Chuck Ponzi February 24th, 2009

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Chuck Ponzi February 23rd, 2009

What is magical thinking?  It is a detachment of causality from the source of an action.  It is simply, to believe that if certain conditions are met, a natural outcome is to be expected.

Magical thinking comes in many flavors, but isn’t entirely unuseful.  It helps when systems are so complex that it would take so much time to simply understand the system of events required that it would be impractical to act before a rational decision could no longer be effective.  Much of what we see today in public economic forums is massive amounts of magical thinking.  That somehow, if we meet certain conditions of yesteryear, we will “put a floor” in on home prices, the stock market, and the economy as a whole.  Unfortunately, we are in some cases only delaying the inevitable, and in many cases worsening the outcome of the housing bubble.

In a rational, efficient market, participants act in a personally beneficial way.  Often, when participants act in a personally beneficial way, this benefits society as a whole.  However, because the system of decisions needed is inherently complex, a bit of the system sometimes needs to be mentally “fudged” to make the whole issue work.  This is often what people mean when they refer to the “50,000 foot view”.  In centralized organizations, a leader with this type of view depend on their underlings being able to translate this kind of vision with on-the-ground experience to execute the plan.

Some examples that have recently come to the forefront:
1.    Provide a tax credit to homebuyers

2.    Banks failures cause more hardship than paying to save them

3.    Large industrial producers cannot be reduced because they will crash our economy

Tax Credit to Homebuyers:

Unfortunately, it appears that we have more turned into a Cargo Cult that focuses not on the productive activities, but to somehow hearken back the golden days of yore through repeating the same stupid rituals that brought the original cargo planes and our former riches.  This is a complete erosion of the American fabric; a lie to western peoples that economists know the way out better than prudent business people.

Many in the government have noted that in the last 20 years, rising home prices produced a large benefit to homeowners.  They were able to borrow against their houses to fund growth in the economy.  The solution to our ailing consumption, it must mean, that houses are undervalued and need to be propped up.  Never mind that the last 20 years has been an historical aberration, a flyspeck on the overvalued of all overvalues.  In our current policy, “reversion to trend” means an upward reversion of the home price appreciation to +10% per year.  No matter that in many locales in the US, our incomes have not kept pace with the cost of homes and therefore we are already dedicating too much of our income to housing.  We all need a REDUCTION in home prices for consumer spending to increase.  Anything else (such as increased incomes) would put us as a country even further behind in competitiveness with respect to global wage arbitrage.  I’m not a purist in the sense that I feel that we need to have a large manufacturing base, but our economy has got to consist of more than trading houses and debt amongst ourselves.  The longer we wait to realize this and return incentives to work, risk, and honest reward, the more we as a country suffer.  There should never be a return to leisurely earning above the rest of the world because there is no such thing as barriers to entry in the long run.  Eventually, our wealth will be eroded if we do not continue to maintain a global competitive advantage (and I don’t mean in financial engineering).

People are currently rational.  They’d love nothing more than to return the heady days of 2007 where they spent willy-nilly on consumer goods.  They really would, but they also realize that the only way to do that is to reduce their consumption of something else.  Something that doesn’t produce much satisfaction in their lives: housing.

Bank Failures

This is perhaps one of the most prevalent of magical thinking.  In the participants mind, the bank failures of the 1930’s created a fear of banks when they failed.  At that time, this had 2 effects:  1.  People would have rather stuffed the money in their mattresses, collapsing monetary velocity and trade.  2.  This collapse of bank deposits put otherwise healthy banks in a more precarious positions since they could not maintain adequate reserve ratios and were then insolvent.  I believe that we do not have this type of environment, partially because of the lessons learned over the past 80 years.  The FDIC creates a kind of buffer that assures accountholders that their money is safe (within limits)  Most can ensure all of their money is safe by maintaining multiple accounts at multiple banks.  People do not want money stuffed in their mattresses, and will only do so if they believe the government will begin to confiscate it.  Harebrained ideas such as an asset tax or cash taxes will assuredly collapse velocity and many banks along with it as depositors choose to stuff Ben Franklins in their pillow cases.

Today’s problem has little to do with the same problems as the 1930s.  Today, the mark-to-market accounting rules have substantially decreased the value of assets that depositors’ money was attached to while bank deposits have not done much.  However, most of those assets should never have been purchased because they were junk to begin with.  Most were a Ponzi Scheme where the greater fool needed to come along before their next balance sheet review or FDIC stress test.  In the past, the FDIC would sieze the bank and sell off the parts, making the secured creditors partially whole and making the equity holders eat dirt.  The shortcomings on depositors would be made whole by the FDIC before anyone else.

Circumventing normal market clearing practices for these liabilities and assets will ensure that the required write-downs necessary to produce never happen and that the remaining “Zombie Banks” will continue in perpetuity with damaged assets; unable to lend due to the need to recapitalize.  More importantly, (or at least as important), the current leadership fails to be deposed; ensuring the problems of yesteryear are never allowed to become discovered and the organization can never move on from prior mistakes.  The leadership is every bit as damaged as the assets the banks hold.  To keep them in place is to reward bad behavior and ensure that we do not have a return to long-term profitable business practices.

Our current populace is engaging in magical thinking to believe that if we just keep the banks alive for a little while longer that they will be able to return from the dead.  The only result will inevitably be zombies; having the appearance of life, but dead and hungry for brains.

Large Industrial Producers

This one is about GM.  I believe this one to be a very different animal than banks and requires a more sophisticated resolution; but let’s be clear: allowing GM to continue to operate without destroying the unions as they now exist is in effect transferring taxpayer money directly to GM union workers.

At the present time, bankruptcy for GM holds 2 major obstacles that are not related to the above
1.    No sufficient Debtor In Posession (DIP) financing exists in the private sector.  Without government intervention, GM could only progress directly to Ch7, which would be a shock to the economy.
2.    Even progressing to a Ch11 bankruptcy protection shows that consumers would likely boycott GM products as a safety measure.

Therefore, you can see that a traditional bankruptcy for GM is not an option if we do not want to add several hundred thousand directly to the dole and probably reach several million before all is said and done.

In the 80’s Chrysler was bailed out with a loan from the government.  It is simply magical thinking to believe that we can make a loan with attractive terms and the whole problem will go away.  The issue is that with each infusion, the company becomes more dependent on the donor.  We are raising a vegetable company.  Therefore, the problem must be attacked with swiftness and exactness.  Most importantly, the 30 and done has to be removed and made retroactive.  Sorry, you shouldn’t be able to retire until 70, and if that sucks, it sucks; get a job lowlife.  None of the rest of America has a cush job with secure retirement; you won’t be getting it either.  Sorry.

However, doing nothing while making large loans that go directly to pension beneficiaries is inherently unfair to workers everywhere and distorts normal competitive markets.  With the kind of money that GM is getting, many skilled could come forward and rebuild a competitive auto company.  The failed leadership that has complained about the problem yet done thing for the last 30 years while foreign competitors ate our lunch cannot be rewarded, nor should bondholders who are essentially being treated like Treasury holders be either.

In conclusion:

I believe our country’s leadership is unable to see how the magical thinking of today will translate into actionable items of tomorrow either because they fail to see personal motivations of participants, or because they have failed to see the solution and worked their way back putting into place contingency plans.  Until we have a workable solution, we will continue to pour money down the drain and extend the recover further.

• Bailout , Credit Bubble , Deflation
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Chuck Ponzi February 20th, 2009

A short pictorial of the coming pain.

This is why there is no bottom in Southern California in 2009 or 2010:

Reason 1:

Reason 2:

Reason 3:

Reason 4:

We haven’t even seen the worst of what is to come here.  Coastal areas are the next to be hit; look at the map of misery.

• Foreclosures
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Brad_Davidson February 19th, 2009

Only 1690 homes are listed as closed sales on the OC MLS in January and the median price of those sales took another huge hit. $358,000 was the median sales price of all closed sales as reported on the MLS. That number is lower than any pending sales price I’ve tracked so far. The Data Quick number about to come out will probably be in the $375,000 range either number is a big hit from the December figures.

The median list price of pending sales seems to have stabilized a bit and ticked up to $370,000. I don’t think it points to any sort of market wide stabilization as I have three bedroom single family homes in escrow in Anaheim and Placentia at $237,000 and $270,000 respectively. Those are low prices that make sense for investors who can rent those properties and get a decent cash flow.

I know of a two bedroom condo in Laguna Hills that’s in escrow for $119,000. The low end of the market is still getting clobbered but I’m seeing more sales in the over $600,000 market for homes that were previously selling for over $800,000.

I’m afraid that our government is going to screw things up and prop up over extended home owners. The market is working just the way it’s supposed to with buyers scooping up what they perceive to be good deals on foreclosures. If the Fed’s start rewriting the bad loans people took out they had better rewrite mine too.

Brad Davidson
We Help-U-Buy Realty

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Brad_Davidson February 19th, 2009

Every once in a while, I find a comment on a blog that captures an important thought. This one comes’ from Wally on The Big Picture

The systemic risk is that since credit = debt = money, we can pretend that there is more of it than is possible. That is because debt cannot exceed some fraction of the potential future amount of work. When it approaches that point, confidence collapses and the debt is destroyed. We have gone through this over and over and over in history. The hot fad now is to think government can alter this cycle by creating even more debt. The answer to that is : ha ha ha ha. Think it over: by preventing the destruction and extending the time frame of debt (by financing with future deficits) the government lengthens the process, as it did in the 1930s, rather than decreases it.
We are in for a loooonnnnnnnng one this time.

That is why we are just fiddling while Rome burns.  Twist from Housing Doom had it right: what we need right now to fix the housing market is MORE Foreclosures, not LESS.

• Contrary Indicators , Deflation , Denial
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Chuck Ponzi February 18th, 2009

• Psychology , Speculation
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Chuck Ponzi February 18th, 2009

Hint:  It’s not from our own corrupt government; and I think the answer will surprise you:

Ladies and gentlemen,

Unfortunately, we have so far failed to comprehend the true scale of the ongoing crisis. But one thing is obvious: the extent of the recession and its scale will largely depend on specific high-precision measures, due to be charted by governments and business communities and on our coordinated and professional efforts. In our opinion, we must first atone for the past and open our cards, so to speak. This means we must assess the real situation and write off all hopeless debts and “bad” assets. True, this will be an extremely painful and unpleasant process. Far from everyone can accept such measures, fearing for their capitalisation, bonuses or reputation. However, we would “conserve” and prolong the crisis, unless we clean up our balance sheets. I believe financial authorities must work out the required mechanism for writing off debts that corresponds to today’s needs. Second. Apart from cleaning up our balance sheets, it is high time we got rid of virtual money, exaggerated reports and dubious ratings. We must not harbour any illusions while assessing the state of the global economy and the real corporate standing, even if such assessments are made by major auditors and analysts.

In effect, our proposal implies that the audit, accounting and ratings system reform must be based on a reversion to the fundamental asset value concept. In other words, assessments of each individual business must be based on its ability to generate added value, rather than on subjective concepts. In our opinion, the economy of the future must become an economy of real values. How to achieve this is not so clear-cut. Let us think about it together.

Third. Excessive dependence on a single reserve currency is dangerous for the global economy. Consequently, it would be sensible to encourage the objective process of creating several strong reserve currencies in the future. It is high time we launched a detailed discussion of methods to facilitate a smooth and irreversible switchover to the new model.

Fourth. Most nations convert their international reserves into foreign currencies and must therefore be convinced that they are reliable. Those issuing reserve and accounting currencies are objectively interested in their use by other states. This highlights mutual interests and interdependence. Consequently, it is important that reserve currency issuers must implement more open monetary policies. Moreover, these nations must pledge to abide by internationally recognised rules of macroeconomic and financial discipline. In our opinion, this demand is not excessive. At the same time, the global financial system is not the only element in need of reforms. We are facing a much broader range of problems. This means that a system based on cooperation between several major centres must replace the obsolete unipolar world concept. We must strengthen the system of global regulators based on international law and a system of multilateral agreements in order to prevent chaos and unpredictability in such a multipolar world. Consequently, it is very important that we reassess the role of leading international organisations and institutions.

If only we could have this kind of leadership in this country.  I was convinced that Obama would not simply revert to politics as usual, and my hopes have been severly dashed.  We are screwed up more than I thought.  You cannot fix free markets with state intervention; our speaker will attest to that.

• Denial , Housing Crash , Panic
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Chuck Ponzi February 17th, 2009

It seems like our country (and state) aren’t able to run on much more at this point.

Of course, I wonder how much is right now buyer’s remorse… not that the options were all that great to begin with.  I oscillate between extreme optimism and pessimism.  Perhaps I need to stop reading so much.  Just bums me out.

Isn’t that what puntcuates market bottoms?

Mr. Obama… that housing thing.  Let housing prices fall to market clearing levels.  All this messing around only lengthens the recovery and makes it deeper than it otherwise should have been.  Be a leader.

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Chuck Ponzi February 11th, 2009

Word is out that the stimulus package is set to pass or has already passed congress.

At least insult wasn’t added to injury through the $15K credit being discussed the last few days.  That’s the current meme, and I wouldn’t be surprised if that later gets added to the next pork stimulus package.

Which should remind us what stimulus is supposed to be about:

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Chuck Ponzi February 10th, 2009

Dean Baker says it best, if you ask me once I found out that the $15K credit was not only open to first-time buyers, but all home buyers:

Still, many critics doubt that the credit will have as deep of an impact as Yun and Howard predict – and some have been scathing in their critiques. “This is the biggest, most hare-brained scheme,” said Dean Baker, the co-director of the Center for Economic and Policy Research. “If this passes, I’ll be amazed.”

One major objection is that the credit is available to existing homeowners, who would essentially be selling house A to buy house B and thus have no stimulus impact on the economy. Baker called it a “house-flipping subsidy.”

Plus, he added, it gives a credit to others who would buy anyway.

“I actually like this bill,” Baker said sarcastically, “because, with home prices in Washington plummeting, I’m considering buying a house.”

He also raised the possibility that it could be gamed: What’s to prevent two people from selling their houses to each other, in name only, just to claim the $15,000 each?

Dean Baker is right: this is a gimme for real estate agents who earn a commission for each and every sale.   It promotes flipping (and adding as much inventory as it gets rid of).  There is no incentive for a first-time homebuyer that will actually reduce the inventory, since as soon as the stimulus is gone, prices will fall to reflect the new reality (likely at least $15K).

This is proof positive that the only proper action is to let home prices fall to their market-clearing price.  Any attempt to influence when that happens extends the recovery.  Sad, really sad day for American taxpayers.

• Unintended Consequences
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