| The After-Life
Tallinn, Estonia
Thursday, August 16, 2007
Countrywide teeters on the brink of bankruptcy,
The bubble has burst – have you prepared for the after-life?
Out with the new, in with the old – a return to unpopular prudence and
plenty more...
-------------------------
Joel Bowman, happy and homeless, reports from
Estonia...
When borrowers default on their bills, lenders are
soon obliged to follow suit.
Two days ago, countrywide Financial Corp. announced
that mortgage delinquencies and foreclosures had risen to their highest
level since June of 2002. Yesterday the nation's largest mortgage lender
suffered its worst day in the stock market since the crash of '87.
Sparked by fears it would be unable to finance its
debt, shares of the beleaguered giant plummeted 13% to close at $21.29.
So far this year, Countrywide has bled 50% of its value and now stands
on the precipice of bankruptcy.
What went wrong? What events conspired to push the
nation's largest mortgage lender to the brink of bankruptcy? We commence
our bubble autopsy by revisiting a Rude column first published in 2005,
when the slow march to certain death was just getting started. Read on
below as Eric dissects the calamity, one borrowed dollar at a time...
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-------------------------------------------------
The After-Life
By Eric J. Fry – June 15, 2005
Financial bubbles are mortal organisms. Even though
they might seem immortal for a time, they never live forever. The
housing bubble will be no different. It will perish...eventually.
Are we ready for the after-life? Are we prepared to
cross over into that netherworld where home prices tumble from the
heavens like falling angels, and where property speculators weep and
gnash their teeth and where the U.S. economy itself abides in the outer
darkness of excess debt and inadequate savings?
Based on America's limited capacity to absorb a
substantial bear market in housing, we fear that very few homeowners
will find salvation in the afterlife of the bubble. A select few of us
might achieve a partial salvation, provided we have not committed the
mortal sins of borrowing too much or saving too little.
"US economic growth depends entirely on the
continuation of the frenetic housing bubble," warns Dr. Kurt
Richebacher, editor of the Richebacher Letter.
Dr. Kurt may be wrong, of course. But what if he
isn't? Is America prepared for the end of the bubble? Are any of us
prepared? Most macroeconomic indications do not inspire confidence.
Real Estate, both as an asset class and as an
industry, has assumed such an outsized share of US economic activity,
that the entire economy would mourn the passing of the housing boom.
Let's consider a few surprising – if not alarming –
facts.
Since the end of 2001, housing-related industries have
produced a whopping 43% of the nation's total net private sector
employment growth. Obviously, therefore, any slackening of real estate
activity would slow employment growth in the industry. Indeed, this
massive job-creator could become a job-destroyer.
The nation's banking operations have also become
heavily reliant on the real estate sector. Mortgage-related assets at
U.S. banks have swelled to more than 60% of total assets. As the chart
below illustrates, mortgage lending used to comprise a much smaller
share of total bank lending.
Back in the days of Eisenhower, Kennedy and Johnson,
U.S. banks would lend to businesses for the purpose of investing in
plant and equipment. Today, banks lend to homeowners for the purpose of
buying garden plants and stereo equipment. Additionally, the American
homeowners of 40 years ago were far more likely to pay off their
mortgage debts than to increase them.
Net-net, the U.S. economy has become increasingly
reliant on real estate transactions. The proceeds of used home sales as
a percentage of nominal GDP have soared to new all-time highs. "At
10.36% of nominal GDP, the dollar volume of trading in existing homes is
nothing to sneeze at," notes Northern Trust economist, Paul Kasriel.
"Of course, the principal direct contribution to GDP
from existing home sales comes from commissions paid to real estate
brokers, mortgage brokers and Wall Street securities houses which
'securitize' mortgages," Kasriel notes. "[But] if this housing frenzy
were to slow down, it likely would have a major ripple effect on the
economy as a whole."
Clearly, therefore, any prolonged slackening in the
real estate market would directly imperil job growth and GDP. In
addition, the adverse "knock-on" effects could be substantial.
"All bubbles essentially end painfully, housing
bubbles in particular," warns Richebacher. "They are an especially
dangerous sort of asset bubble, because of their extraordinary debt
intensity. The debt numbers speak for themselves: In 1996, U.S., private
households borrowed $332.2 billion...With the housing bubble in full
force, it hit $1 trillion in 2004.
"This debt intensity has its compelling reason in the
particular way that accruing 'wealth' has to be converted into cash,"
Richebacher continues. "In the case of an equity bubble, in general, the
owner realizes capital gains simply through selling a part of his stock
holdings. No bank and no debt are involved...In this respect, a property
bubble is a totally different animal. Since homeowners normally want to
stay in their house, 'wealth effects' have to be extracted through
additional borrowing against the inflating property value; that is,
through mortgage refinancing. In essence, twofold borrowing is needed:
FIRST, to boost housing prices; and SECOND, to withdraw equity.
"Yet," Richebacher notes, "there is a second, even
more dangerous, aspect to housing bubbles: they heavily entangle banks
and the whole financial system as lenders. For this reason, as a matter
of fact, property bubbles have historically been the regular main causes
of major financial crises. During its bubble years in the late 1980s,
Japan had rampant bubbles in both stocks and property. While the focus
is always on the more spectacular equity bubble, hindsight leaves no
doubt that the following economic disaster was mainly rooted in the
property bubble. Both bubbles burst in the end, but the property
deflation has continued for 13 years now, with calamitous effects on the
banking system..."
Clearly, a post-bubble economy would be no friend to
the debt-heavy, savings-lite U.S. consumer. Throughout the 1960s, 70s
and 80s, we Americans would save about 10% of our income each year. But
today, the national savings rate has tumbled to zero - We don't save
nuthin'! "In 2004," Richebacher observes, "household debt increased more
than twice as fast as disposable income." As we never tire of
mentioning, therefore, American households have never before dared to
face the future with so much debt and so little savings.
"For consumer spending to slump in the wake of a
fading housing bubble," Richebacher warns, "house prices do not need to
fall at all. It is sufficient that the stop rising, thereby depriving
households of new wealth effects..."
The housing bubble has not crossed over the
after-life, but that day approaches.
Are you ready?
[Joel's Note: No longer are we writing about the
"coming" crisis, the "future" catastrophe. The crisis is here. The
catastrophe is happening now. The following housing survival report was
authored with protection of your largest asset in mind. No longer can
you ignore the adverse effects of the subprime bubble...even if you are
a prime borrower. Read On Here And Protect Yourself:
Surviving the Housing Tsunami – The Report
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Rude Endnote: Will the markets steady themselves at
today's opening? Will they sound the death knell for Countrywide and the
like? We'll hand you over to the 5 for all the intraday action. Until
tomorrow...
Cheers,
Joel Bowman
Rude Awakening
aussiejoel@the-rude-awakening.com |
