Tentacles of The Credit Beast III
This financial crisis has been like an AIDs virus attacking the machinery that usually protects the system. That machinery is the creation of credit. It is being attacked the way acquired immune deficiency syndrome attacks the body's defenses by using the immune system itself to hide and multiply. When you think further about the analogy, one is an amazing piece of viral evolution and the other is an amazing piece of market evolution. Both lay bare weaknesses in the systems they have infected. The former crisis was only forestalled by instituting safer practices and the same will be the case for this one. Let's hope the patient can survive long enough for the safe practices to be instituted. One wrinkle with the financial crisis is that safe practices when instituted all at the same time can make the crisis worse rather than better.
To wit, in this morning's Wall Street Journal, Meredith Whitney, of Oppenheimer banking analysis fame, and now proprietor of an eponymous consulting firm, writes that credit card debt is the next credit crunch. You can find the gist of her piece here. Whitney's contention is that credit card companies are pulling back from lending all at once and are in fact threatening the availability of consumer credit even to those who deserve it. The credit card companies have found that their tried and true FICO scores failed them, when highly rated borrowers got underwater on their mortgages. They are therefore now limiting credit in hard hit zip codes. Whitney's contention is that revolving credit is used as a cash flow management tool, citing the statistic that 90% of credit-card users revolve a balance at least once a year and over 45% of credit card users revolve every month (I am amazed that the second number is that high). I would argue that for 45% it's not a cash flow management tool, but rather a way of maintaining higher consumption through a larger balance sheet for some period of time. As I have discussed previously on Urban Digs in my piece Regulator Revenge: There's a New Sheriff in Town, after the crimes have all been committed regulators wake up and put strong deterrents in place, that usually cause the collapse of the bubble which incited the fraudulent activity to be even worse. The same apparently goes for unfair lending, where according to Whitney, new provisions of the Unfair and Deceptive Acts or Practices (UDAP) regulations, which would restrict credit card providers ability to raise rates on customers, will likely result in no credit being offered at all.
Whitney makes a good point here about not having the medicine kill the patient. In keeping with this, up and down the economy we have seen officials tread lightly on things like allowing banks to stay open, despite severe losses, as they recognize that causing a panic on top of a crisis is self-defeating. However, moral hazards seem to be running very high and my personal feeling is that tacitly saying to 45% of the population that it's okay to carry revolving debt all year long, is a bad practice. Furthermore we need to all recognize that this unsustainable behavior, won't be sustained long-term no matter how many dollars are printed by Uncle Sam. The Deleveraging Will Be Televised. What do Urban Dig's readers think? It will be a delicate balance to not choke off the economy, by limiting credit, while trying to reform the unsustainable practices that got us here. Going back to 2006 ain't gonna happen, neither should it.
We need a lot more transparency in order to understand how to carry out the delicate work of fixing what is broken, without making matters worse. We still don't seem to be getting it. The Federal Home Loan Bank of Seattle has apparently failed to meet certain regulatory capital ratios at month's end due to writedowns on mortgage backed securities (MBS). I have highlited the risks to the Federal Home Loan Banking system before, but it does not seem like any significant steps are going to be taken by regulators at the present time. Interestingly, the Seattle Home Loan Bank took a $304.2 million write-down on the MBS paper, but said it only expects to have an actual loss of $12 million over the life of the loans. Yet the accounting language trigger for the write-down is if the drop in value is deemed "other than temporary". Come on guys let's get it straight, this paper is either going to go bad or it's not, pick one and conduct yourselves accordingly. This needs to happen up and down the system and hopefully the banking stress tests will give the markets some confidence here. Although I'm not sure I want to wager on that with how it has been handled to date.
Apparently however, another over-leveraged and likely under-regulated part of the system is coming under increased pressure as the tide of leverage goes out. There is no turning this tide, people are not dumb and if they didn't know before, they know now that they shouldn't depend on their bonuses to maintain their basic standard of living, that they shouldn't carry outrageous revolving debt to boost their living standard and speculation on housing prices is an easy way to go bankrupt. The economy must and will shrink to meet this lower level of leverage and activity. Only from that new equilibrium level can we move forward. In the meantime, I agree that the government must keep the patient on life support, but let's not encourage any new risky behavior.
For New York city residential real estate, the question is: Despite working in the notoriously cyclical business that is Wall Street and being ingrained in risk management culture, how many of our brethren engaged in the risky behaviors cited above? If many did, the risk to all will be greater. What are your thoughts?
Comments (15)
What do you mean by "revolve a balance"? If (as I would assume) it means that the balance is fully paid and re-incurred each month, why do you assume that's not a cash management tool (i.e. instead of using a debit card, people pay for everyday purchases with a credit card, get more reward points, and pay off in full with each paycheck?) I guess you could view this as financed consumption since the balance stays fairly constant, but if it's at a level less than a month's pay (and therefore meets my definition of revolving above), is it really a problem? (assuming of course one has adequate emergency cash reserves, but that's a whole other discussion!) Or am I missing the point? Thanks!
Posted by anon | March 10, 2009 10:59 AM
Find your website fascinating in its detail and devotion to real stats and analysis.
Unfortunately I think this is one of the times in American history where we will be seeing a huge "reset" on not just the economy, not just financial regulation but on the entire American "mindset." Your analysis of the NY real estate market and other blog's analysis of key sectors of the financial sector consistently reflect the same thing over and over again. Financial deregulation (or lack of regulation at all) allowed bubbles to be formed based on maximizing short term profits any way you could through leverage leverage leverage. Isn't it understandable that that we will have an over-reaction the other way?
The truly sad thing is that if not for a few regulations here and there (rules deposit/leverage ratios, not repealing the Glass-Steagall Act, sane rules for derivative trading) none of this would have happened. We also wouldn't have had the massive profits over the last decade but now we will have the opposite effect - de-leveraging to the point of ruin.
As many other blogs have pointed out, we used to be fine with the incredibly generous bonus scheme of Wall Street because we thought it came with competence. Well, that's all over with and NYC is the epicenter so I don't see the bottom in 6 months or a year. This will be years in the making, just hang on for the ride down.
And your question "how many of our brethren engaged in the risky behaviors cited above?" is rather moot - our entire society engaged in this behavior and it may be time to "reset" back to the transcendentalists of the 19th century (bone up on Whitman, Thoreau, etc. - met the new American values, same as the old American values) and hope that there really isn't a populist revolution.
I am probably just restating the obvious and banging my head against the wall but wanted to give a shout out to your (pretty awesome) blog. Keep up with the the well thought out posts.
Posted by Calloway | March 10, 2009 11:14 AM
Jeff - another good post. You open question in the final paragraph is interesting. I can only speak anecdotally, but those who I know closely enough to have any insight to their finances were typically on the conservative side (did not carry high interest debt, paid off cc's monthly, kept their monthly housing costs to <25% of gross income, maxed out 401Ks, etc.)
I don't know how much of an impact the issues you cite will have on NYC. I think the single largest factor will be unemployment numbers, particularly in the high end professions of finance, law, insurance, etc. Once the employment numbers stabilize and the perception of job security solidifies, I think we will be closer to a bottom. While we still have many who don't know if they will be employed in 3 or 6 months time, I think the market will be slow and therefore soft.
I do think we will come out of this stage in the next 12-18 months, that prices will stabilize at lower levels within that timeframe, and will likely remain flat for 3 - 5 years following. How far down is anyone's guess, but for those waiting for prices 50-75% down, I think they will be waiting for a long time. Just my opinion.
Posted by OT | March 10, 2009 11:33 AM
Jeff wrote:
"We need a lot more transparency in order to understand how to carry out the delicate work of fixing what is broken, without making matters worse."
And this is why many (including James Baker recently) keep pointing at JAPAN as the model for how we are dealing with the exploding credit bubble.
As to NYC real estate, what is destroying value (and will continue to) is the decimation of net worth, the significant declines in income and the tremendous loss of jobs. Leveraged practices are just icing on the cake of real estate destruction.
People use to talk of NYC economy being driven by FIRE... finance, insurance and real estate. Each one of these is circling the toilet bowl. There is no question the fate of NYC's economy in the near term; to think otherwise, is to be living in your own little bubble of denial.
Posted by lars | March 10, 2009 12:34 PM
Anon,
You ask a great question. According to Meredith Whitney's editorial "revolve a balance" means "don't pay it off in full". She says 90% of folks do this at least once per year. (I think the last time my wife and I did it was by mistake because we got our payment in late.) More shocking 45% of people do it every month...that is they leave a debt balance on their card for which they are charged egregious interest rates all year long. To me this means they are subsidizing their living standard with high cost money. This can't continue.
Posted by jeff | March 10, 2009 12:57 PM
Jeff - another good post. You open question in the final paragraph is interesting.
Posted by charlotte nc real estate mediation | March 10, 2009 3:49 PM
I agree with OT that the real estate market is all about employment but I think sentiment is also a big factor. Real estate needs a similar flushing that the stock market has gone through. I mentioned in a prior post that I thought the stock market bottomed last week. I based this on sentiment indicators. They indicated most people had either given up or were expecting a complete collapse. That typically means the selling is done and the little guy has gone short at exactly the wrong time. Doesn't mean we are going to rocket up(although we had a nice short covering rally today) but probably base out for sometime, with the occasional stab up and down. Some will view this as an immediate precursor to a real estate turnaround. That would be a mistake. Just harken back to 1987. I purchased my first condo in August of '87. The stock market crashed in October '87 and I, like many others, was under water until '92. However the employment picture now is far worse than '87, there was no housing or credit bubble then and the collapse of stock prices was not as severe as today's. Yet it still took 5 years for real estate prices to recover. I will not hazard a guess as to where real estate settles but my bias is down, hard and fast. Here's why:
1. You purchased your condo in the past 4 years and are seriously underwater. Your asset is down 15-25% and heading south with predictions of another 25% leg down. What goes down 50% needs to recover 100% to get back to where it was. That would require another housing/credit bubble to form. Ain't gonna happen and you panic sell.
2. You purchased your condo 4+ years. You may be still solvent but your 401K and other stock holdings have been decimated. Now your only performing asset is threatening to go red. You panic sell.
3. You are a foreign investor who purchased your condo when the dollar was cheap. Your asset has grown in value as the dollar strengthened against your currency but the bursting of the bubble threatens your profit. You sell.
Will all the people in the above 3 scenarios sell? Probably not but a significant number will. Add those who must sell(the newly unemployed) and you have a surge in inventory at exactly the worst moment. At some point we will read how real estate is the worst investment, Manhattan will never recover, blah blah blah. Even some of the self-serving mega brokers may turn bearish. The media are a great contrarian indicator. Just look at the new cover of Vanity Fair magazine with its depression era theme. Anyone remember a book called Dow 36,000? Was the perfect time to sell your stock holdings.
For those of us on the sidelines, our time will come. Patience will be rewarded.
Posted by cfranch | March 10, 2009 4:42 PM
This is going to be a nuclear winter for NYC. A home or apartment is a roof over your head, not to be bought and traded like a piece of gold.
There is nothing at all to bolster residential real estate prices in NY any longer. It's finished, dry off your tears and just consider your apartment a nice place to live, not a commodity you sell to the next sucker on line.
A safe mortgage is three times income. Around here, mortgages were upwards of 15 times income. So prices will come down to unprecedented low levels and remain there for years and years.
I'd say we're looking at a drop of upwards of 60-70%.
When that happens, liquidity will be restored to the market. Until then, we'll be dead in the water.
Posted by truthteller | March 10, 2009 5:37 PM
I put in a bid for "prime" williamsburg @ $300 a square foot. They thought the number was a little low.
Posted by me | March 10, 2009 5:40 PM
Me,
I don't think any condo developer in Williamsburgh can afford to sell at $300 psf (maybe the bank can). It must have cost them at least $300 psf to build, without the land. But good luck. I know a year ago, people were paying upwards of $700 psf. there's your 50% + haircut.
Posted by jeff | March 10, 2009 8:17 PM
Oh boy, janitor-boy TT is off his meds again. TT, I will continue to harass you until you give us ANY indication that ONE SINGLE person in NYC got a mortgage for 15 times income, much less any sort of trend there. That is absolutely ridiculous - I don't know a single person who took out a mortgage greater than 2.5 times BASE salary. What on earth or you TALKING about?? Do you even live in the tri-state area? Tool...
Posted by OT | March 10, 2009 9:27 PM
OT- he won't. It's far easier to influence the minds of market participants by spreading disinformation, ignore requests to qualify it, then pop up and spread it again every couple of threads where it's fresh once again. The regulars here dismiss his remarks, but my theory is he's betting on newcomers buying into his mindset. I am surprised though that other than you, no-one here really comes out to question or disassociate from his more provocative claims.
Posted by Former Seller | March 11, 2009 1:27 PM
FS - I think the reason people ignore TT is that this is for the most part a mature and intelligent board. It's like a 2-year old that throws food at dinner time - best thing to do is ignore them, they don't really quite understand "no" just yet. I have willingly taken on the sheriff role and have no problem being the one to expose TT's idiocy and complete irrelevancy to the discussion.
And TT, it has nothing to do with your predictions. I have said before, and I will say again, that you may well be right before all is said and done. But it won't be because of any intelligent analysis.
Posted by OT | March 13, 2009 1:54 PM
I think this is one of the times in American history where we will be seeing a huge "reset" on not just the economy, not just financial regulation but on the entire American "mindset."
Posted by Water meters | May 17, 2009 10:59 PM
Love the picture you chose to accompany the article! They just pull you right in don't they. lol
Posted by real estate school | December 28, 2009 10:56 PM