Michael Gracie

Here’s a tasty look at the notional value of the credit default swaps outstanding (*) for the last few years:

The notional value is essentially the par value of the underlying credit. We know there was a heck of a lot of credit being granted during the period, and it also seems that a lot of “insurance” was being written against its potential for default.

Around the same time bankers everywhere were looking over their shoulder if someone asked them how their debt portfolio was doing, everyone and their mother was scrambling for sanity in the rate markets (*):

Of course, there’s an awful lot of speculation buried in those numbers, as well as hedging previous hedges. How it all unwinds is anyone’s guess. Meanwhile, investors are “bracing for more bad bank news”. With banks bantering around numbers in the tens of billions, while exposure is floating around in the tens of trillions, I wonder what investors are actually “bracing” with.

Meanwhile, at least a few analysts are starting to speak out (and keep in mind that sub-prime is only a sliver of the total indebtedness floating around).

* Data taken from the International Swaps and Derivatives Association’s twice yearly dealer surveys.

UPDATE: Just a sliver.

Bernanke Says `Saving Glut’ Still Helps Lower Rates

Riddled with conflict. The savings glut is not domestic, the dollar is weak, there’s pressure to lower rates, and inflation lingers in staples. Mortgage rates have de-coupled from Treasuries - rates are dropping, but for lack of mortgage demand.

Meanwhile…

Former Fed Chairman Alan Greenspan adds insult to injury by taking a shot at US housing prices (and notably in a foriegn paper).

Mr Greenspan said he would expect “as a minimum, large single-digit” percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was “in double digits”.

Greenspan no longer has his hands on the rate button, but it seems the button is now broken (and he knows it). He’s no stranger to conflicting commentary as of late either.

UPDATE: Ok, maybe the button is just a little sticky.

Forbes just posted a graph showing the expanding gap between median home prices and median wages, based on data garnered from the National Association of Realtors and the Social Security Administration.

Now, a whizbang economist could probably enhance this analysis by commenting on the relative interest rates during the period (taken from Ibbotson), the rising mortgage and consumer credit levels (from the Federal Reserve), and even the balance of trade between the US and foreign countries (from the US Department of Commerce). He or she could go on and on about how the difference between the two elements means housing prices are primed for a severe downturn or we are headed for depression-era styled times. Others might expound upon the information as a sign that hard assets are the place to be, and the numbers reflect good times, particularly increasing wealth versus working hours.

I am no economist. I walk my dog around my neighborhood each morning and each evening. I see cars parked on the street in front of houses with large two car garages.

Based on my data I still thought the graph needed a little work:

Ben Stein is crying out to Alan Greenspan not to raise interest rates too fast. I think I know why.

Mr. Stein claims the “the real pressure on prices has come from increases in the cost of oil and natural gas.” That is not entirely true. Just as big a pressure on most Americans’ cost of living has come from skyrocketing housing prices. Now some folks say “well you don’t HAVE to buy.” And they are correct. In fact, in most major markets it is actually cheaper (after taxes) to rent right now. Rents have simply not kept up with purchase prices. Unfortunately, you can’t just look at the top-line personal P&L.

What we have is a continually higher leveraged American public. And those interest costs are not included in the CPI. “But rates are so low.” It doesn’t matter if you ignore your balance sheet. The fact is, buying an overpriced home at a low interest rate is actually worse for you than buying a home at a deflated price in a high rate environment. Broadly brushed, your payment is the same, but your balance sheet looks much worse - you owe more. Herd mentality took over long ago, and herding always turns out the same way. Bad. Adjusted for inflation, housing prices in major markets have skyrocketed. In the last three or four years, the trend is nearly straight up.

These types of moves never last. Read Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds if you don’t believe it. Despite all the pundits being wrong for the last few years, some highly inflated housing markets are now seeing housing economics favoring the buyers.  I think Ben knows this, as well as the impact it may have on an economy where everyone seems to be a real estate agent or a mortgage broker nowadays. I hope his pleadings don’t go unanswered, even if they are for the wrong reasons.

Michael Milken once said “It isn’t okay to leverage to buy overvalued assets,” and I have been sticking to that adage for a while. Maybe the buying window is about to open, and maybe it is not, but Alan Greenspan has certainly become very chatty about asset price euphoria. I recollect a trader friend of mine saying that houses are trading like bonds, and if you read the article above closely, you’ll see that Greenspan might just think so too.

What’s the catch?
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I was having dinner a few weeks back with an old friend, and the subject turned to the US economic situation. I’ve known this guy for roughly two decades and trust him like a brother; he is a very smart character who doesn’t pull punches. I was inclined to listen - the fact that he analyzes high-yield bonds for a big investment bank’s private client group certainly didn’t hurt his cause either.

I’ve believed that indebtedness at every level of our society, from federal, state and local government, right down to consumers’ credit cards, home equity lines and first mortgages, has reached epic proportions. But when this fellow said he thought we were headed for another depression, my sceptical nature reared its ugly head. I have a predilection for looking at the downside, as I started my career in restructuring situations, but I relish that downside for its opportunity and I also know that nobody likes a doomsayer. It wasn’t until I read about our nation’s savings rate hitting zero that I began to rethink his claim.
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“What goes up must come down” applies faultlessly to physical matters. But I have heard every excuse as to why it can’t happen to housing prices. Location, short supplies, and “no chance interest rates will ever rise above 6%” have all been used as reasons.
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We hear a bit about home prices falling in the UK, and then the government pulls a tax rabbit out of the hat to spur more demand. Read SocietyGuardian.co.uk | Society | The change that will make some grin up north.

I wonder what politicians in the US could do to make home ownership more advantageous. Make mortgate interest a tax credit instead of a deduction? With interest rates on the rise, there isn’t much else left to subsidize the market.

It begs the question (again). Can residential price increases hold their own, without the persistently low cost of money advantages they enjoyed in the past?

With regard to my comment yesterday on housing prices “already beginning” to correct, here is a report from across the pond: Guardian Unlimited Money | News_ | House prices fell in December.

Note that interest rates in the UK crossed the trough before those in the US. Rates started climbing in Australia round about the same time, and the lines at open houses Down Under have long since disappeared. Also keep in mind that the UK is densely populated, and is loaded with real estate speculators (those buying properties with no intention of moving in and/or investing in developments), much like many of the areas in the US which have see the biggest price increases. Those speculators will go running for cover first. Then the games begin.

I may be way off base, but these three countries (the UK, Australia, and the US), have something else in common too, trade deficits. Wealth being sucked out of the systems, some (like the US) at an alarming rate. With price driven by indebtedness, and liquidity on shrink, I say…

Welcome to the global economy.