Wednesday, January 31, 2007

The trend is you friend until…well, you know.

'The trend is your friend until it ends'. Many people chant that catchy phrase like a mantra, believing it means ‘follow the trend, it won’t let you down’. What it is actually saying is ‘you just don’t know when it’s going to turn, follow at you own risk’.
I think that sums up investing nicely.

Anyway, the trend for housing was up, way up for 2004 and 2005. The trend up has ended, the psychology changed. The trend is now down, the psychology goes without saying. It will surely remain trending in a downward direction for sometime, of course until it ends. No one cans say when that will be but we can guess.

After a sharp rise a trend will usually correct relative to that rise. (Big rise, big correction). After the crest there is often a rapidly increasing fall to an over correction on the downside. This followed by a move up slightly to a mean bottom or new stable low. It’s a predictable pattern.

In housing it seems we still have a ways to go. The acceleration is just starting. But if you pay attention you can se it happening.

I expect that this trend could over-correct at 70% in some parts of the U.S., with a later move back up to a 40% new mean low. Housing will probably hit these low lows within the next two years finally moving up and languishing at 40 to 50% off the highs for some years afterward. At least that’s how I see it.

The trend is your friend until it ends, whenever that is.

“The number of vacant homes waiting to be sold surged 34% to 2.1 million at the end of 2006 compared with the end of 2005, by far the fastest increase ever recorded, the Census Bureau reported Monday.”

“A year ago, 1.57 million homes were vacant and awaiting a sale. The vacancy rate for owned units jumped to a record 2.7% from 2.0% a year earlier. From 1965 to 2005, the homeowner vacancy rate had never been above 2%. The long-term average is 1.4%.”

“‘We have more than a million housing units of excess supply,’ said James O’Sullivan, an economist for UBS. ‘If you are looking for evidence that the worst is over for housing, you’re not going to find it in this report. This argues that housing starts need to go down more.’”

“Home-price appreciation weakened to its slowest pace in more than 10 years in the 12 months ending in November, MacroMarkets and Standard & Poor’s reported Tuesday. Home prices fell in 17 of 20 cities in November compared with October.”

“The last time prices were rising so slowly was in late 1996, at the end of a six-year period of flat or falling prices. A year ago, home prices were rising about 16% year-over year.”

“‘Countrywide, home-price declines appear to show no signs of slowing down,’ said Robert Shiller, chief economist for MacroMarkets, in a press release.”

Tuesday, January 30, 2007

The brittleness factor

The following is a discourse on the ‘brittleness’ of systems. I found the piece interesting as it can be applied to any system, from your immune system to economic systems.

The point being that it raises some serious questions about where we are right now in our global economic cycle and how vulnerable the whole thing really is.

Moving the analogy to economics I would ask: Is it better to have an economy that degrades and rebounds gracefully under stress or one that bears heavy loads but which fails dramatically when it hits the limits? The first is inherently robust but exhibits many variations in state. The second shows much more stability - but offers fewer indicators of the stresses the system is under. Which style of economy do we have now? In practice it would seem that there is a spectrum which ranges from bouncy to brittle.

Looking at business cycles, it appears that 50 years ago most western economies tended to be a bit bouncy. The exception was the Soviet block economies which exhibited characteristics of the stable-to-failure type. Now, with today's much more flattened economic cycles it would appear that most of the developed world's economies are at the brittle end of the scale. One sees articles proclaiming the end of the business cycle as a fine and wonderful thing - I have my doubts. It's more than just the flattened business cycles that make me think today's economies are brittle.

As I look at things I tend to see a lack of robustness everywhere and this is my fundamental problem with an organization like Wal-Mart. It is big, it is massively wealthy and it can take a lot of stress and it will show little external effect. It is vulnerable though - there is quite a list: long supply chains, dependency on a high value dollar and low fuel prices etc. etc..

Wal-Mart is very strong but because of the centralized simplicity of the organization and the inability of its component parts to adapt it is brittle. Hit it in the right place and it will fail. Its not a matter of running out of money - the failure could take other forms. Perhaps it will manifest itself as a sudden inablity to offer the goods and services it used to provide. This will leave a huge hole in the economy.

You don't get that catastrophic failure mode with an equivalent collection of mom-and-pop operations. Wal-Mart's dominance makes it an economic monoculture: very strong but brittle. Too many brittle components and you get a brittle economy. I subscribe to the view point that this is not a good thing. Though I am still learning about such analytic tools, it seems that many of the complex systems we rely on are also extremely brittle in the sense that they depend on a handful of chokepoints.

Oil: The majority of the seaborne world's oil passes through two narrow, vulnerable channels: the Strait of Hormuz in the Persian Gulf and the Strait of Malacca in the South China Sea.

Grains. Monocultures of corn, wheat and rice mean that any blight which adapts to attack one of these crop strains would have an undue effect on yields.

Electrical power lines. A relatively small number of main lines transfer electrical power from one area to another.

Ports. The vast majority of goods arriving in the U.S. by sea come ashore at a small number of major ports. And so on. The idea behind hubs and ports and highly consolidated industries (there are only two manufacturers of large commercial aircraft in the entire world, for instance) is that the resulting economy of scale will be efficient. But as our U.K. Correspondent points out, that consolidation carries a cost which is only visible when the brittleness of such concentration becomes glaringly apparent.

To take another disturbing example: bird flu (H5N1) has killed 150 million birds globally. This virus somehow overcomes birds' normally robust immune system. Research suggests that the global Flu Pandemic of 1918 which killed millions of humans was a bird virus which "jumped" to human hosts. The immune response to that virus caused massive congestion in the lungs, causing the human host to suffocate.

In effect, the normally resilent human immune system was rendered brittle by this terrible microbe. The global financial markets, we are constantly reassured, are actually made more resilient by the instantaneous flow of capital across borders and by the proliferation of derivatives. But what if the opposite is true, and the global financial markets have been pushed by an unprecedented tide of derivatives to the edge of chaos?

Sunday, January 28, 2007

The shape of things to come?

The Union Tribune reports from California.

“For years, new-home construction was the engine that drove the growth of the San Diego economy. But since the housing industry hit the brakes, regional growth has slowed to a crawl, local economists said at a forum yesterday.”

“The regional housing downturn has prompted layoffs in real estate and construction, said economist Alan Gin of the University of San Diego. ‘The big story in 2007 is going to be the real estate market and its impact on employment,’ Gin said.”

“Hiring for real estate-related jobs has declined steadily over the past year in San Diego County, Gin said. The local industry began to shed jobs in November, and roughly 6,000 jobs were eliminated during the last two months of 2006.”

“Construction of single-family houses has fallen so sharply that Alan Nevin of MarketPointe Realty Advisors said, ‘The new single-family home here is pretty much of a dodo.’”

“On a related front, the high cost of housing has become the biggest hurdle for employers to overcome in recruiting new employees, said Michael Schuerman, director of research for the San Diego Regional Economic Development Corp.”

“In a 2006 survey of local companies, 90 percent of the employers and 100 percent of the employees identified the high cost of housing as their top local business challenge.”

“As a result, far more people are leaving San Diego County than are moving here. Citing data from the California Department of Finance, Schuerman said only 900 people moved to San Diego County over the past two years, while more than 28,500 residents moved out.”

“That’s ‘hard evidence of what the housing situation is doing,’ he said.”
“Consumer confidence represents an additional risk, speakers said. Consumers also could be shaken by a spike in loan defaults and home foreclosures, Gin said.”

It should be noted that San Diego is one of the largest bubble areas of the U.S. It was not long ago however that they were laboring under the belief that their housing market was bullet-proof, a belief found in other areas of the U.S. right now among those who have not yet felt the sting of a broader housing and economic downturn. This is not to say it will happen, but I wouldn’t bet against it.

As more cities loose jobs, where will the jobless migrate to? With more cities joining the list of those in economic distress, safe havens (places with jobs) will come under more stress do to an influx of the migrating jobless, until we once again see ‘No jobs here’ signs as we last did in the 1930’s.
Possible? – Yes.
Probable? - It could happen.

There are many factors weighing on the U.S economy right now, outsourcing of jobs to China, India as well as other countries for one thing. The end to the housing bubble( ya, the bull-run is over). This directly effecting the spending habits of Americans further driving down production and related jobs at home.

I think it is safe to say we will be seeing more stories like this play out in 2007 and beyond. Welcome to the new reality, the shape of things to come.

Wednesday, January 24, 2007

Falling rents and downward momentum

Not long ago the housing talk was about a slow-down in sales and an increase in housing stock. Then came 3%, then 4%, then 6% decreases in prices from some areas of the country.
These were the topics that had our attention just yesterday.

Now the popular topic is foreclosures. Did anyone not see this coming?
Soon other topics will become the subjects of our blogs; vacancy rates and tightening of credit standards for instance.

Some people believe that as former home owners and those people forced into foreclosure join the bubble sitters in the rental pool, rents are bound to rise. It could happen.

The larger question however is over-building. It is taking place in every corner of the U.S. Couple this with speculators who hold an estimated 30 to 40% of residential real estate. Ad in just now retiring baby-boomers, a group estimated to hold 25% of residential R/E primed to sell to fund their second childhoods and you have a very large potential pool of homes entering the market.

Also consider properties that will be foreclosed on. There is a good chance they will be sold cheap to investors and become rentals. At the very least these will put downward pressure on home prices in their respective neighborhoods causing some owners to shelve their plans to sell and rent their properties out instead.

I think the most likely path is downward pressure on rents. With condo and condo-conversions at record levels and R/E sales flagging, current rental properties will continue to be rental properties and condos that don’t sell will most likely join that pool of rentals. I see an oversupply of rental units developing and lower rents in the near future.

Monday, January 22, 2007

Private Equity and Pyramids

The Economist:

"THE art of private equity, it might be said, is finding and polishing diamonds in the rough. No wonder, then, that more firms are venturing off the beaten path in search of uncut gems. With record sums pouring into the asset class in recent years—the biggest funds have topped $15 billion—more investors and fund managers are turning to the developing world. Just this week Citigroup unveiled plans for a new $200m fund dedicated to Africa."
"Even veteran investors warn of the hassles of working in such markets. These can include decrepit infrastructure, poor corporate governance and a limited pool of skilled managers. Governments can turn hostile and currencies can turn against you. The cost of borrowing may also be dearer in emerging markets, making it too expensive for acquiring firms to load up on as much debt as they do elsewhere. It takes longer to turn a company around in emerging markets, veterans say, and at the same time exiting from a deal may be trickier."
Private equity investing has been called the great ponzi scheme of the 2000s.
Something like a pyramid scheme, the ones at the top are the founders of the schemes. Those at the bottom (the rest of us) seem destined to be left holding the bag when things unwind.

Private equity groups appear to have picked clean the lowest branches of fruit, and are now stretching for smaller berries.

I’ve notice as of late that these groups are starting to shy away from mortgage debt instruments. That tells me that they believe that the credit market is all played out and private equity is betting it will soon go south.

This is a bad sign. I say this because being private, they know what’s going on with their investments, the rest of us can only guess.

In an article in The Australian Herald Sun newspaper recently, the National Bank of Australia was quoted as saying ‘The wave of private equity takeovers is bound to "end in tears".’,21985,20832000-664,00.html.

It would appear that time looms close. I find the fact that private equity is looking in notoriously unstable regions of the planet for ever diminishing returns alarming. With derivatives markets leveraging somewhere around 4 times global GDP, the ramifications to an unwinding there could be vast. It could very well end in tears for more than those who participated in the investments.

Thursday, January 18, 2007

Derivatives, The Monster That Ate The Future part III

I have reprinted Mish Shedlock’s article below in it's entirety. I do not pretend to know the first thing about the derivatives markets, but Mish has brought up the subject a number of times and can tell us something about it.
Ponzi Financing On Interest Rate Swaps
The third-poorest city in Pennsylvania is a lot poorer because of a 28-year bet on interest rates that already has gone awry.
The Reading, Pennsylvania, school district, which has 18,323 students, this week must pay $230,000 to Deutsche Bank AG, Germany's largest bank, because it's on the losing side of a wager that long-term interest rates will rise faster than short- term interest rates.
In April, the board rushed approval of the so-called interest rate swap in eight days after its adviser said the transaction may earn the district $16 million by 2034.
While Reading's taxpayers are liable for the loss, bankers and advisers already have pocketed $1 million in fees for arranging the swap, enough to buy 11 Mercedes-Benz S-550 sedans.
This week's payment to Deutsche Bank would have covered the school district's monthly utility bill.
"It was all done in a real hurry," said Keith Stamm, the only member of the board to vote against the deal. "The whole board is so desperate to try to find a way to raise money, they see this floated in front of them as a big-time amount of money and they want to go forward with it.
"Local governments from Augusta, Georgia, to Oakland, California, are being lured by similar opportunities to speculate with derivatives created by the world's biggest banks. Most of the $400 billion of private agreements sold to municipalities escape taxpayers' notice and are little understood by the public officials and administrators who approve them.
The school board paid Frankfurt-based Deutsche Bank $575,000 to arrange the contract, known as a constant maturity swap, and awarded $400,000 to its financial advisers, including Reading-based Concord Public Financial Advisors Inc. and lawyers for arranging the trade, school officials said.
Ted Meyer, a spokesman for Deutsche Bank in New York, declined to comment on whether the agreement, also called a yield-curve swap, was suitable for the school district.
Dennis Kelley, the school district's director of finance, said he was "surprised" to learn he owes $230,000. He said the district would pay the money using proceeds from another interest-rate swap.
"Nobody Questioned It""
It was arcane, nobody questioned it," Cinfici said. "Everything was presented to us at the last minute. I said, `Well, I'll trust in the guys' judgment.
"More than 70 Pennsylvania school districts have notified the state they planned swaps with banks including Morgan Stanley, Wachovia Corp. and JPMorgan since 2003, when state legislators permitted them. Is there any wonder now why profits at Goldman, Merrill, etc are soaring?
Top 5 Reasons for Interest Rate Swaps
5) "It was arcane, nobody questioned it"
4) "It was all done in a real hurry"
3) "Well, I'll trust in the guys' judgment"
2) "The whole board is so desperate to try to find a way to raise money"
1) "The district can pay the money owed using proceeds from another interest-rate swap"
If this is not ponzi financing at its finest, what is?Mike Shedlock / Mish

Seattle may not be immune

This news from Southern California. (It should be noted that San Diego is one of the largest bubble areas in the U.S.)

“Lenders increased their consumer warnings in the final months of 2006 to Orange County homeowners who fell behind on mortgage payments. They sent 688 notices of default in December, marking the fifth consecutive monthly increase in such notices, DataQuick reported.”
“Foreclosure totals also rose more or less steadily in the second half of 2006. For the full year they totaled 647, more than quadruple the 2005 total.”

The Union Tribune. “Residential foreclosure activity in San Diego County rose sharply in 2006, DataQuick reported. There were 1,612 foreclosures last year, compared with 212 in 2005, a jump of 660 percent. Notices of default, the first stage in the foreclosure process, totaled 8,816 during the year, compared with 3,933 in 2005, an increase of 124 percent, said DataQuick analyst John Karevoll.”

“The county’s housing market ‘is precarious in a way it was not five or 10 years ago,’ Karevoll added. ‘It could get bumped out of whack with much smaller movements in the broader economy. It is very stretched.’”

Other areas won't experience the same market dynamics as the areas mentioned above. However, who can deny that the aggregate effect of the national market following this trend will not eventually spread to the broader economy, then to other less volatile housing markets?

I recently checked out the Seattle Bubble blog as I lived there once and have some knowledge of the market there. Many in the 'Emerald City' believe they are not affected by the national housing bubble. They are half right. A strong economy, jobs, and a housing market that didn’t reach the heights of other areas of the country lulled them into a sense of security.

Reality however may not be so kind. Washington Sate does not exist in a vacuum. They not only trade with other states but other countries. A broad based downturn, either national or global is bound to touch their jobs market, economy and housing.

The sentiment that is coming out of Seattle today is similar to what I saw coming out of other cities like Boston a year ago. Boston is not a fair comparison to Seattle, but I’m sure you get my point.

We are not immune to a broad economic downturn!
None of us. As the global economy has flattened this past decade we all will feel the ripple.

Wednesday, January 17, 2007

U.S. housing as a linch-pin

The Telegraph

The US Federal Reserve will need to slash interest rates three times this year as the housing slump goes from bad to worse and the American consumer begins to buckle, Goldman Sachs has warned. ‘Americans have shown a complete lack of self-control. The personal savings rate is at its lowest point ever, and has actually been negative since April 2005.’”
“‘We believe that housing will soon become the proverbial ’straw that breaks the camel’s back’,’ said David Kostin, the investment bank’s US strategist.”
“Goldman Sachs said homeowners had treated windfall gains from rising house prices as if they were ‘recurring income,’ using home equity withdrawls to subsidize over-stretched lifestyles. This artificial boost to spending has already dropped from 7% to 4% of GDP over the last year, and is likely to halve again in 2007.”
I've said it before; housing has been a key to U.S. domestic spending. As recently as August 2006 I was ridiculed for my views that Americans viewed their rising home values as something akin to an ATM machine, thereby liberating copious quantities of cash from equity to spend on stuff. Stuff not only made in the U.S.A. but in China and other countries as well.

As much as 70% of the U.S. economy is domestic spending, spending that I believe stopped around October 06 as the reality of the housing market started to sink in. Around that time people started to find themselves with no more rising equity or even upside-down under second or third mortgages, owing more than their properties were worth. A sure fire way to end a party if there ever was one.

The news now is beginning to reflect my opinion but has not yet addressed the ripple effect this is bound to have on the global economy. I predict the news will get even worse as we reach the middle of February and by Spring 07 when the housing rebound fails to materialize the news is bound to shift to how it affects the global economy.

Double talk in California

This from California:
“Sylvia Starbird, broker in Mission Valley, said would-be buyers may want to buy at the bottom of the market but she cautioned against waiting, since no one can tell if that point has already passed. ‘For sellers, if they don’t have to sell,’ Starbird said, ‘they may want to wait a little bit before they do that.”

which is it Sylvia, are we running out of homes to buy or are there too many on the market?
If the stock of available houses is drying up, maybe you should tell potential sellers to sell their properties and you can reap the commissions!

Lessons from Japan

I sit in wonder sometimes considering how so many people put their faith in government or private sector entities. History shows us that government intervention in anything doesn’t work very well and the Fed has no power to save our economy. In fact Fed meddling has in the past caused more harm than good.

The Fed can no more decide the price of money than it can decide the price of tomatoes. The free market, like water will always find its own level. It seems to work best that way.

It is true, we have never been here before. Even though the landscape looks familiar dynamics are always, well, dynamic. Therefore we are in the unknown, left groping in the dark toward some future destiny, we know not what. The best we can do is to take lessons from others who have gone before us, compare the situations to our own and guess.

I’m guessing that Japans economic policies have some lessons for us in the U.S.
They should not be ignored.
"On March 9 last year, the BoJ ended a five-year-old super-loose monetary policy under which it flooded the short-term money market with excess cash to keep short-term interest rates near zero in a bid to defeat deflation."

"Obviously "flooding the short-term money market with excess cash to keep short-term interest rates near zero in a bid to defeat deflation" was a totally failed policy. Yet for some reason people think it will have a different effect here if and when we get to the same point."
Read the entire article: Japanese Economic Data January 17 2007 at

Monday, January 15, 2007

I'm officially a renter

I’ve been off line for a while as I sold my house here in southern Norway and moved into a rental.

Reports on the housing market here last week had local pundits speculating on a 20 to 30% drop in home prices in 2007. That is a big change from the cheerleading of August with projected gains of 10 to 12%.

I got out of housing at around the top I guess, which is about all one can ask. Now the big question: how to invest the proceeds. It seems that even though I have dodged the housing bullet there are still financial landmines to negotiate. I imagine that even though gold is my favorite bet, there is much risk there to be considered. There are foreign currency plays, but who knows how 2007 will unwind? The U.S. stock market is too risky now with pricing fundamentals no longer reflecting reality so no dice there.

Parking cash in a bank here in Norway is no more attractive with state taxation on ownership of money, adjustments for inflation and low interest rates it just doesn’t pencil out. I’m at a bit of a loss.

Friday, January 5, 2007

Housing is on a slippery slope

I have questioned reported figures before, both by corporate and by government reporting agencies. These days it is prudent to cast a dubious eye on them all.

It has been pointed out that R/E agents can pull a house off of the market, reintroduce it a few months later as a new listing with no record of it having been listed before. Also, large builders are experiencing high numbers of cancellations on new houses. These numbers don't get reported by the census Bureau. They are recorded as sales thus on paper affecting the apparent quantity of houses for sale.

Does anyone else see a fundamental problem with this and recent news stories of reduced housing stock and increased sales?

This from Ben Jones at The Housing Bubble Blog
From Bloomberg. “Anyone who thinks ‘housing has bottomed should talk to Lennar,’ says Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. ‘Inventories of completed homes continue to increase, both in absolute terms and relative to their total inventories,’ he said. ‘Historically, until the relative inventories of completed homes begin to decline, the starts of new homes continue to decline.’”

“Because the Census Bureau, keeper of the new home sales data, doesn’t capture cancellations in the monthly statistics, sales are probably being overstated and inventories understated.”

“The lag between turning points in residential and non- residential construction is variable, economist Ian Shepherdson said, but one follows the other as night follows day. ‘The plunge in housing construction promises tough times ahead, sooner or later, for the non-residential construction business,’ he said.”

From the “Homebuilders rivalry is intense. The result is shrinking home prices and eroding profitability. Lennar remains the biggest bully in many markets, cutting prices and aggravating fellow builders.”

“Lennar announced this week that orders were down 6% in its latest quarter, but its backlog of homes fell 42% year over year in dollar terms. JMP Securities analyst Alex Barron says those numbers imply the prices of Lennar’s new orders fell at least 30%.”

“‘If that is remotely true, I don’t see how or why any builder, public or private, will just sit there and not eventually have to begin cutting prices down to match or beat that,’ Barron says.”

“The only real way to hold steady on prices in such a market is to offer a differentiated product. If you travel around the country, you’ll find Lennar’s homes similar to other builders, Barron says. ‘There is not a huge noticeable difference from one to the next,’ he says.”

“The threat of substitutes remains high for builders. There is a glut of existing-home inventories, and rental apartments and houses are often more affordable across the country. In some communities, builders selling new homes are facing competition from buyers looking to sell a version of an identical home purchased a year ago.”

From Forbes. “Automatic Data Processing on Wednesday forecast a 40,000 decline in American jobs. If the payroll processing firm is correct, it would be the first time in nearly four years that U.S. employment rolls have declined.”

“‘Given the economic slowdown, particularly in housing, firms could be getting more cautious about hiring,’ Goldman Sachs economist Andrew Tilton said.”

“Tilton said the most vulnerable employees are those working in the residential real estate market. ‘You have seen huge declines in home sales,’ he said. ‘Yet housing employment is just slightly off. So this sector needs to shed some employment.’”

Tuesday, January 2, 2007

Fox News calling for housing recovery this year!

Umm… is it me or did the world change suddenly at the turn of the new-year?
Charles Payne writes in his January 2nd article that there is lots of value in the building sector and homebuilders will race upward in value ahead of a housing market recovery this year.

Maybe everything I read and that I see outside my window is wrong, colored simply by my own world view and my subconscious wish to confirm that view. Or Mr. Payne has information that I and many others do not have access to. Or Mr. Payne is wrong. Statements like this make me question reality.

Any way you slice it it mystifies me…


"Sure, there will be the continuation of mergers and acquisitions around the world and widespread consolidation will pace the broad market. There is still a ton of value trapped in the market. Speaking of value, although the group has already made a nice move off the bottom, I think homebuilders are going to be huge winners as their share prices race ahead of the eventual housing market recovery. This will happen a lot sooner than the timetable, laid out by the pundits, predicted."
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