Chuck Ponzi March 24th, 2008

The following is a copy of a post I made back in November 2005 (nearly 2 1/2 years ago).  Pay close attention to what is supposed to happen next:

from Interest Only - Creative Financing or Harbinger of Deflation?

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

The economists over at Elliott Wave have a great write up about deflation and what causes deflation in a piece titled “What is Deflation and What Causes it to Occur?”

All deflationary periods were marked with the following conditions:
(a) All were set off by a deflation of excess credit. This was the one factor in common.
(b) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
(c) Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
(d) None was ever quite like the last, so that the public was always fooled thereby.
(e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
(f) Credit is credit, whether non-self-liquidating or self-liquidating.
(g) Deflation of non-self-liquidating credit usually produces the greater slumps.

From the article: “Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan - for business start-up or expansion, for example - generates the financial return that makes repayment possible. The full transaction adds value to the economy.”

Credit lent against homes are most definitely non-self-liquidating credit. Unless, you count the opportunity cost of renting as a form of liquidation - however this requires there to be some relationship of rents to monthly payments; something that can’t be said of current market. The relationship of these nonproductive asset backed loans to productive asset backed loans, it would seem is at its peak historically.

Reading this type of semi doom-and-gloom scholarly article makes me think about the many types of financing recently available to the public masses and what impact they might have.

It takes a bit of economic sense to understand a risk premium. A risk premium is an additional amount that a lender expects to compensate them for additional risk. If risk is considered great either a high risk premium is attached or sometimes a transaction cannot take place. We currently have some of the lowest risk premiums in history; interest rates on non-productive assets are at historical lows.

Typically, a lender requires that at some point, principal on the note must be paid back. Interest only loans are an exception to this. Why? And, why have they become popular now?

It’s easy to see why a borrower would want to take on one of these loans; why pay for something now if I can pay later. But, what’s more interesting is why are they so popular for lenders?

Human beings are a fickle bunch. Each one wanting to do something different than the other. Like watching an ant, it runs to and fro, sometimes lost, sometimes productive, but always unpredictable. But, take a step back, and the anthill is an extremely efficient, coordinated jumble of activity. A very predictable bunch. Human financial systems are similar. Each borrower is very unpredictable, but bundle a few thousand together and they suddenly become more predictable; hence the popularity of Mortgage Backed Security Bonds (MBS’s).

BUT… and you knew this was coming… you need to take even a step back to see what is going on in the macro environment. Who has all of this money, and why are they lending it at such low rates. A flat yield curve would signal that lenders see little reason require a larger risk premium for longer-term loans because they expect long-term rates to be about where they are far into the future. How often is the bond market right? Well, that’s for you to decide. Greenspan has even named it a conundrum.

So, this brings me to the title of my post. How could interest only loans signal possible deflation in the future? We already know that low-interest rates can be a signal, but what about creative financing?

Interest only loans cannot be self-liquidating in the short run. When they switch to a liquidating (fully amortized) loan, the payments jump substantially because they do 2 things at once: 1, they begin fully amortizing 2, they adjust to prevailing interest rates. One would expect that people faced with these issues would simply replace the shorter amortizing period with a longer amortizing period at the same rate. Or, they would attempt to liquidate the loan by selling. Since interest-only loans are not self-liquidating in the short run, the bond market is signalling that for the medium-term, interest rates and returns will be low, or that investors are extremely risk-averse to the stock market. The investors feel justified that any possible deflation is offset by the Fed’s moderate inflationary policy, or at least an attempt to prevent deflation. So, MBS investors have signalled that for the medium term (3 to 10 years), that they would rather take their chances with low interest rates AND non-liquidating debt.

Will this truly end as Greenspan has put it? I will leave you with one of his most famous statements on the subject:
“But what they perceive as newly abundant liquidity can readily disappear. 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 prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.“

• Mean Reversion , Speculation , Debt , Deflation
• Comments(5)

Chuck Ponzi March 17th, 2008

Last year, Jim Cayne was one of Fortune’s top 400 richest men in the world with a net worth of approximately 900M; which was calculated when BSC was valued at approximately $150/shr and would have been more than 90% of his net worth.

He held 5.6M shares of BSC as of December 2007.

With the buyout today, that holding is now worth about 11.2M.

Not bad.

Until you consider that this amount was formerly worth about 840M.

Unfortunately, his net worth decreased 151M on Friday and another 140M today.  That’s a spicy meatball.

Hope he got a good golden parachute from BSC.  We won’t be seeing him on the Forbes list anymore unless he sold short… which might arouse the suspicions of some federales.  As we say… what  happens in Vegas, stays in Vegas.

• Uncategorized
• Comments(3)

Chuck Ponzi March 14th, 2008

Wonder why the high-end is shut down?

Take a gander at these current rates for a 600K loan in California; which will pretty much buy you a 3 bedroom condo.

Last time we saw rates like that it was 1999 and housing prices were a LOT lower in California

• Uncategorized
• Comments(11)

Chuck Ponzi March 11th, 2008

Despite all that you hear and see in the headlines about rising oil and gold prices, we are about to experience the worst deflation in the history of the United States, or at least the 2nd worst after the Great Depression.

I have to write this entry because of the amount of absolute rubbish that I see printed throughout the media and repeated ad nauseum in the blogosphere regarding the money supply and how the recent fed actions are inflationary.

Even with the dramatic action today in the stock market (the last time we saw a 400 point day in the dow was mid 2002, near the depth of the last bear market), the general trend is that the market is quickly siphoning off the dollars put out via the central bank the past 8 years.

Noone now doubts that Greenspan made 2 fatal mistakes that caused the largest bubble in history. First, he brought interest rates too low and held them too long, and secondly and more importantly oversaw the most complete and utter breakdown of lending standards in history. Put together, it pumped too much debt into the system.

This debt became non-servicable from income during a time when debt should have been waning, not peaking since the largest demographic baby boomer bulge is passing into its retirement age. The sad state of affairs of most baby boomers is only a testament to the incredibly poor management of their finances until this point. Several decades of declining interest rates and ever-increasing credit has created a new age of debt serfdom where most can only hope to ever service the debt and hope it never gets called, the serf ever sickens, or misfortune visits a single household.

Put succinctly, increasing the money supply is inflation, deflation is decreasing the money supply. The accomplished blogger Mike Shedlock has made this case quite well, and the facts speak for themselves.

In the deluded minds of those pumping housing, they are hoping that actions by the FED will rescue housing. It won’t. Housing was in a bubble that was reinforced by the increase in money supply, and as long as the money supply is contracting and remaining contracted, we not see a return to the insane days of lending we have seen the past 7 years. This is deflation. Assets going down in value. Housing, stocks… even commodities should be declining. Which brings us to the next bubble… commodities. It was only a matter of time; and frankly I haven’t a clue as to how long it will last. But it’s not ready to pop yet. We are just now getting the first whiff of a bubble; and there will be plenty of time for commodities apologists to scoff it off and disprove recent price action, but let’s not forget the fundamentals… commodities are priced between the cost of production plus normal profits and the cost of alternatives. Gold, corn, rice, sugar, even oil has alternatives, and let’s be honest… we have departed from these fundamentals. It costs approximately $400 to produce an ounce of gold. It costs approximately $4 to produce an ounce of silver. We have all gone mad in the search for the next place to put our dollars. We are living in an inflated world where stocks and housing are no longer considered safe havens after the last 2 bubbles have popped, yet commodities are just warming up.

But, let’s not forget that even with the bubble forming in commodities, it does not yet have a complicit Federal Reserve bank… borrowing for precious metals is much more difficult than leveraging equity in a house or margining stocks; and there are few takers to lend the money in that kind of speculation.

I predict this next commodities bubble will be much shorter than the last 2 and more violent to the participants.

Disagree below.

• Bubble , Inflation , Deflation
• Comments(43)

Chuck Ponzi March 5th, 2008

This Happy Birthday Socal comes to us with 577 days on the market. That’s some serious time waiting for a buyer.

Nice house in Costa Mesa… not upscale like Newport, not clean like Irvine, not breezy like Laguna. But, it was priced like it when it was first listed:

Listing Price History

Currently, the price stands more than half a million lower than it was one year ago without a sale executing yet.

Here’s hoping they make their sale. Good thing they won’t be walking away empty handed.. you know, cause they’re not gonna GIVE it away!

Sales History

I’ll leave you with this moment of zen… is this kitchen overimproved?

Kitchen:

House:

• Happy Birthday SoCal
• Comments(12)

Chuck Ponzi March 4th, 2008

Rarely does the Chuck Ponzi Law of Unintended Consequences have such colorful supporters being quoted in Bloomberg.  Yesterday, Fed Chief Ben Bernanke suggested in a speech to bankers that the best option might be to reduce loan balances rather than pursuing legal foreclosures.

Remember, I stated:

The other is the physics of a forgiveness. Like Newton’s third law of physics, for every action there is an equal and opposite reaction. If Banks believe that they can lose up to 20 or 30% of the value of a home, they will begin to require borrowers to “self insure” by raising collateral requirements to mitigate their new risk. They will also likely offset the risk through higher risk spreads translating to substantially higher rates with stricter requirements for credit worthiness.

Bloomberg quoted the following:

We could not imagine that the policy response would be to pour napalm on the fire,” said Julian Mann, who helps manage $3.4 billion of bonds at First Pacific Advisors LLC. “I’m going to demand higher and higher rates” to buy mortgage debt if the collateral is altered, he said.

Go Julian.

BTW, banks will get their pound of flesh one way or the other.  The only thing left is for the government to start making housing payments for people.  I’d like a little of that action.  My rent is breaking me here in OC.  I’d also like to take a heloc out against my rental, go to Hawaii, buy a Hummer like my a-hole neighbor and have it paid off by the other taxpayers too.  Only, I realized that as a renter, I pay higher taxes anyway… D’Oh.

I guess the only logical conclusion left is to revert to anarchy if that happens.  I’ve been looking around for a good MAK90 like I used to have in college.  It’s hard to believe how much they’ve gone up in recent years.  Good ole Chinese manufacturing practices.

• Lending Standards , Debt , Lizard Brain , Unintended Consequences
• Comments(6)

Chuck Ponzi March 4th, 2008

Is that too dramatic?  I have been too sick lately to post.  Luckily, they say laughter is the best medicine.  Zillow delivered an interesting tidbit to my inbox this morning

Nothing like Zillow to pour some salt in an open wound.  I love the way they can turn the screws… although it’s more like 80 to 90% of the people in Socal who purchased in 06 and 07 now have negative home equity.  Might as well throw in 2005 as well, as the bottom seems to be falling out of the market.

Highly recommended is Rich’s new post up over at Piggington about the crash:

I guess the good news is that in the last 2 years, you’ve only lost about 4 times your yearly income.  That means your income is only negative 2.

• Uncategorized
• Comments(0)