Kurt Johnson

http://www.washingtonpost.com/ac2/wp-dyn/A38725-2005Apr8?language=printer

Paul Volcker (ex Federal Reserve chairman) is concerned about the continuing US current account deficit and the lack of political initiative to fix it before a crash becomes inevitable (non-technical, from the Washington Post):

The difficulty is that this seemingly comfortable pattern can’t go on indefinitely. I don’t know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.

I don’t know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.

I’ve mentioned this to a couple of people in conversation but never had a link handy until now.

Check out the articles here and here (quoted below).

The ancient game of Buzkashi [aka Bozkashi] has been played in northern Afghanistan since the days of Ghengis Khan, the Mongol warrior whose army swept across Asia in the 13th century. It is a fierce game of competition played on the steppes of Asia by expert horsemen. The Mongols lived and died in the saddle. Today, it is played in the Afghan provinces of Maimana, Mazar-i-Sharif, and Kataghan. As a rule, women are not allowed to watch.

The carcass of an animal is used. Goats are preferred, but small calves will do if goats are in short supply. A carcass is soaked in cold water for 24 hours before the game. This is done so the carcass will remain intact and not be torn to pieces as hundreds of chopendoz horsemen independently compete to grab and carry the carcass to the winning circle. Usually, a the carcass is beheaded, its four legs are cut off from the knee, and its insides emptied before soaking. Sand is sometimes packed inside for extra bulk….

Some outstanding photos are here and here. I learned about it first from P.J. O’Rourke’s hilarious travelogue All the Trouble in the World. He characterized Bozkashi as a game where one team of horsemen compete against another team in a kind of capture-the-flag with a calf carcass. However prize money went to the winning individual, not the winning team; teamwork was undermined by individual gamesmanship for the cash prize – all in all a pretty neat sports metaphor for central asian politics.

It’s funnier if you imagine it in the voice from the Guinness commercials.

From 1850 but new to me. Bastiat’s petition entitled: A PETITION From the Manufacturers of Candles, Tapers, Lanterns, sticks, Street Lamps, Snuffers, and Extinguishers, and from Producers of Tallow, Oil, Resin, Alcohol, and Generally of Everything Connected with Lighting.

Found via the excellent Mahalanobis blog.

…as opposed to me. From the Federal Reserve:

This paper examines the statistical evidence of a connection between GSE secondary market actions and the interest rates paid by mortgage borrowers. While GSE portfolio purchases benefit GSE shareholders directly, the purchases must lower the mortgage rate paid by the homeowner in order to have a wider social benefit.

We find, however, that portfolio purchases has economically and statistically negligible effects on mortgage rates. Further, portfolio purchases are not any more effective at decreasing spreads than securitization volume. Our results were robust to several alternative identifying assumptions, including those suggested by the efficient markets hypothesis.

The results of the study are still a little counterintuitive for me – maybe if I learn a little more about who actually holds default risk it’ll make more sense. The article does make some mention of lag effects that could cloud the relationship between GSE actions and market rates. Otherwise, if the GSE’s are in fact not getting a lower cost of debt than non-GSE competitors it implies that MBS buyers are not attributing a lower risk to GSE debt, so we should formally break the GSE-government tie and remove any doubt that the government will bail out the GSEs.

Greenspan also testified on GSEs this morning, basically stating that Fannie/Freddie have grown large enough to pose a systemic threat to the financial markets – the transcript is here.

From the LA Times:

Confronted with soaring home prices, Californians are adopting a “buy now, pay later” strategy on a massive scale. The boom in interest-only loans — nearly half the state’s home buyers used them last year, up from virtually none in 2001— is the engine behind Californians surging home prices….Interest-only loans, and other forms of so-called creative financing that are far riskier than the traditional 30-year fixed-rate mortgages, have allowed more people to afford homes in California even as prices have skyrocketed.

When the price of houses in California soared 17% in 2003 and 22% in 2004, a curious thing happened: Instead of home ownership decreasing because fewer people could afford houses, it rose to record levels.

During the last two years, according to U.S. Census Bureau data, home ownership in the state rose to 59.7% from 57.7%. The previous record was 58.4%, measured during the 1960 Census.
….
Rather than closing the door, lenders have apparently been opening it wider, inviting in people like Herron who would not have qualified for a mortgage under the more rigorous standards of an earlier generation.

“If you can fog a mirror, you can get a home loan,” said mortgage analyst Ralph DeFranco.

An interest-only loan offers the ability to defer for three, five or seven years any payment for the house itself. That allows a potential buyer to stretch to afford a place that otherwise would be out of reach.

Of course, everyone else using an interest-only loan can stretch too. The result is that prices keep rising. That, in turn, encourages still more people to use interest-only mortgages, which fuels still more appreciation.

In 2001, as the current housing boom got underway, fewer than 2% of California homes were bought with interest-only loans, according to an analysis done for The Times by LoanPerformance, a San Francisco mortgage research firm. By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases. What’s propelled the market up in California, some experts worry, could just as easily speed its descent. “In the last few years, rates went down and values went up. It’s like you were paid to live in California,” said analyst DeFranco, who works for LoanPerformance. “People got so used to refinancing. They’d think, ‘No problem. My house will be worth twice what I paid, and I’ll refinance my way out of trouble.’ That’s not going to be a good approach going forward.” Here’s how he thinks a collapse could occur: Rising interest rates put a brake on price appreciation and refinancings. People realize their interest-only period is coming to an end, raising their monthly payments substantially. Since they have no equity in the house, they choose to default. “If housing prices go down or even are flat, heaven help us,” said DeFranco.
By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases.
…
Here’s how he thinks a collapse could occur: Rising interest rates put a brake on price appreciation and refinancings. People realize their interest-only period is coming to an end, raising their monthly payments substantially. Since they have no equity in the house, they choose to default.

“If housing prices go down or even are flat, heaven help us,” said DeFranco.
…
The number of buyers falling into this category in any given month is unclear. But a California home builder recently got a sense when he sought to answer this question: How many of the potential buyers of his houses could still afford them if interest rates went up even a little?

To find out, the builder conducted a little experiment.

His firm’s preferred lender had pre-qualified 90 potential buyers for a group of new houses. Since the houses wouldn’t be ready for another six months, the builder tightened the loan criteria. He didn’t want buyers to sign up for a house and then get frightened into canceling by rising rates.

He raised the threshold from a fully variable loan, the easiest to get since it immediately moves upward when rates increase, to a mortgage that was fixed for the first three years. That would shield buyers from rate jumps for at least a little while, but it’s also more expensive.

Under the higher threshold, only about 15 of the buyers still qualified.

“People are really pushing to borrow as much as they can, and the lenders are right there,” said the builder, who declined to be identified. “There’s apparently not much of a cushion.”
…
In California, the traditional fixed-rate loan is in danger of becoming extinct. According to recent LoanPerformance data, the percentage of new loans that are adjustable in Santa Cruz and San Diego was 85%; in Oakland 84%; in Santa Rosa 81%; in Los Angeles 74%.
…
If disaster does strike, he believes, the housing market will be propped up. “The real estate economy is too important to the country and the state,” Stafford said. “Lenders don’t want foreclosures. They’ll introduce new loan products that will allow people to stay in their properties.
…
“I have $40,000 in student loans from my master’s degree,” Herron said. “I have high credit card debt. I’m a typical American. And yet they wanted to give me more debt to buy a house.”
…
“If you’re like me, you’re so incredulous that anyone would give you any money whatsoever, you just close your eyes and sign the papers,” Herron said. “I would have signed anything.”

I think I’ve said most of this before, but let me highlight a couple of points the article makes:

• People who shouldn’t be getting loans are getting them (easy money is driving prices up)
• Variable interest rate mortages and lower equity balances are exposing people to a triple threat when interest rates rise (higher monthly mortgage payments combined with lower market prices from higher mortgage rates and less of an equity cushion to ride out losses)
• Because so many people are so heavily invested in this bubble politicians will find it very difficult to burst the bubble; there will be heavy pressure to manipulate interest rates, banking regulations, or legislative solutions to bail out the market if 50% of California homeowners find themselves underwater in their mortgage. This isn’t really fair – somebody who was actually responsible is going to get left holding the bag for their speculation losses. If nothing else Fannie Mae will take it in the shorts for billions or trillions of dollars and the feds will be expected to bail them out (again, at taxpayer expense).

All in all I think this reinforces my comments from a few weeks ago on the need for more transparent/flexibile mortgage rates (i.e., localized rates) to capture the higher risk of lending in the California Market vs. Peoria. Peoria should not have to subsidize the risk that California borrowers are incurring (via higher rates).