banks and keep them lending to each other, they can lower the cost of money and boost bank profits, but they can't (and shouldn't) force banks to lend or lower their lending standards using moral suasion alone. Additionally, the real banks are having to take assets back on their balance sheets and write them down to market value, which is shrinking their capital bases significantly. In order to meet reserve requirements they must pull back on lending volumes. Perhaps most importantly, the central banks can't bring back the non-bank lenders with their added multiplier effects. As a result central banks are trying....in new creative ways.... to offset the destruction of money that is taking place...but they can't un-pop the bubble. This chart shows what the fed has been doing with the printing presses.

Independent Strategy noticed that asset prices and financial sector balance sheets were growing at multiples of GDP in recent years while measurable money supply wasn't. This set them on their objective to identify the missing money. Well, that extra un-measured money supply is shrinking and it will have an impact on the other parts of the equation: asset prices, GDPs and financial sector balance sheets generally. So there you have it. This conclusion puts me at odds with the "Great Maestro" Greenspan, who is worried about inflation....if your a monetarist, money supply is contracting and the Fed needs to address it, it follows that inflation will be coming down with just about everything else.

From the Blogosphere

Bernanke Goes to Statue of Liberty Play - Bank System Scores

The Collapse of the Modern Day banking System

Monetary Policy Using the Asset Side of the Fed's Balance Sheet

Five Things You Need To Know About Stagflation

No Way Back - the Horrible US Economic Morass

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US Foreclosures Up 68% From Year Ago

A: Ehh, nothing unexpected here. However, we did see a 10% decline in foreclosure filings from last month; a trend I don't think will continue! With 2008 expecting a record number of mortgages to reset to higher interest rates, it's likely the foreclosure problem is still evolving rather than nearing an end.

If there is one point I would like to get across here, it's that this will be a slow and painful process that we will have to go through; to weed out the bad bets, let the system fix itself, so that we can return to a more healthy environment of longer term sustainable growth. I'm sure there will be plenty of silver linings and hopeful data reports during this process, but overall, expect the foreclosure/defaults trend to get worse before it gets better.

According to Bloomberg:

U.S. home foreclosures rose 68 percent in November from a year earlier as adjustable-rate mortgages left subprime borrowers unable to meet higher payments, according to data compiled by RealtyTrac Inc.

There were 201,950 foreclosure filings in November, including default notices, auction letters and bank repossessions, down 10 percent from October's total, RealtyTrac reported today. California, Florida and Ohio had the most filings and Nevada had the highest foreclosure rate.

Interest rates increased on more than $87 billion of subprime mortgages in the third quarter, and another $84 billion will reset in the fourth quarter, according to New York-based analysts for Credit Suisse Group. Foreclosures may surge next year as payments rise on about 1 million home loans, Rick Sharga, executive vice president for marketing at RealtyTrac, said in an interview.

This is an affordability problem for many homeowners. With rates rising, bills piling up, re-financing options restricted, and falling home values, its just a matter of time for those struggling to meet debt payments to be forced into foreclosure. Gloomy, but reality.

People normally do whatever they can to avoid foreclosure: start using credit cards for payments they can't make now, file chapter 13 bankruptcy protection to stop foreclosure action, borrow from friends, cut down on spending, etc.. Unfortunately for those that bought a house they couldn't afford and rationalized that purchase by taking out an aggressive loan product, its a ticking time bomb that will ultimately go off. This story is still being written and who knows what the next chapter will bring as we are yet to see the future effect on wall street innovations.

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Congress Acts to Assist Low Income Homeowners

Allow me to introduce myself as a new contributor to UrbanDigs.com. I've always enjoyed following politics, whether good or bad. After a stint as a bank analyst with the Fed I've been following how regulatory actions affect business and markets. For this site I'll be focusing on how government policy affects the housing market and welcome your comments. So on to my first post below.

- Beth
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