Chuck Ponzi January 12th, 2010

Andy Xie of Morgan Stanley has written some of the best commentary describing the innerworkings and problems of the Chinese bubble (don’t ask me if there is one, although it sounds like there is, I have not done my homework, as I’m sure Andy has).

Some time ago, he wrote Chinese asset markets have become a giant Ponzi scheme that perked up my ears and got me to thinking.

But, his more recent piece in Caing has me thinking he’s talking about Southern California:

The overwhelming desire for getting rich quick dominates every nook, fissure and strata of Chinese society.

Ok, replace “Chinese” with California, and you’ve got a definite match.

Bubbles exaggerate reality but are not formed out of thin air. Cheap money and strong growth are the usual ingredients for bubble-making.

This is almost exactly what I wrote with “What is a bubble?” several years ago.  However, most interestingly is what is happening in China, and happened in California:

China’s property market is creating winners and losers based on timing. All other factors – including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.

This is exactly what happened during Southern California’s property bubble.  Many people got rich simply by being in the right place at the right time.  Many of them were incapable of understanding the circumstances of the rise, and so therefore simply did more of the same (buy real estate) without understanding the underlying problem that widespread repetition of that practice would cause a housing shortage (too many people “storing” housing instead of allowing it to be bought).  Rents reflected the “real demand”, and appreciated strongly.  Meanwhile, properties exploded with enough appreciation in 2 years to account for 30 years of inflation to support the prices.

The most poignant in my mind was a short-sale that Brad (my co-blogger and realtor) and I visited.  The original owner was trying to sell from a purchase made in 1996 at more than 300K lower than the short-sale.  The “owner” was so destitute that when the pool pump broke and they were unable to replace the $800 unit, the resulting ground shift due to hydrostatic pressure when quickly emptying the pool caused many more thousands in damage to the surrounding concrete.  They had been trying to support a 600K+ mortgage with a single income from working at Macy’s.  When regular equity withdrawals worked, the Ponzi scheme continued.

In normal times, the ponzi would have never worked, but because of the bubble, it allowed the “owner” to continue to persist in a property many times more expensive than they could support.  At the peak of the market, this would have sold for more than $1M, requiring the income of several well-paid professionals, not a single retail salesperson’s income.  The world did not make sense in 2006.

This separation of is true of a speculation/investment-centric economy.  This is part of the reason why most people make terrible investors; the concept of time is nebulous and fraught with uncertainty.  Indeed, I wrote (and bolded) in What is a Bubble? the following:

The most fundamental concept of investing is the concept of timing. The most fundamental flaw in most participants logic is that the asset provides more than just money… everything that costs money is an investment and can be traded again for money, nothing more.

This Southern California phenomenon of irrational belief has been covered extensively in another blogger’s repertoire, Irvine Renter’s Southern California’s Cultural Pathology.

We are quickly approaching the Day of Reckoning in our housing market. In my view this will be Armageddon for California debtors: the spending will stop, they will lose their homes and with it their illusion of wealth, and they most definitely will not be enjoying life. The cause of all the weeping and gnashing of teeth will not be some exogenous event, but rather a direct result of the circumstances they themselves created.

My thoughts exactly.

• Credit Bubble , Housing Crash , Speculation , Unemployment
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Chuck Ponzi October 22nd, 2009

“We didn’t truly know the dangers of the market, because it was a dark market,” says Brooksley Born, the head of an obscure federal regulatory agency — the Commodity Futures Trading Commission [CFTC] — who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country’s key economic powerbrokers to take actions that could have helped avert the crisis. “They were totally opposed to it,” Born says. “That puzzled me. What was it that was in this market that had to be hidden?”

• Bubble , Debt , Deflation , Delusion , Speculation , Unintended Consequences
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Chuck Ponzi May 6th, 2009

Don’t think it can happen in prime areas?

This Newport Beach residence sold for 2.5M in August 2006.  It’s now for sale for $781,000.

One might consider buying this just to rent it out and sell it later on to a developer.

Contrary to my first thought, it’s not trashed inside:

Better like some traffic noise, though.  It backs to Newport @ Via Lido.  Nice weather, too bad you won’t want to open your windows.

• Housing Crash , Speculation
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Chuck Ponzi February 18th, 2009

• Psychology , Speculation
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Chuck Ponzi December 22nd, 2008

Over 3 1/2 years ago, I posted my first “Jobs, Jobs, Jobs, Recovery to Crash” post and followed up when layoffs began in 2006 to corresponding residential lending.

My basic premise was that housing created a lot of imbalances, most notably in job creation.  This included both traditional construction jobs as well as well paid professional jobs in lending and real estate sales.  At the time, the ranks of California realtors had swelled to nearly one in every 50 adults in California, and loan brokers were probably not far behind.  This not only supported high prices, but also ensured that even a slight downturn in one would result in a crash for the other.  Indeed, when sales volumes hit their lows last year, it was hard for many real estate agents, or even loan brokers to continue to exist which is evidenced by the Lender Implode-o-Meter.

Today’s news comes from the Inland Empire (and Coachella Valley), which is now sporting some impressive (if downright incredible statistics):

This corner of Southern California had the highest unemployment rate of any area with 1million or more people in the United States — including metropolitan Detroit.

“We are the epicenter of the economic crisis in this country,” said John Husing of Economics and Politics Inc., a leading regional economist.

Federal labor statistics showed the two-county Riverside-San Bernardino area that includes the Coachella Valley with 9.5 percent unemployment in October, compared to 8.8 percent in metropolitan Detroit.

What’s interesting is how much previous forecasts from so many economic think tanks based in SoCal were based on strong employment numbers.  While this has steadily worsened, it has not been completely unseeable; I saw it developing more than 3 years ago when I first began the blog as an outsider to the housing market.  Shouldn’t more have seen it coming?  I would argue no, due primarily to groupthink, and that we are generally programmed in larger groups to not question authority unless that kind of activity is rewarded; something that cannot be said about the last 30 years.  Most Americans have been told to shut up, sit down, and take what we give to you.  However, this blog is not about social commentary; greed is more of an objective observation to me since it motivates people.  Understanding others’ motivations will ensure you can achieve what you want.

Which after all, leads us to the basic questions posed by Southern Californicators:

1.  If we came to SoCal for the jobs, and they’re no longer here, why are we still here?

2.  If there are no jobs (or the ones available are transitory) why does it cost so much more to live here than anywhere else?

3.  Can weather pay the bills; house payment, electric, water, gas, and taxes?

4.  If weather can pay the bills, what about places with crappy weather like the IE?

5.  Also, if weather can pay the bills, what about cheap places with good weather like Florida?

6.  Oh, yeah, can’t forget the once-in-a-lifetime opportunity to have your life destroyed by a massive earthquake.

All of these questions have in the past kept SoCal home prices pretty well tethered to similary type-housing prices in other states.  And why did they go so out of whack this time?

Was it Subprime?  No, that wasn’t widespread enough, since only a small percentage of the people were getting subprime loans.

Was it Option ARM?  Maybe, but that’s a Ponzi scheme that requires a lot of confidence that others have more than you.

Was it Loosening Standards?  Maybe, but then you gotta be able to pay off that note.

I believe, in the end, the only conclusion that one can come to after so many other possibilities is that people were irrationally optimistic about housing.  Just like internet stocks in 1999.  Just like Tulips in the 1600’s.  We really have learned nothing, and many will lose their entire lives’ savings from it.  Hopefully, most of the innocent can keep their jobs, but I’m not optimistic.  I believe unemployment will get worse before it gets better.

• Bubble , Lending Standards , Speculation
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Chuck Ponzi June 19th, 2008

I always said we didn’t have a bubble until we had some perp walks.  These are from today thanks to Bloomberg:

Ralph Cioffi

Matthew Tannin:

The NYT has a great piece on the indictments of former Bear Stearns Fund managers.

In an April 22 e-mail from Mr. Tannin — which the indictment said was sent not from Mr. Tannin’s account at Bear Stearns, but from his personal account to the personal e-mail account of Mr. Cioffi’s wife — Mr. Tannin wrote:

the subprime market looks pretty damn ugly… If we believe the [CDOs report is] ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [the CDO report] is correct then the entire supbrime market is toast… If AAA bonds are systematically downgraded then there is simply now way for us to make money — ever.

Three days later, Mr. Cioffi and Mr. Tannin hosted a conference call for investors in the funds. This time, his tone was very different.

Lying openly like that to garner more money needs to be treated pretty harshly.  Maybe some in the securitization business can get some religion.  If not, they can always find Jesus in the clink.

• Bubble , Speculation , SubPrime
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Chuck Ponzi May 13th, 2008

There are 2 must-reads for the future of foreclosures:

1. Calculated Risk has a great visual of projected 2008 foreclosures in “1000 Foreclosures per Day in California”

2008 is off the charts. Anyone calling a bottom at this point doesn’t have the facts straight. Notice of Defaults are projected at over 450K based on Q1 data. You may start to see some houses make sense in pricing, but there’s no doubt we’re going to overshoot fair valuation on the way down this time. No doubt at all.

2. The second one is Mr. Mortgage’s videolog and blog where he recieved California Foreclosure stats from Foreclosure Radar 2 days early. You can alternatively read it here
if you cannot access youtube. (at work, anyone?)

Some great excerpts:

we will have approx 122,000 units slamming the CA auctions over the next 4 months.

That’s over 1000 per day. That’s making the 90’s bust look like a walk in the park. However, when one considers that it is likely that more than half of all purchases within the last 3 years were speculative, the toll is likely largely hitting only those who took excessive risk. Boo Hoo.

Remember to visit Angry Renter. Please be sure to check out ways to contact your local representative to voice your opinion against any kind of government intervention. The invisible hand of the market is in the process of sifting the wheat from the chaff.

In California, renters and homeowners with no mortgage outnumber by a wide margin the number of reckless individuals who overextended themselves. Don’t let yourself be duped into inaction. I’ll post more on specifics later.

• Foreclosures , Speculation , Unintended Consequences
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Chuck Ponzi May 13th, 2008

This is a travesty.

No mortgage bailout! None at all! Not to striving homeowners, not to the insanely-paid CEOs. Risk has penalties too.

Here’s our typical homeowners:

Here’s the problem with CEOs:

• Bubble , Housing Crash , Psychology , Speculation
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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.“

• Debt , Deflation , Mean Reversion , Speculation
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Chuck Ponzi February 22nd, 2008

The Chuck Ponzi Law of Unintended Consequences is alive and in full force. I had to whip it out another time when Congress started considering the subprime rate freezes. And now, it rears it ugly head again and I am forced to once again remind people how “helping” most often ends up just hurting people.

Remember the original rule:

If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.

I had to later add:

while you may need to pay for it, anything other than letting the market deal with it efficiently will likely crash it anyway

This time, I’ll have to add the following:

And messing with it will make it crash harder than if you had just kept your stupid nosy butt out of it.

and that’s how I can frame the message to those reading the MSNBC article about “saving” people from their underwater houses.

The current plan to “save” homedebtors is to “forgive” the amount that borrowers are underwater. Meanwhile, the Jeffrey Birnbaum seems to take the tack that we should be poopooing on the stupid lenders for lending that amount in the first place. Naturally, banks are fighting it. In the short run, this “solution” becomes their problem. Unfortunately, in the long run, it becomes everyone’s problem.

The legislation would allow bankruptcy judges for the first time to alter the terms of mortgages for primary residences. Under the proposal, borrowers could declare bankruptcy, and a judge would be able to reduce the amount they owe as part of resolving their debts.

There are at least 2 significant problems with this solution.

1. There is a moral component to paying back what you owe. It is supremely unfair to prudent citizens when gamblers and speculators are saved from their own poor decisions. But, it goes further than that; this bailout encourages more risk taking and gambling – a term referred to as moral hazard. The fear is that open risk taking can create systemic risk that at some later date cannot be bailed out; the captains must go down with the ship.

2. 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.

Consider who this is attempting to help:

The Democrats and their allies see the plan as an antidote to the recent mortgage crisis, especially among low-income borrowers with subprime loans. The legislation would prevent as many as 600,000 homeowners from being thrown into foreclosure, its advocates say.

The poor? Who would least likely be able to handle an increase in the collateral requirements and interest rates set forth for the purchase of a home? My belief is that if this law is passed, it will severely deepen the housing crisis. Indeed, this will likely make the housing problems a super-crisis; akin to raising interest rates in a deflationary environment. This would mean not only that we would be erasing all of the gains of the bubble, but likely much, much more. If first-time buyers were required to save 20% collateral again, it would literally shut down the first-time homebuyers in Southern California. It would not return to the existing levels for perhaps another generation as the system cleanses itself. All of the increased savings would have a positive effect of actual savings, but it would create a severe recession since consumers would need to retrench and cut off discretionary spending. We could easily see homeownership rates erode by 10% or more over the coming decade of turmoil.

This “solution” is quite possibly the worst kind of consequence in itself. It will crash housing markets in high-priced locales and deepen the coming recession throughout the country. I’m a fan of just letting the markets right themselves and sort out the mess itself. Any kind of well intentioned tinkering will only make the problem worse. The time to act is past and cannot be recaptured. The right time to fix the problem was to prevent it in the first place.

Unless the US Government wants to become the lender of last resort (see the discussion of systemic risk) and to personally insure low collateralized mortgages in an inflated market, there is no way this legislation cannot wipe out innovative lending. All of the lending and borrowing participants will have been crowded out by risk aversion.

Let’s hope that our government is aware enough to see what this would do and kill this legislation before it becomes a reality.

Don’t get me wrong, I’m no banksters apologist. They are greedy, self-serving, and destructive. Their moral compass is broken and their money guides their actions. Congress, unfortunately are worse. They work with a corrupt moral compass and other people’s money.

Here’s hoping that if Congress can’t pull their heads out of their collective asses that President Bush has enough sense to wield the necessary veto rights. The very civil liberties of property rights must be protected; both for individual citizens and corporations. Once we take it from one class, we can take it from others; it’s only a matter of time before we find a reason to.

• Housing Crash , Lending Standards , Speculation , Unintended Consequences
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