Did you hear the credit bubble pop last week?
Chuck Ponzi August 28th, 2006
If there was any doubt about the creditworthiness of the housing bubble belief, you need to look no further than the credit expansion that created it. In the end, our housing bubble, like all financial manias of the past, rested on a great willingness expand credit at a rate greater than the growth of the economy.
Our credit bubble likely popped last week.
The growth rate of the economy, that’s like what, 5-6% or so for the past few years?
Well, more or less (although primarily less).
Credit (Monetary) expansion does several things for an economy. The most important is that it allows more dollars (or euros, or whatever) in circulation to buy more stuff. (and stuff is the scientific term for plasmas, Hummers, and granite countertops with obligatory stainless steel appliances). All joking aside, this allows companies to buy more machines to manufacture more stuff, people to buy more houses, and companies to build more buildings to work in. This is generally good for an economy. Imagine an economy with a restricted supply of money that had very little to lend. Banks could not offer reasonable rates on borrowed money due to it being pledged to deposits, jobs could not be created because companies could only buy machinery to be operated in the amount of its earnings, and growth in the economy would be limited in the short run.
So, who controls the amount of money available? Well, the easy answer is… he who prints it!
Of course, it’s not that simple. In fact, if you ask some of the most brilliant people you know, most would not be able to tell you how we create more money in the US.
In the olden days, (when we had a standard set by Gold), money could only be expanded to equal as much as the available gold supply. Each dollar was tied to a specific fraction of an ounce of gold. Ideally, this didn’t change in relation to the amount of gold, so the only way to expand money supply was to mine more of the stuff. This was a barbaric way to live. Mining was a way to grow rich… or so it seemed. The government decided it would rather allow productive enterprise as a means to grow rich, rather than digging stuff out of the ground. So, the dollar was decoupled from gold. (this is intentionally simplified)
It has remained that way in the US since. Gold has gone up and down in relation to the value of the dollar, and the swings have been quite mighty! Still, gold is a “barbarous relic” and its greatest value is that it’s in limited supply. However, many cultures still cling to this funny yellow metal; it’s still used in jewelry, and as a backup currency in times of severe economic uncertainty.
Under the new model, more money could simply be “printed” and a fresh batch of capital could be whipped up in no time flat.
Now, some astute readers may be asking…
What about electronic funds, or money that is deposited? That’s not printed!
Well, that’ s the beauty of the system. Under a standard banking system, banks would be required to hold entire customer deposits, available upon demand to the owner. This is why bank robbing used to be such a great gig… mounds of money sitting in one single place. Now, customer balances are little more than a number on a screen.
Of course, now we have another invention called the Fractional Reserve System. A fractional reserve system means that banks only have to hold a fraction, or a portion of the money, and the remainder can be lent out to businesses or people needing money. This fractional reserve process would allow deposits to be reused, and make them lesser targets for bank robbers… yes, today, robbing a bank might yield only a very, very, very small fraction of their entire deposits. However, that fractional amount still needed to be held as “a reserve” in case depositors required immediate funds.
The “fractional” portion of the banking system allows monetary growth. Fred at Itulip describes it well:
(T)he gist is that banks are required to keep a fraction of their assets on hand, deposited safely at the Fed, to act as a “cash cushion” at times when depositors demand their money from the bank as cash. This cash reserve is in proportion to the amount of depositors’ money that is loaned out. The proportion of this cash reserve to the total amount loaned out is intended to provide just enough of a buffer to keep the bank solvent and keep things running smoothly in the event a lot of depositors make demands for cash at once, such as during a run on the bank. This fraction, called the reserve fraction (or ratio), is typically from 5% to 20% of the amount of money the bank has loaned out. This may seem low, but holding any more cash in reserve than is needed except for outlier cases is considered an uneconomical use of capital by a bank. The cash in reserve is not making money for either the bank or its depositors as loans, so from a day-to-day operations persective, the less reserves the better. From a longer term risk management perspective, the more the better. Statistically, 5% to 20% reserves is the “right” amount, except in those outlier cases where these levels are either too high because reserves at those levels are at some times constraining the economy’s access to credit or, conversely, too low at other times because too many depositors are making a rush to liquidity and demanding their cash.
The reserve fraction, considered as a number that is mutable as a matter of policy, is also one of the most powerful tools a central bank can use to adjust the amount of money available to the economy. It is easy to see why: a reserve requirement of 10% means that banks can lend out ten times the actual money on deposit with the fed. Even a seemingly small change from, say, 2% to 8% means that 12.5 times the money on deposit can be lent out. For example, $10bln initially on deposit with a 10%, reserve requirement results in approximately $100bln of money available as loans. If the reserve fraction is reduced from 10% to 8%, the for the same $10bln cash on deposit there can be approximately $125bln of money available as loans in the economy. This is an increase in the money supply of around 25% from a reduction of the reserve ratio by 2%.
This is where our story gets interesting. If the Federal reserve can increase money so easily as to change reserve requirements, isn’t the flipside to out-of-control increase in monetary supply that reducing money supply in times of inflation as simple as increasing the reserve requirements?
If you guessed yes, you would be right.
So, getting on to the meat of the issue: Would you believe me if I said that an article titled Sub-Prime Lenders’ Shares Fall has nothing to do with the Fractional Lending system, and yet has everything to do with the impending housing bubble bust?
Many, too many if you ask me, have blamed the Federal Reserve for the credit expansion. I only partially agree with that statement. You see, the FED has lost control of the money supply.
Lost control of the very thing they are supposed to control?
Yes, and very badly. The problem arises with the reduction of the fractional reserve to 10%. I recommend reading Fred’s entire treatise (takes about 20 minutes, but is chock full of facts and great figures). For me to write an entire basis for these assumptions would mean I would be recreating his work, which is a great read.
What about lending outside of the “reserve banks”?
Good question! The next pin to be pulled in the financial markets was subprime lending, which has caused some of the worst type of lending. These are some of the bizarre outcomes of expansion of the subprime lending markets:
1. A great deal of subprime is now concentrated in Stated Income Loans (aka liar loans) which have been estimated to contain 60% liars. Question is… if you lie on your application or on your taxes, which one is worse? The answer… does it matter? Lying leads to more lying, which can lead to overstretching financially and failure when difficulties arise.
2. The greatly expanded access to credit allowed borrowers with a diminished ability to pay and questionable personal financial responsibility. This is evidenced by the increasing number of “never-paid a single payment” loans being floated. So much that investors have balked and required these bad dealers to repurchase their own junk.
3. Other banks that needed to compete, needed to lower their lending standards. This introduced more systemic risk into our banking system.
4. Expanded credit markets depressed risk premiums overall, and “chasing returns” meant a flight to risk, in the form of subprime lending.
So, what caused the shift to subprime lending? Would it surprise you if I told you the FED did it to themselves?
By lowering the cost of money, creditworthy people could borrow money and lend it to other at a higher rate. This is nothing new, it’s called rate arbitrage, and is practiced all over the world; between countries, and in subprime lending.
In addition, pension funds and insurance companies based future values of their portfolios on a certain return rate. To accept the abysmal rate that the FED was offering would have mean big losses or underfunded liabilities. What do you really think caused the big pension funds to fail? Hint: It wasn’t that companies didn’t put enough into them, it was that the returns failed to match historical returns, and defined benefit (as opposed to defined contribution plans) require that the company come up with the shortfall. In a higher-rate, higher-return environment, we likely wouldn’t have heard a peep out of defined-benefit pension funds.
Essentially, because interest rates went down with restricted reserve requirements and expanded competition, banks could only take on more and more risk to preserve their income. The easy solution? Sell the risk to someone else through MBS (Mortgage Backed Security) agreements! Yes, through this handy-dandy little feature, banks and loan brokers can just make money on the transaction and take none of the risk to the toxic loan you just made. Because investors had not yet figured out just how much risk there is in those loans, rates remained low, creating very low risk premiums.
Which brings us back to Greenspan’s words a little over a year ago:
Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.
Cryptic? Yes. Prescient? Yes.
But, these are the words of a desperate man, not of an in-control central banker who wields magnificent financial power. He is in one sentence lamenting his loss of control over the credit environment, and warning of risk in the system. However, he feels there is nothing that he can do at this time. Raising interest rates creates an inverted yield curve, and the FED can no longer push the yield curve in any direction. Raising reserve requirements only puts banks at a disadvantage. It seems, investors have an insatiable desire for more risk because HE put them there. The fabled “Greenspan Put” is exactly that; a fable. He would be pushing on a string to try to solve any problems at this point.
I think we just heard the pop last week that makes this house of cards come down.
Nanosolar is exactly who I was referring too… although they don’t have exclusive rights to the technology, just the use of printing-manufacturing techniques that are unique to them.
Daystar (DSTI) also produces CIGS (Copper, Indium, Gallium, diSelenide) photovoltaic cells on metallic foils. I don’t currently own them because I would rather be buying Nanosolar…who coincidentally is buildign a 1.6GW/year plant in NoCal.
To me, this is about as close to free energy as you can get. In the past, storing that energy has been difficult, one which I believe can be overcome with personal hydrogen storage tanks. I don’t like the idea of batteries because of the 2 big ones; environmental impact and on-demand power storage. I also hate losing so much power in cars from having 600lbs of batteries to hold power and a limited driving range.
Ideally, we could have solar collectors on our cars that convert to hydrogen using an on-board conversion device and they could be self-powering. We would then see people competing to park on the top of the parking garage as opposed to in the shade. With the old flat-panel silicon wafers, it was out of the question, but with flexible CIGS, it would would be possible. I’m also hoping that the safety of using hydrogen fuel-cell vehicles does not present a roadblock. All-in-all, yes, I am a nut for clean fuel. Anything to get the ME off of our backs and maintaining our current lifestyle would be great.
Who wouldn’t want a 600 horsepower 20 ft SUV that never needs gas, doesn’t require oil drilling, and has zero emissions except for purified water?
“and has zero emissions except for purified water”
and we could even collect the water and sell it to Sparkletts!
it’s like the world of tomorrow!
somebody call Disney!
i’m sure mortgage brokers knew how to use photoshop quite well.
“…in the end we believe that underlying market fundamentals will prevail,” Mr. Lereah added.”
Is that just too funny or what!
this guy recommends MONTHLY ARMs!!! Is this straight out deception or what?
http://video.google.com/videop.....6689834604
I have a feeling that the credit bubble is now popping in a big way in my neighborhood (extreme north end of 90278). Very recently I’ve noticed a few alien realtor signs on fairly new construction, one selling in December 2004 and one selling early this year. The realtor signs in front of these bubbleminiums are from realtors way outside the area, not the standard local realtors. People can find themselves in over their heads almost overnight.
I’ve posted the real estate $$$ transaction charts for August:
South Bay Beaches Bubble Blog
Cheers!
yah and that’s really sad..
Debt Monetization?
Debt monetization is what has been going on for the past five years across the globe (i.e. assets and wages are deflating relative to goods and services). However, rather than argue on the subject, I think that is better to just let the charts speak for themselves.
Various gold to X ratio charts:
[Link]
Gold as priced in various world currencies:
[Link]
Many think that there is a bubble in gold (and commodities in general) and that this ‘bubble’ can crash any day now. However, I tend to think that the real bubble is in the current central-bank managed global fiat currency system, instead.
If it wasn’t for ’stated income’ loans, no one in Cali would be able to buy a house. That should tell us something.
Housing Boom Bust — I disagree. You wrote:
If it wasn’t for ’stated income’ loans, no one in Cali would be able to buy a house.
I think there are many people who documented their $50,000 a year income before the bank gave them a $950,000 no money down option ARM.
here is why you should buy now:
http://www.bubbleinfo.com/proc.....usenow.wvx
I totally agree with everything you’ve said.
I fully expect San Diego to drop 40-45%. I think the dollar will drop 20-40% too.
I’ve been investing in gold, canadian income funds, foreign mining stocks, oil wells, and recently AUD as a hedge. I sold my real estate in CA last year and started buying in Utah and Indiana. So far everything’s been great. But the best is yet to come!
Check out my blog for more articles on why the dollar sucks!
Silicon Valley house prices are headed in the same direction.
Santa Clara Co prices are -$47K the last four weeks: http://www.viewfromsiliconvalley.com/id125.html
See http://www.viewfromsiliconvalley.com for more complete coverage.
gosh, when will you losers realize that prices are NOT coming down more than 5 or 10% at the very most!! Inventory is increasing only because people are trying to cash in and make a quick buck, but they will just take their homes off the market if they can’t get their price and then inventories will fall again and the appreciation will start back up, although at a more normal level. This is a soft landing folks.
You guys are underestimating the amount of non-real estate related wealth that people have. Do you know that most Americans have fixed mortgages or no mortgage at all, yes, they own their homes outright. The number of people with exotic loans is a small minority, they will indeed cause a small disturbance in the market but nothing significant to warrant a real estate meltdown like the media predicts!
Cover your ears anonymous!!! You are about to get called every name in he book by these naysayers. You have the temerity to come into their church and spout this blasphemy and you will be held accountable. You must be an evil realtor because they are the only people on the planet who do not believe in the impending meltdown of the real estate market.
There may be a few coherent comments made but most of them will include name calling. The shrill whine of non-homeowners will soon be ringing on this blog.
Hello last two anons!
Would you mind if i disagree in a pleasant way? I have no problem with real estate agents like yourselves. Like every other profession, there are good ones and bad ones, well-meaning ones and deceiptful ones. The ones I’ve used have all been very pleasant and delightful people.
I happen to be of the school that thinks we are in for a bigger than five to ten percent drop. I think we’re looking at a situation like Japan, where after their real estate bubble the average price of a home went down 50 percent and stayed down 50 percent for 20 years. This is not a typical real estate cycle. This was a speculative mania, akin to the dotcom bust. (Sorry to compare real estate to tech stocks — i know this drives you guys NUTS. I know, I know, “you can’t live in a tech stock.”) But as you know (or if you don’t, google “real estate” and “yale professor robert shiller”) this is the biggest speculative housing bubble in the history of the United States. And bubbles never end well. They simply don’t. It’s a fact. And to think otherwise is simply wishful thinking. Remember, MANY people, especially stock market professionals, were convinced it was a “new economy” and that the boost to productivity unleashed by the Internet had led to a “paradigm shift.” and so it goes with real estate today. but with both, the old adage applies: those who ignore history are doomed to repeat it.
I happen to own my own home (okay, it’s a condo) and I believe that owning real estate for the long term over renting is a no-brainer. And I can make my payments so I can ride out any big drop, and even as the amount i paid for my place was doubling and even tripling, I knew it wouldn’t last because I know that money doesn’t grow on trees and that there’s no such thing as a free lunch. but a lot of people forgot that, or maybe they grew up sheltered and never learned it. maybe they’re young and they missed the drop in real esate prices after the run-up in the late 80’s, which was NOWHERE NEAR as big a run-up as this one. (i know, there was the aerospace bust and the earthquake, but we’ve got more specualtion and the R.E. job bust to come.)
if you look at historical charts, home prices have separated from rent costs, wage growth, and historical appreciation as never before. I guess you guys think we’ve entered a new world and that’s just the way it is, but it’s like Morgan Freeman says in Shawshank Redemption: “I’d like to tell you that bobby got away from those boys, but there ain’t no fairy tales in prison.”
Well, there ain’t no fairy tales in real estate either.
I trust that both of you have done very well the past few years. Save that money for the tough times to come. And why are the tough times coming? Well, i don’t think it’s quite as simple as real estate agent anon #1 makes it sound. he says that people will simply take their homes off the market and wait. but what about carrying costs? for anyone who bought in the past few years, they are huge, and they are much higher than what you can get by renting your place out. people can only wait so long, especially if they know their ARM is re-setting. and even if you are right and it’s only a 5 to 10 percent drop, they won’t be able to re-finance. in fact, many people think they’re going to be able to re-finance their way out of their ARM pain and they’re going to be in for a rude awakening. and even that ten percent drop, once it comes through in the YOY figures, it’s going to make a lot of people want to sell because they’ll fear it’ll drop more, and then you get the snowball that drove the Nasdaq down from over 5000 to about 1000. (80 percent drop!)
Look, probably nothing I can say can convince you guys, and truth is, I sure hope you’re right. I’d love to have my condo really be worth $650K instead of the $350K i’m guessing i’d be able to get for it in two years, but again, “There ain’t no fairy tales in real estate.”
By the way, I DO know that most americans have a fixed rate or no mortgage at all, i think something like 30 to 40 percent of homes are owned free and clear. but as you must know as a real estate professional: prices are set at the margin. and the fact that so many own free and clear is going to actually be a problem once prices hit that 5 to 10 percent drop that even you guys are saying is coming. all those old folks who have been marveling at how the house they paid 50 grand for is now worth a million are going to finally feel it’s time to get out and downsize and lock in that gain when they see the price drop down from a million to 900 grand.
for all the truth that many people on this blog are just bitter or regretful that they didn’t buy five years ago, i think the naysayer real estate agents that post here are just trying desperately to convince themselves that everything is going to be okay. it isn’t. this is going to be bad, possibly very bad, and unfortunately a lot of those young couple you’ve sold homes to recently with an I/O neg am are going to be wiped out.
but you know what? no one can really predict the future. I could very well be wrong, and hey, if i am wrong, I WIN!
P.S. : real estate agent #2, you say that everyone on this blog is a nasty name-caller, but your fellow real estate agent began his post by saying that everyone who disagrees with him is a “loser.” i hope my tone in this post was civil and in the spirit of a friendly disagreement. i look forward to your response.
Foreclosures are already up 160% in California, enough said!!! I believe that is a new record. I don’t know about 5 or 10%, price reductions are already more than that on some listings I’m seeing and it’s only the beginning. Just go to the OC Fliptrack blog and you’ll see many properties selling at a NET LOSS! That hints at an extremely serious problem brewing!
This downturn is setting new records every day! When will people believe that if the run up can be something that has never occured in history, then the downturn will also be something so bad that has never before occured in history
Unfortunately it will take the US Economy and the US dollar into the dumps with it which is why I’m investing abroad and in International funds.
I talked with a smug homeowner yesterday. I told him prices are going to fall 30% at least if not more especially in his area (Corona, CA) and his response “Ah, no…that will NEVER happen”. It’s amazing the rose colored glasses these homeowners are wearing…most of them 100% believe that the gains they’ve made are permanent. The stupidity and naivity of these people is incomprehensible. Most of these people are going to get burned so bad they will be reeling in shock for years to come!
When homeowners think this way, that their 300% overvalued piece of crap home is worth what it is, then the situation is just hopeless I tell ya!
Jason, you make a lot of good points and it’s hard to tell what the final number is going to be.
Prices are going to come down some and I’m happy to agree to disagree with intelligent, reasonable people like yourself.
I just post the abrasive stuff to piss off some of these jerks who think any real estate agent is evil reincarnate. I’m sure they also hate lawyers, CEO’s and the President.
I’m not afraid of prices falling. It would be great for business if more people could afford to buy. I’ll lose some paper profits but it will come back. I’m going to be around for a few more years.
This whole boom and bust are the result of massive fraud, just like in the late 80’s. Once again, the real estate industry has bilked the public big time with falsified applications, liar loans, inflated appraisals and lenders with their hands over their eyes.
As far as I’m concerned, the whole world would be better off without the real estate and appraisal “Professionals”
29 September 2006
Federal officials confirm that thousands of bodies have been discovered in 38 states and are expected to be found in all states. Similar to the killing fields of Vietnam or mass graves discovered in Iraq. “Many of the bodies have been decapitated, some hung and many have been shot multiple times”, said Agent Earl Carbus of the FDA. “It is beyond description; Many have been beaten to a pulp, I’ve never seen anything like this. The stench is overwhelming. Such carnage just cannot happen in the United States” - Special Agent Patty Smith of the FBI declared. The bodies are for the most part whole, unravaged by animals. “Coyotes and mountain lions are conspicuous by their absence. Normally the wild carnivores would have cleaned the bones by now” - declared Lt. Marvin Saugus of the St. Paul Police Department.
Reminiscient of Hitler’s death camps in WWII, there are almost too many bodies to count. But unlike the Jews at Auschwitz, these bodies are not gaunt, but bloated. “Obviously they were very well fed and did not die of starvation. The bodies were all very well dressed and bore very expensive jewelry, which evidently the killers didn’t want. The mass graves also contained many expensive automobiles; Lexus, Infinity, Porsche, etc., said a state Coroner’s assistant.
Like all mass murders, there is a common thread. All the dead have business cards forced into their teeth, identifying them as either real estate appraisers, realtors, mortgage brokers, loan agents, mortgage bankers and hundreds of employees of Mortgage Servicers like Ameriquest and Fairbanks Capital. The FBI has preliminarily identified the motive as mortgage fraud. As so many innocent mortgage borrowers have lost their homes and investors have gone broke recently upon finding out that there was no housing boom, it flows that the real estate industry is the object of retaliation.
“But these were human beings, with families and hopes and dreams” cried one woman upon discovering her mortgage “professional” husband had been tortured, his genitals stuffed in his mouth, and shot. “Not really” declared a passery-by at one gravesight. “They’re just pollution in another form now”. Such comments have become common since the housing market crash of 2006. Once homeowners and investors discovered that the entire housing boom was the result of massive fraud, sensitivites have been lost to more forward positions against the real estate industry. It is no secret that some industry insiders had been warning the FBI, AGs, and the Fed that hell was coming, to no avail. Apparently, civil justice has been supplanted by vigilante justice. When all 2 million residents of San Diego, California were questioned by authorities, not one suspect was arrested.
“It appears that a nationwide professional cleansing is taking place on a massive scale, Special Agent Timothy Carston, SEC, said”. Authorities are powerless to control carnage on such a massive scale. All efforts are currently being focused on decontaminating the gravesites and searching for new ones, as missing person calls multiply.
Sgt. Richards of the Pomona Sherriff’s Department said “Sure, these people ruined our lives, put the nation into a deep recession at a time of war and we are all on rations because of their misdeeds, but Jesus Christ, this is over the line”.
The authorities are classifying the crime as a misdemeanor.
-ABN News Network
Hatemonger at ABN News, that was pretty well written.
That you would actually take the time to write something so awful says volumes about you. I hope you’re very proud.
Would you please post your name and address so that we can all keep our children away from you.
wow that was a lot of effort.
hey dostoevsky, don’t you mean crash of 2007?
Read: http://millionairenowbook.blog.....-arms.html