Notorious R.O.B.

Conversations about the real estate industry, marketing, technology, and public policy

Sep 23, 2008

Into the Maelstrom, We Go

There, but for the grace of God, go I.

There, but for the grace of God, go I.

If you are at all interested in the real estate industry, then you need to be reading Dan Green on a regular basis. I just met him at RE Blogworld, and have put his blog into my reader ASAP (and linked it here). Dan is brilliant, and understands the financial markets and mortgage markets better than most people in the world.

And even he finds himself getting verbal whiplash these days from having to contradict himself more than Obama does.

Exhibit 1: Dan’s post of Sept 16, 2008 titled, “How Mortgage Rates Are Responding To Lehman Brothers, Merrill Lynch, And AIG” which says, in part:

It’s a shame because the post went deep on Wall Street’s recent troubles and how each piece of bad news actually helps everyday homeowners. When I went to publish, the post vanished. And by that point, markets were already open, mortgage rates were already plunging, and I wanted to be the phone with clients. I did manage to Twitter, however.

A one-paragraph recap follows:

The government’s takeover of Fannie Mae and Freddie Mac rendered mortgage bonds among the safest investments in the world. Therefore, when political or economic uncertainty exists, mortgage rates should fall in safe haven buying.

The post was especially timely because safe haven buying driving mortgage rates down yesterday. As the stock markets shed $800 billion in value, investors moved into safer instruments like bonds — including mortgage bonds. With more demand, prices were up and rate were down. And how.

Because mortgage debt is now government-guaranteed, the sell-off in stocks was terrific news for both active home buyers and for homeowners that missed last week’s gold rush. However, it did little to soothe Wall Street’s nerves. That job falls to Ben Bernanke.

Then, a mere seven days later, on Sept 23, 2008, Dan posts “Mortgage Rates Respond To A Rapidly-Devaluing U.S. Dollar” which says in part:

And lastly, the mortgage market got hit.   Because mortgage bonds are repaid in U.S. dollars, the value of those repayments dropped.  This forced mortgage rates higher because the only way to entice investors to buy devalued mortgage-backed bonds is to offer them with a higher interest rate.

If you’re wondering why conforming mortgage rates are up by 0.750 percent since last week, this is it — it’s because mortgage rates are responding to the expectations of a weaker dollar going forward.  This is the reverse of what happened in August.

Simply amazing, in part because Dan is spot on, and in part because politicians in government simply do not seem to understand the economy and markets, despite being Wall Street tycoons and brilliant academics and the like.

Why wouldn’t inflation rise when the government has just signed a blank check to big American corporations?  Of course it would.  And as inflation rises, interest rates — including mortgage rates — are bound to go up as well.  People don’t enjoy getting paid 10 years out in dollars that are worth half what they are worth today, do they?

This whole fiasco with the bailout reminds me of my favorite Thomas Sowell quote, “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”

At the Blogworld event that just happened, the panelists on the Financial Blogs panel were unanimous in excoriating the government — and they appeared to be politically all over the board — for its latest actions in intervention.  One panelist called it (paraphrasing) “the absolute triumph of socialism.”

I think we’re seeing the absolute triumph of idiocy as well — and all parties, all branches of government, are indicted in this.

Until things stabilize — and no one knows when that will be — we’re in for a wild ride.  The markets behave in unpredictable (although common-sensical) ways to economic shocks like a $700B bailout of financials by the government.

But a couple of things seem possible, at least when one thinks about our industry.

1.  If it was hard to find buyers who can afford to buy houses before, I’m thinking it’s going to get more difficult, not less, going forward.  Even if the removal of junk mortgages from the market (thanks to the taxpayer bailout) means banks can breathe easy again, the inflation-induced rise in mortgage rates (combined with the shellshock of banks coming out of this mess) likely means fewer buyers for homes.

Of course, that means home prices are about to take another pounding.  If I were a seller, I’d be shaving another several thousand dollars off the listing price right about now.

2.  Selling a house in today’s environment — unless you absolutely have to — became far more complicated and likely less attractive.  For example, I locked in 30-year fixed rates long  before this crash (something in the 6% range, I believe).  Inflation could very well hit 6-7% annually, as most financial experts appear to think the $700b figure is actually the floor not the ceiling of this bailout.  If inflation = my interest rate, then my loan is effectively free.  Unless I can get a bank to give me free money (zero-interest loans) to buy my next house, I just can’t see how it benefits me to be selling in this market.  At all.

All in all, I have a feeling that realtors are going to have to get educated on this in a hurry.  Some of them really understand finance, the markets, and macroeconomic factors and may be able to help clients make the right decision.  But the ones who think “yield” is only a street sign are going to have a tough time getting people to trust them as real estate experts.

As Alex Periello likes to stress, real estate markets are all local.  That remains true, of course.  But giant macroeconomic factors will play a role, at least if your client is paying in (or looking to get paid in) U.S. Dollars.  It’s high time to get boned up on financial matters.

-rsh

Related posts:

  1. In Which I Support Government Bailout of Foreclosed Homeowners
  2. What Am I Missing Here: Multifamily Loans Down 63%?
  3. Washington Post and Assumptions

Category: Real Estate

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  • http://blog.homegain.com/ Louis Cammarosano

    Rob
    I am not sure inflation is inevitable.

    Traditional “causes” of inflation include low unemployment and increased consumption. These two factors are minimalized in the current environment as credit is harder to get, consumption will be curtailed and unemployment will rise.
    Indeed, if home prices decrease, why should other prices rise.

    Paradoxically, we had high consumption and low unemployement in the late 90′s and we saw no significant increase in inflation.

    Not to worry, if we get inflation, we can always recommend what Gerard Ford did- wear WIN buttons (Whip inflation Now) http://en.wikipedia.org/wiki/Whip_inflation_now

    or we can more to the SALT standard-prices of salt have remained constant throughout the past century or two…

  • http://blog.homegain.com Louis Cammarosano

    Rob
    I am not sure inflation is inevitable.

    Traditional “causes” of inflation include low unemployment and increased consumption. These two factors are minimalized in the current environment as credit is harder to get, consumption will be curtailed and unemployment will rise.
    Indeed, if home prices decrease, why should other prices rise.

    Paradoxically, we had high consumption and low unemployement in the late 90′s and we saw no significant increase in inflation.

    Not to worry, if we get inflation, we can always recommend what Gerard Ford did- wear WIN buttons (Whip inflation Now) http://en.wikipedia.org/wiki/Whip_inflation_now

    or we can more to the SALT standard-prices of salt have remained constant throughout the past century or two…

  • http://www.homegain.com/ Louis Cammarosano

    Rob

    I am not sure inflation is inevitable.

    Traditionally, inflation rises when unemployment decreases and consumption increases.

    Currently we are moving the other way on both fronts.
    While interest rates may decline, the availability of credit won’t get any easier, so consumption fueled, full employment inflationary pressures won’t exist.

    If housing prices drop, why would other free market items (other than oil) rise?

    Predicting inflation is difficult. In the late 1990′s we had exactly the supposed toxic inflationary cocktail of full employment and an internet bubble inspired consumption boom and yet there was no inflation.
    Conversely you had people out of work in the late 70′s, hunkering down, clipping coupons and gas rationing and inflation was rampant.

    Remember Gerry Ford’s WIN buttons? (Whip Inflation Now)

  • http://www.homegain.com Louis Cammarosano

    Rob

    I am not sure inflation is inevitable.

    Traditionally, inflation rises when unemployment decreases and consumption increases.

    Currently we are moving the other way on both fronts.
    While interest rates may decline, the availability of credit won’t get any easier, so consumption fueled, full employment inflationary pressures won’t exist.

    If housing prices drop, why would other free market items (other than oil) rise?

    Predicting inflation is difficult. In the late 1990′s we had exactly the supposed toxic inflationary cocktail of full employment and an internet bubble inspired consumption boom and yet there was no inflation.
    Conversely you had people out of work in the late 70′s, hunkering down, clipping coupons and gas rationing and inflation was rampant.

    Remember Gerry Ford’s WIN buttons? (Whip Inflation Now)

  • http://robhahn.wordpress.com -Rob

    Louis,

    I subscribe to the Friedman description of inflation, as articulated by Thomas Sowell:

    An increase in the amount of money, without a corresponding increase in the supply of real goods means that prices rise – which is to say, inflation. (Conversely, when output increased during Britain’s industrial revolution in the 19th century, its prices declined because its money supply did not increase correspondingly.)

    Basically, inflation isn’t caused by employment but by the government printing more money in lieu of raising taxes (which depresses consumption and investment).

    In the current case, I can’t think of what real goods or services have been added to the economy to the tune of $700B that corresponds to the increase in the money supply by the same amount. So either the Feds will have to raise taxes (to the tune of roughly $2,300 for every man, woman, and child over the course of this bailout, assuming it only costs $700B) or they’ll simply print money, which it can do simply by making an entry into the computers at the Fed or at Treasury.

    If the latter, then we’re looking at inflation.

    Housing prices can drop simply because the banks, figuring on higher inflation, need to charge higher rates of interest in order to offset the impact of inflation. That means fewer borrowers, and fewer buyers — which means price pressure on housing.

    At the same time, other goods and services have not increased. We haven’t seen any major increase in productivity to warrant a $700B injection into the economy. So, with more dollars chasing the same amount of goods and services, inflation is almost inevitable.

    -rsh

  • http://robhahn.wordpress.com/ -Rob

    Louis,

    I subscribe to the Friedman description of inflation, as articulated by Thomas Sowell:

    An increase in the amount of money, without a corresponding increase in the supply of real goods means that prices rise – which is to say, inflation. (Conversely, when output increased during Britain’s industrial revolution in the 19th century, its prices declined because its money supply did not increase correspondingly.)

    Basically, inflation isn’t caused by employment but by the government printing more money in lieu of raising taxes (which depresses consumption and investment).

    In the current case, I can’t think of what real goods or services have been added to the economy to the tune of $700B that corresponds to the increase in the money supply by the same amount. So either the Feds will have to raise taxes (to the tune of roughly $2,300 for every man, woman, and child over the course of this bailout, assuming it only costs $700B) or they’ll simply print money, which it can do simply by making an entry into the computers at the Fed or at Treasury.

    If the latter, then we’re looking at inflation.

    Housing prices can drop simply because the banks, figuring on higher inflation, need to charge higher rates of interest in order to offset the impact of inflation. That means fewer borrowers, and fewer buyers — which means price pressure on housing.

    At the same time, other goods and services have not increased. We haven’t seen any major increase in productivity to warrant a $700B injection into the economy. So, with more dollars chasing the same amount of goods and services, inflation is almost inevitable.

    -rsh

  • http://blog.homegain.com/ Louis Cammarosano

    I agree with all of the above EXCEPT the $700 billion is not a stimulus package that will have the effect of pouring “cheap” money in to the system. This is not a measure that ADDS cash to the money supply.

    Rather, the $700 billion as I understand it is a stop gap, a prop up of the banks. It will go towards taking the toxic paper off the banks that made the ill advised loans and putting it into the US government hands so the banks can continue to operate.

    No new money will be put into the economy. Indeed there will be strings attached to the money in the form of lower executive compensation and tighter lending requirements.

    This all should have the impact of making the purchase of goods and services more difficult than it is today. The alternative to not providing the relief to the banks is a crippled banking system where access to capital would be even more limited. In such cases, DEflation is a risk.

  • http://blog.homegain.com Louis Cammarosano

    I agree with all of the above EXCEPT the $700 billion is not a stimulus package that will have the effect of pouring “cheap” money in to the system. This is not a measure that ADDS cash to the money supply.

    Rather, the $700 billion as I understand it is a stop gap, a prop up of the banks. It will go towards taking the toxic paper off the banks that made the ill advised loans and putting it into the US government hands so the banks can continue to operate.

    No new money will be put into the economy. Indeed there will be strings attached to the money in the form of lower executive compensation and tighter lending requirements.

    This all should have the impact of making the purchase of goods and services more difficult than it is today. The alternative to not providing the relief to the banks is a crippled banking system where access to capital would be even more limited. In such cases, DEflation is a risk.

  • http://robhahn.wordpress.com/ -Rob

    It’s entirely possible (even likely) that I have no idea what I’m talking about, as I’m no banker, and have merely a layman’s knowledge of the financial systems.

    Having said that, I just don’t see how buying up toxic assets with USD is anything BUT adding cash to the money supply.

    The classic money supply operations has the Fed buying treasuries from the banks that hold them: it takes the bonds off the market, and credits the bank with USD in their account.

    How would this be any different?

    Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.

    As far as I understand it, that is precisely the mechanism for how the bailout plan is supposed to work.

    If so, I just don’t see how this is NOT adding new cash to the money supply. I just don’t see how this is NOT adding new money into the economy.

    Inflation, then, absolutely has to be the result. There will be more USD in the money supply than there are goods and services — after all, it isn’t as if we’ve had $700B worth of new goods and services added to the economy overnight.

    If we do not do the bailout, then yes, deflation becomes a risk, as banks fail, which reduces the money supply. (Banks serve an important function of creating new money through the magic of reserve deposits.) There are all sorts of bad consequences of that, of course, including increased unemployment.

    For real estate, the immediate impact of deflation is that existing mortgages are more valuable to the lenders — they’re getting paid with dollars that are worth more tomorrow in real terms than they are today. Might that mean increased defaults, as individuals choose to hoard money and not make payments? Possibly, though I doubt that those who haven’t defaulted yet would suddenly decide to do so because of deflation.

    No one truly knows, in my opinion, what is going to happen. The economy is far too chaotic and complex a system for any one person to claim to know what to do.

    But as this discussion viz inflation suggests to me, I’m really nervous about making enormous policy decisions without thinking through things, instead of taking smaller steps that give the free market the opportunity to correct the situation through normal market operations.

    -rsh

  • http://robhahn.wordpress.com -Rob

    It’s entirely possible (even likely) that I have no idea what I’m talking about, as I’m no banker, and have merely a layman’s knowledge of the financial systems.

    Having said that, I just don’t see how buying up toxic assets with USD is anything BUT adding cash to the money supply.

    The classic money supply operations has the Fed buying treasuries from the banks that hold them: it takes the bonds off the market, and credits the bank with USD in their account.

    How would this be any different?

    Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.

    As far as I understand it, that is precisely the mechanism for how the bailout plan is supposed to work.

    If so, I just don’t see how this is NOT adding new cash to the money supply. I just don’t see how this is NOT adding new money into the economy.

    Inflation, then, absolutely has to be the result. There will be more USD in the money supply than there are goods and services — after all, it isn’t as if we’ve had $700B worth of new goods and services added to the economy overnight.

    If we do not do the bailout, then yes, deflation becomes a risk, as banks fail, which reduces the money supply. (Banks serve an important function of creating new money through the magic of reserve deposits.) There are all sorts of bad consequences of that, of course, including increased unemployment.

    For real estate, the immediate impact of deflation is that existing mortgages are more valuable to the lenders — they’re getting paid with dollars that are worth more tomorrow in real terms than they are today. Might that mean increased defaults, as individuals choose to hoard money and not make payments? Possibly, though I doubt that those who haven’t defaulted yet would suddenly decide to do so because of deflation.

    No one truly knows, in my opinion, what is going to happen. The economy is far too chaotic and complex a system for any one person to claim to know what to do.

    But as this discussion viz inflation suggests to me, I’m really nervous about making enormous policy decisions without thinking through things, instead of taking smaller steps that give the free market the opportunity to correct the situation through normal market operations.

    -rsh

  • http://blog.homegain.com/ Louis Cammarosano

    Rob

    I agree that “the economy is far too chaotic and complex a system for any one person to claim to know what to do.”

    The fact that you are I are having a fundamental disagreement on what spending $700 billion will mean is troubling- not because we disagree- but because either one or both of us is wrong or right and that’s a hefty bet to make!

    How about this headline that was in CNN today as support for my argument

    “CNNMoney.com
    In crisis, banks pullback consumer credit card limits
    Friday September 26, 12:29 pm ET
    By Jessica Dickler, CNNMoney.com staff writer”
    http://biz.yahoo.com/cnnm/080926/092508_credit_limit_pullback.html

    As such LESS money will be heading into the system which means there will be less consumption, and under the traditional model, less inflation.

    As to the bail out-that money is ALREADY in the system. The debt is just changing hands.

    The consumption already happened in the form of home purchases. Who holds the paper for past purchases doesn’t add any new money into the system. (other than keeping the banks around so they can put SOME money into the system).

    The inflation from the spending spree three years ago should have already led to inflation.

    As you wrote: “Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.”

    Inflation is always a possibility. I would say however it may come as a result of a lower dollar and increased energy prices. So we may disagree on why inflation may occur, certainly the bail out plan given its enormity could be a thing sui generis of which applying traditional or amateur economic analysis will prove futile.

  • http://blog.homegain.com Louis Cammarosano

    Rob

    I agree that “the economy is far too chaotic and complex a system for any one person to claim to know what to do.”

    The fact that you are I are having a fundamental disagreement on what spending $700 billion will mean is troubling- not because we disagree- but because either one or both of us is wrong or right and that’s a hefty bet to make!

    How about this headline that was in CNN today as support for my argument

    “CNNMoney.com
    In crisis, banks pullback consumer credit card limits
    Friday September 26, 12:29 pm ET
    By Jessica Dickler, CNNMoney.com staff writer”
    http://biz.yahoo.com/cnnm/080926/092508_credit_limit_pullback.html

    As such LESS money will be heading into the system which means there will be less consumption, and under the traditional model, less inflation.

    As to the bail out-that money is ALREADY in the system. The debt is just changing hands.

    The consumption already happened in the form of home purchases. Who holds the paper for past purchases doesn’t add any new money into the system. (other than keeping the banks around so they can put SOME money into the system).

    The inflation from the spending spree three years ago should have already led to inflation.

    As you wrote: “Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.”

    Inflation is always a possibility. I would say however it may come as a result of a lower dollar and increased energy prices. So we may disagree on why inflation may occur, certainly the bail out plan given its enormity could be a thing sui generis of which applying traditional or amateur economic analysis will prove futile.

  • http://blog.homegain.com/ Louis Cammarosano

    I agree that “the economy is far too chaotic and complex a system for any one person to claim to know what to do.”

    The fact that you are I are having a fundamental disagreement on what spending $700 billion will mean is troubling- not because we disagree- but because either one or both of us is wrong or right and that’s a hefty bet to make!

    How about this headline that was in CNN today as support for my argument

    “CNNMoney.com
    In crisis, banks pullback consumer credit card limits
    Friday September 26, 12:29 pm ET
    By Jessica Dickler, CNNMoney.com staff writer”
    http://biz.yahoo.com/cnnm/080926/092508_credit_limit_pullback.html

    As such LESS money will be heading into the system which means there will be less consumption, and under the traditional model, less inflation.

    As to the bail out-that money is ALREADY in the system. The debt is just changing hands.

    The consumption already happened in the form of home purchases. Who holds the paper for past purchases doesn’t add any new money into the system. (other than keeping the banks around so they can put SOME money into the system).

    The inflation from the spending spree three years ago should have already led to inflation.

    As you wrote: “Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.”

    Inflation is always a possibility. I would say however it may come as a result of a lower dollar and increased energy prices. So we may disagree on why inflation may occur, certainly the bail out plan given its enormity could be a thing sui generis of which applying traditional or amateur economic analysis will prove futile.

  • http://blog.homegain.com Louis Cammarosano

    I agree that “the economy is far too chaotic and complex a system for any one person to claim to know what to do.”

    The fact that you are I are having a fundamental disagreement on what spending $700 billion will mean is troubling- not because we disagree- but because either one or both of us is wrong or right and that’s a hefty bet to make!

    How about this headline that was in CNN today as support for my argument

    “CNNMoney.com
    In crisis, banks pullback consumer credit card limits
    Friday September 26, 12:29 pm ET
    By Jessica Dickler, CNNMoney.com staff writer”
    http://biz.yahoo.com/cnnm/080926/092508_credit_limit_pullback.html

    As such LESS money will be heading into the system which means there will be less consumption, and under the traditional model, less inflation.

    As to the bail out-that money is ALREADY in the system. The debt is just changing hands.

    The consumption already happened in the form of home purchases. Who holds the paper for past purchases doesn’t add any new money into the system. (other than keeping the banks around so they can put SOME money into the system).

    The inflation from the spending spree three years ago should have already led to inflation.

    As you wrote: “Would not the Fed/Treasury be buying bonds (the toxic CDO’s and RMBS’s) from the banks that are holding them now, and crediting their account with the Fed with USD? E.g., Lehman Brothers has mortgage bonds “worth” $10B; Treasury says to Lehman, we’ll take those off your hands for $5B. Lehman’s account with the Fed is increased by $5B; the title to its mortgage bonds are transferred to the Treasury. Voila, rescue.”

    Inflation is always a possibility. I would say however it may come as a result of a lower dollar and increased energy prices. So we may disagree on why inflation may occur, certainly the bail out plan given its enormity could be a thing sui generis of which applying traditional or amateur economic analysis will prove futile.

  • http://robhahn.wordpress.com/ -Rob

    Great discussion, Louis.

    After I make my millions, I want to go get a degree in economics… :)

    Remind me to talk to you about a pet project of mine, btw….

    -rsh

  • http://robhahn.wordpress.com -Rob

    Great discussion, Louis.

    After I make my millions, I want to go get a degree in economics… :)

    Remind me to talk to you about a pet project of mine, btw….

    -rsh

  • http://blog.homegain.com/ Louis Cammarosano

    Rob
    Would love to hear about the pet project…

    Even in wake of the $700 billion bailout demand has not been stimulated and oil prices are falling. Oil prices are down 40% since July.
    The bailout is not putting any new money in the system and credit remains tight.
    Demand for consumers goods will also fall (note ebay let go of 1000 employees this morning)
    With no new money flowing into the system and with little expectation that foreign investment will pick up the slack I think we will have a classice recession with falling prices.

    AP
    Oil falls below $90 as financial turmoil spreads
    Monday October 6, 7:13 am ET
    http://biz.yahoo.com/ap/081006/oil_prices.html

  • http://blog.homegain.com Louis Cammarosano

    Rob
    Would love to hear about the pet project…

    Even in wake of the $700 billion bailout demand has not been stimulated and oil prices are falling. Oil prices are down 40% since July.
    The bailout is not putting any new money in the system and credit remains tight.
    Demand for consumers goods will also fall (note ebay let go of 1000 employees this morning)
    With no new money flowing into the system and with little expectation that foreign investment will pick up the slack I think we will have a classice recession with falling prices.

    AP
    Oil falls below $90 as financial turmoil spreads
    Monday October 6, 7:13 am ET
    http://biz.yahoo.com/ap/081006/oil_prices.html