Some will point to smaller countries that suffered rampant inflation after their central banks printed money but we have more in common with Japan, what was the 2^nd largest economy in the world.  In this article we will try to carefully look at research on the Japanese boom and bust and also take a look where we stand in our current financial crisis.

Source:  The Economist

The first definite comparison we can make is with the rampant rise in home values.  Japanese real estate values saw a massive ten year boom during the Heisei boom.  The chart above clearly shows the trajectory of land values.  Yet research shows that a large part of this was concentrated on a few urban cities.  In this regard, the U.S. had a much larger and more pervasive boom impacting multiple cities across the nation like Miami, Las Vegas, New York, Los Angeles, San Francisco, Phoenix, and many other locations.  If we separate Tokyo out we see that overall Japan did have a bubble but it doesn’t seem as large or as widespread:

Source:  Debt Deflation

The above is an interesting chart because it reflects a concentrated urban bubble.  We had many suburbs popping up with home builders trying to create demand where there was nothing more than a bubble to chase.  Many of these areas including the Inland Empire in California have large homes selling for half off (or more) with very little demand chasing after the homes.  It is an interesting case study as to why values go up so quickly but miscalculations by the Federal Reserve and misguided policies led to the biggest and most widespread housing bubble here in the United States.

A 2003 paper by the Bank for International Settlements (BIS) focused on the Japanese housing bubble and concluded the following:

“What should be noted regarding Japan’s experience is that the enthusiasm of market participants, together with the inconsistent projection of fundamentals, contributed to a large degree to maintaining temporarily high asset prices at that time. Such enthusiasm is often called euphoria, excessively optimistic but unfounded expectations for the long-term economic performance, lasting for several years before dissipating.”

“It was thus excessive optimism rather than consistent projection of fundamentals that mainly supported temporarily high asset prices.”

There is little to debate that what fueled housing prices in the U.S. was also ignited by euphoria for real estate that was largely disconnected from fundamentals.  Let us construct a chart similar to the above with Tokyo and Japan but in this case, we will look at the Los Angeles MSA and the 10 city composite from the Case Shiller data:

Although it would appear that Tokyo had a much quicker and faster rise in prices, an area like Los Angeles saw a very similar trend.  Yet what separates the two bubbles is that the U.S. as an entire nation also saw a massive rise in prices over a short period of time.  Looking back, we see that the peak for U.S. housing values was reached in 2006 with the Los Angeles MSA also reaching a peak in this year.  The chart above shows the clear decade long boom in housing values.  What we find over this decade period is that home values in the U.S. increased by a factor of 3 while home values in L.A. increased by a stunning factor of 4.  In other words, the U.S. housing bubble was equally as large in magnitude as that faced by Japan but much more widespread.

The BIS paper also makes the comparison that Japan faced nearly two decades of bubbles, one started in the stock market followed by the real estate bubble:

“First, at the time of the Iwato boom, when Japan’s economy entered the so-called “high economic growth period”, asset prices increased rapidly, reflecting an improvement in fundamentals due to technological innovations. The real economic growth rate exceeded 10% per annum, driven mainly by investment demand due to technological innovations that replaced the post World War II reconstruction demand. On the price front, consumer prices rose while wholesale prices remained generally stable, thus leading to the so-called “productivity difference inflation”.

“Kakuei Tanaka, who became Prime Minister in 1972, effected extremely aggressive public investment based on his belief (remodelling the Japanese archipelago) that it was necessary to resolve overpopulation and depopulation problems by constructing a nationwide shinkansen railway network, which led to an overheated economy.”

This economy is largely seen by the charts below:

We have a very similar parallel here with our NASDAQ boom of the 1990s followed by the real estate boom reflected on the previous chart looking at Case Shiller home values.  If we look at the NASDAQ, we realize that even after the recent boom in stock values prices are nowhere near their peak:

On a nominal level the NASDAQ is still off by 55 percent from the peak reached a decade ago.  Often we hear about the lost decade comparison.  In stock values, we are already there.  In terms of real estate values, we are quickly approaching that point.  So we have more similarities in our booms and busts with Japan than many would like to admit.  The 1990s saw a rise also in productivity brought on by technological innovation but this also paved the wave for an economy largely decentralized on a global level.  This hit hard in the manufacturing core of our country.  Someone made the argument to me at the height of the real estate boom that “you can’t outsource real estate” which is true but that is a double edged sword as we are seeing.  The Nikkei peaked on December 29, 1989 closing at 38,915.87.  Today it stands at 9,431, a drop of over 75 percent.  Massive bubbles can have long lasting impacts on the economy.

Missing asset bubbles and targeting inflation

Another important comparison made in the paper is that of perceived stable inflation and how central banks can miss asset bubbles while they are happening.  It is the mistaking of a bubble for real economic growth:

“Third, in the Heisei boom, asset prices increased dramatically under long-lasting economic growth and stable inflation. Okina et al (2001) define the “bubble period” as the period from 1987 to 1990, from the viewpoint of the coexistence of three factors indicative of a bubble economy, that is, a marked increase in asset prices, an expansion in monetary aggregates and credit, and an overheating economy. The phenomena particular to this period were stable CPI inflation in parallel with the expansion of asset prices and a long adjustment period after the peaking of asset prices.”

“The decline in asset prices was initially regarded as the bursting of the asset price bubble, and an amplifying factor of the business cycle. Although the importance of cyclical aspects cannot be denied, further declines in asset prices after the mid-1990s seem to reflect the downward shift in the trend growth rate beyond the boom-bust cycle of the asset price bubble.”

This is an important key point.  The Federal Reserve publicly stated that during the bubble (it wasn’t labeled as such) that inflation overall remained tame and therefore keeping interest rates low was viewed as a prudent policy.  If the economy is growing and is stable, then the central bank should keep liquidity flowing into the system to keep building up legitimate businesses.  Yet separating real growth with an asset bubble can be tricky especially when the policies taken are part of the reason for the asset inflation.  Japan viewed there measures as stable.  We did this in a similar fashion but part of it was that our metrics to measure inflation largely missed the housing bubble.  The CPI measures “owners equivalent of rent” which completely ignored the rise in home values.  This measure is the biggest in the CPI so the data was skewed.  Also, innovation in mortgage products with teaser payments altered the true monthly payment and understated it.  The government for most of this time also only focused on OFHEO (now FHFA) which only looked at home loans secured by Fannie Mae and Freddie Mac and ignored the vast majority of subprime Alt-A, and option ARMs that fueled the last stage of the housing bubble.  In fact, year over year changes in the inflation measure from 1980 to 2000 seemed to be as stable as they come:

During this time we saw the massive NASDAQ bubble and also, the subsequent real estate bubble.  Inflation data largely ignored most of it because the measure was flawed when it came to measuring bubbles.  Japan had similar problems and taking policy decisions on this data has given their economy two lost decades and their economy is still suffering.  Then why follow that same path?

Japan gives us a working sample as to what can happen with asset deflation, a stock bubble popping, allowing banks to remain propped up by government funding, and massive government spending:

*Japan asset, stock and CPI measures

Some seem to think that Japan just sat back and did nothing during this time.  There is nothing further from the truth.  Japan was the first major economy to go down the path of quantitative easing.  Japan also injected enormous amounts of money into their economy to stimulate growth.  Yet the above chart is rather clear in the outcome.  Some point to unemployment in Japan remaining low.  This is more a sleight of hand with economic data.  Although the official rate is low, nearly 1 out of 3 Japanese workers are considered part-time employed.  That is, no security of long-term employment.  We have seen a massive rise in the number of Americans that now work in a part-time fashion.  No benefits, lower wages, and job security that is no longer an option in the longer term.  It is easy to see why asset prices in Japan have remained depressed for so long.  Prices in the U.S. are showing no sign of inflationary pressures because there is little mechanism to force wages up with such a giant over supply of labor in the market.  This is possibly one of the major points missed by those who predict inflation or hyper-inflation in the future.  Central banks can print but they can’t force wages up especially in a global market where cheap wages are the status quo.  To the contrary, banks are following the zombie like behavior of Japan banks by hoarding funds:

Now that we’ve had three full years after the bubble popped, we can see what banks have done to “fix” the problem:

-Hoard money to fix balance sheet imbalances

-Suspend mark to market (Japan banks zombie like tool of preference)

-Ignore major commercial real estate problems

-Drag out the real estate problems (we have done the same with banks delaying the foreclosure process, stopped lending their own capital in place of government loans, and banks have turned inward with government bailout funds).

The above chart shows that banks are still sitting on an enormous amount of excess reserves.  Now that due diligence is back (to a certain degree) who are banks going to lend to?  4 out of 10 workers in the U.S. are employed by the low paying service sector.  Close to 15 million are officially unemployed and unless we go back to the easy lending mortgage days, they won’t be getting any bank money soon.  We have another 9 million workers that are employed part-time for economic reasons (similar to the large employment base of Japan).  You think this group is going to get a loan for a home anytime soon?  Banks have turned their profits inward while the real economy is largely in stagnation.  Yet if Japan is any indicator, these profits will start to go down:

While it is easy to make money right now since a large part of the competition has failed while a select few have been given government backing and funding, as time goes on this profitability goes away.  And the real economy in Japan has languished all this time.  The BIS paper in 2003 gives a wonderful synopsis of what led to the Japanese boom and bust economy:

“The intensified bullish expectations were certainly grounded in several interconnected factors. The factors below are often pointed out as being behind the emergence and expansion of the bubble:

• aggressive behaviour of financial institutions

• progress of financial deregulation

• inadequate risk management on the part of financial institutions

• introduction of the Capital Accord

• protracted monetary easing

• taxation and regulations biased towards accelerating the rise in land prices

• overconfidence and euphoria

• overconcentration of economic functions in Tokyo, and Tokyo becoming an international financial centre

Focusing on monetary factors, it is important to note the widespread market expectations that the then low interest rates would continue for an extended period, in spite of clear signs of economic expansion. The movement of implied forward rates from 1987 to 1989 (Figure 5) shows that the yield curve flattened while the official discount rate was maintained at a low level.”

You might as well put this label on the U.S.  Aggressive behavior of financial institutions?  Doesn’t get more aggressive than giving a loan to someone with no job and no income.  Progress of financial deregulation?  What about repealing Glass-Steagall in 1999, protection we had put in place back from the Great Depression.  Inadequate risk management?  We need only look at AIG, Lehman Brothers, Bear Stearns, Fannie Mae and Freddie Mac, and many others.  Protracted monetary easing?  Does a zero percent interest rate and buying up of mortgage backed securities count?  Taxation and regulations biased toward rising prices?  How about giving new home buyers a tax credit when they were going to buy anyway?  Over confidence and euphoria?  Just go to YouTube and watch some of the real estate commercials from the peak days of the housing bubble.

We have a lot that is similar to Japan and their boom and bust economy.  If their path is any indication of our own, we have a long road ahead and getting home prices back up is probably going to be the least of our concerns.

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We’ve enjoyed a one year respite in the housing crash.  Yet housing in many parts of the country is overpriced relative to local area incomes.  I want to examine 10 charts that give substantive evidence that we are merely in the eye of the housing correction hurricane.

Chart #1 – Unemployment rate and labor force participation

It is often touted how great it is that the unemployment rate is falling.  First, a large part of that has to do with massive government hiring.  Next, a large part of the rate appearing better has to do with people simply dropping out of the labor force.  The headline unemployment rate is 9.5 percent but if we count those unemployed and underemployed the rate spikes over 16 percent.  Not only do we have an elevated unemployment situation, we have 40 percent of our country working in low paying service sector work.  This doesn’t provide a solid foundation for growing housing prices let alone a bustling economy.  Keep in mind we need to add 150,000 jobs a month simply to keep up with population growth.  Our economy faces challenges that rival those of the Great Depression.  If the unemployment rate were dropping because of adding a good portion of non-government jobs then that would call for a champagne celebration.  Yet calling it great news by massaging numbers is simply an exercise in self-delusion.

Chart #2 – Pending home sales

Given the weak employment situation, it should be no surprise that simultaneously the amount of pending home sales has collapsed to record levels.  The jump you see above from 2008 to 2009 came from gigantic forms of government stimulus.  The Federal Reserve purchased $1.25 trillion in mortgage backed securities.  Why?  No other investor in their sane mind would buy this.  The Fed has also kept interest rates dangerously low trying to encourage additional borrowing.  Alan Greenspan instead of confronting the real structural problems that came after the tech bust decided to take the easy road out and created a credit bubble and brought on a plastic recovery.  We now know none of it was real in sense of it being sustainable.  The above collapse shows the sugar high running out from the Fed and also the very expensive tax credits.

Chart #3 – Construction spending

As home sales jumped on a sugar high from government intervention, construction spending did jump up in the residential sector.  How long will this last now that the government is pulling back?  And in the more sensitive commercial real estate market, growth has contracted.  This is a better reflection of actual demand because who is going to build a strip mall during a time that consumers are embracing austerity?  The residential sector did go up but again, this was merely based on massive government intervention that has no guarantee going forward.  All we did was pull demand forward for one year and operated on tax credit fumes.

Chart #4 – Hires and separations

As expected hires have increased in the first half but this is largely due to government temporary hiring.  But look at the separation line above.  People are hanging on with their clenched hands to their jobs (jobs that are largely paying less).  Do you think these people are looking to buy a massive ticket item like a home moving forward?  The above chart does a good job reflecting the psyche of workers.  Confident workers are willing to leave a job to find a position that better matches their wants in a healthy economy.  What the above shows is that people are holding on tight to their positions even if they are not ideal and fund their needs.  It is all about needs today.  With 5 unemployed workers competing for each single job opening you can tell why the above pattern is holding.

Chart #5 – Export prices

During the Great Depression import and export prices collapsed.  During this globally difficult time we faced massive deflation.  Last week we saw that the CPI went negative.  The market is so tight right now that there is little pricing power for producers.  Ben Bernanke gave a speech a few years ago where he outlined every way we can avoid deflation.  He hasn’t been shy about keeping rates low and also offering quantitative easing.  But this has only helped the banks and that is ultimately who the Fed works for.  Americans as a whole did not benefit from this easy money.  In fact, say you buy a home today with a low down payment FHA insured loan, are you confident that you will have the money to pay off that debt for 30 years?  If anything, the decline in export prices shows that people are not confident about the future and are more concerned about the present.  They are competing on a price level and that is why even with home sales, the large push has come from lower priced foreclosed properties.  As time goes on we are looking more and more like Japan.

Chart #6 – Employment changes in big counties

Even though the stock market rallied in the last year employment has gotten worse.  The stock market is largely an indicator of the casino that we now call Wall Street and really doesn’t reflect reality for most Americans.  Look at the above chart.  While the stock market was raging in 2009 many large counties saw employment contract severely.  This was across the spectrum.  You have your typical Southwest locations but also Texas.  Recent articles have talked about how immune Texas is from the contraction.  Just because you don’t have a housing bubble doesn’t mean you don’t have people that used the same credit cards and auto loans to purchase other items.  We’re all in this together and Wall Street banks are the biggest winners with the stock market rally.  How anyone can look at the above chart and say things are economically good is beyond reason.

Chart #7 – Commercial real estate

Commercial real estate (CRE) prices are down 40 percent from their peak from only a few years ago.  There is no pricing power in this market.  CRE has collapsed and is also guilty of large amounts of toxic high flying mortgages.  This market isn’t going to collapse it HAS collapsed.  The only reasons we don’t see the ramifications of this more visibly is because banks are using extend and pretend tactics while siphoning off money from taxpayers.  The CRE market is enormous coming in with $3 trillion in loans outstanding.  Many of these bad loans are sinking smaller regional banks (we are reminded on bank failure Fridays).  The big banks have these as well but they have a money sucking hose to the taxpayer wallet via the Federal Reserve and every loss they face is already buffered by the majority of Americans.  More and more the public is waking up and public sentiment is furious.  At a certain point, there will be massive calls for action.  You think the public is looking to bailout the CRE market?  There is no political will for helping this bubble market.  In the end, reality will come to the surface.

Chart #8 – U.S. home prices

The only reason that you see home prices increasing above from 2009 to 2010 is because of the government.  From the previous charts, you can see that prices did not go up because of income and wages growing.  This is merely a tiny reflection of easy money coming from the government.  But even with that, you can see that prices are way down from the peak.  The median home price is still down by over 23 percent from the peak.  Why would prices go up if incomes are not?  There is little reason to believe we’ll see any jump here.

And this chart is very important.  I hear people talk about the 1970s and how inflation eventually brought the price of everything up including wages.  Well there is absolutely no pricing power for wages in our current market because we have largely outsourced our manufacturing base.  Working at McDonalds isn’t going to buy you a $175,000 median priced home.  Has anyone looked at what people earn in China?  The real estate cheerleaders make little attempt to connect macro level economic movements with what is going on with housing prices.  The Fed is vigorously trying to inject inflation into the market.  But most of the money is going to the banks!  It isn’t making its way back into the real economy.  What sectors are we seeing wage inflation in?  Without that, good luck seeing higher home prices.

Chart #9 – Total U.S. debt

We have more total outstanding debt as a percentage of our GDP than we did during World War II.  Think about that incredible fact for a moment.  In addition, during the early 1940s we had massive pent up demand and wages because of the deep problems of the Great Depression.  Is a war going to boost our economy?  If you haven’t noticed we are actively in two wars at the moment.  Plus, modern warfare doesn’t require troops that resemble the Battle of Philippi.  It puts things into a precarious state because anyone that is honest realizes we will never pay our debts back.  Why would a global investor put money into a company it knows will never pay it back in full?  Yet we insist on more spending without actually getting money into the economy.  If we really want to stimulate the economy take all the money given to the banks and build infrastructure.  At least it’ll leave something for the country instead of filling up the funds in some investment banker’s offshore account.

Chart #10 – Consumer sentiment

You might have noticed that the casino had a bad end of the week.  Apparently the public realizes how bad things are out in the real world.  Most people (as measured by ratings) don’t watch CNBC and are glued to their ticker tape counting their stock market wealth.  Why?  Because most of it is concentrated in the hands of the top 1 percent but more importantly, most pay their monthly bills and commitments through their job.  The vast majority of Americans simply want a job that allows them to cover the needs of their family.  They don’t care that someone shorted a stock and made a billion dollars.  The demands of their daily life are so removed from that nonsense.  That is why the above surveys are still near their lows.  People are simply not confident with a bad economy.  Outside of Wall Street, Americans are still having a tough time.

In a way, it is something of a coincidence that the big movie out is Inception.  I love the tagline:

“In a world where technology exists to enter the human mind through dream invasion, a single idea within one’s mind can be the most dangerous weapon or the most valuable asset.”

Apparently some people were dreaming when they thought their most valuable asset was their home.

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Take for example this Chase modification that recently occurred here in Los Angeles County:

This loan modification occurred in the 91306 zip code of Los Angeles County.  The current median price for this market is $355,000.  Remember those horrific option ARMs?  Well they are now morphing into other products.  Here are the original terms on the note:

Option ARM payments

Negative Amortization:                 $1,754

Interest Only:                                    $2,265

P&I:                                                       $2,905

The “real” monthly cost on the mortgage is closer to $3,000.  Yet with this new modification, the borrower can stay in the house paying $1,694 per month all the way until 2015 with a 3.75 percent interest rate.  This is someone that took out an option ARM from one of the former option ARM kingpins.  The borrower who speculated wins because they get to stay in the home and the bank has already won with all the taxpayer money they have stuffed into their pockets.  Oh, and what is the new principal balance?

So the bank can assert that they have a $542,000 asset in a market where the median home price is closer to $355,000.  What do they care?  They already have taxpayer money to speculate on Wall Street and basically allow these mortgages to sit fertile for as long as the borrower can string by a few payments.  Moral hazard?  We are beyond that point.  I’m surprised we don’t have tens of thousands of people marching down Wall Street but as long as those iPhones have new apps each week then I guess all is well.

If you look at market rents in this area, it actually turns out that this borrower is making out big time:

Hard to tell the size of the home but assuming the basic 3 beds and 2 baths home, rents can range from $2,300 to $2,400.  Keep in mind that the borrower can write-off on their taxes the interest portion of the note (100% for the next few years) plus taxes.   Ultimately, banks and borrowers are being rewarded for bad behavior.  And this hurts everyone especially the prudent majority.  Keep in mind that if this home was added to the market even as a rental, overall rent prices would go down.  So by funneling money into the banking sector, what is occurring is we are favoring one group over another.  In this case, the vast majority of the reward goes to the bank while the borrower shares in their dirty little secret.

This is only one example of many of the option ARM reworks that are currently happening.  Make no mistake, the vast majority are failing and going into default but there are also many loans like the above that are being reworked through hocus pocus and subsidizing another group that made a very bad bet.  And enough with the keeping people in homes argument.  There have been modifications of toxic loans in million dollar neighborhoods!  These people will be renting in top of the line areas if they lose their home so don’t go sobbing about that especially here in California.  We’ve already analyzed top priced areas and you see that the stats show a very peculiar trend.  Why not say that we won’t allow modifications that go above the median nationwide home price of $170,000?  I think most can live with that.  But that isn’t exactly what is happening.

Shocked yet?  Well how about a 40 year IndyMac loan modification?  A reader sent over this interesting example:

Remember IndyMac?  They were the bank that fell flat on their face and had a large number of people here in Southern California doing bank runs that looked similar to the Great Depression.  Keep in mind that this is a giant loan amount.  The national median home price is close to $170,000 as we just mentioned.  In California, the median price is $278,000.  Who are we really helping here and how do banks have the money to make these kinds of deals?  That’s right, we’re in a crony banking system that basically operates to funnel money into the completely unregulated (actually, regulations are there but no enforcement) and wild west banking industry.

This absurd behavior goes on because both Democrats and Republicans (especially in the Senate) are owned by corporate lobbyist and Wall Street.  Until people demand real change, the same beat will go on and banks will continue to suck every ounce of real wealth from our economy.  The fact that it is cheaper to live in an option ARM financed home today than to rent responsibly tells you a lot of where things are.

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There is a flip side to housing values falling which seems to be ignored since most of the mainstream rhetoric is guided by the FIRE (finance, insurance, and real estate) experts.  The most obvious benefit is those looking to buy their first home don’t need to put themselves into so much debt that they risk their entire financial future for a home.  The next subtle change is the amount of money diverted from housing related spending to other sectors of the economy.  This last change will take time to sink into the overall economy but there is definitely a benefit of moving away from an economy highly dependent on Wall Street finance and real estate.

If we look at the current nationwide situation, the amount of distressed loans is stunning:

I think that the above disaster in distressed mortgages is causing very little reaction because we have somehow adapted to the current shocking situation.  Over 10 percent of all U.S. mortgages are at least one payment behind and another 4 percent are already in the process of foreclosure.  This figure is incredible given the entire mortgage market is made up of over 51 million active mortgages.  In 2007 if you were to tell someone that prices in California would fall by 50 percent (even 10 percent) many would have ignored you.  Now, it is standard practice for the market.

As a country we are much too reliant on real estate.  Commercial real estate is the next tragic saga in the RE bubble bursting with prices already falling by 42 percent.  At one point, CRE values in the U.S. were up to $6.5 trillion (now this was a rough generous estimate at the time).  Today, CRE values are down closer to $3 to $3.5 trillion; this is roughly the same amount of CRE loans outstanding.  This has pushed defaults through the roof:

The exponential rise is cause for serious concern.  There is little energy or political will to bailout the enormous CRE market.  This probably won’t stop the Federal Reserve and U.S. Treasury to game the system yet again and put taxpayers on the hook.  They created this massive monster and now want the public to fight it off with pitchforks.  The above chart is disturbing and the amount of bank failures we are seeing is directly related to the above trend.  Many smaller banks are deep in the trenches with CRE debt and much of this is now going bad.  How many strip malls do we really need?  Maybe having 20 Taco Bells in a one mile radius probably isn’t such a good idea.  Many of the commercial projects were built in the anticipation of sky high residential prices to justify their absurd underwriting expectations.  The above results have no excuse and are largely a reflection of massive delusional speculation in all things real estate.

Now that expectations are coming more into line and the fantasy world of Alt-A, subprime, and option ARM loans are behind us, most people have to qualify to get a loan with actual real income which many are now finding less of.  Banks lending virtually all government money, are now beholden to stricter (aka basic due diligence) in order to give out loans.  Yet if we look at the negative equity situation, the real estate monster grows scarier:

Over 20 million mortgage holders are underwater.  It is amazing that a few years ago, Deutsche Bank estimated that at the ultimate trough of the housing market, nearly half of all mortgages would be underwater.  This “doomsday” scenario seemed extremely farfetched.  Today, another 10 percent nationwide price decline would put us there.  Even without prices declining further, having 20 million Americans underwater is not a good sign going forward.  You figure over 7 million people are one payment behind or in foreclosure.  But what about the other 13 million?  This enormous group is basically a large cohort of renters but in a worse financial situation.  They are stuck.

In this market, renters are treated as second class citizens although they make up a large part of the market:

1 out of 3 people in the U.S rent their place of residence.  In states like California the number is closer to 1 out of 2 (some counties have more renters than owners).  Yet there has been little discussion about this market.  There have been programs to defer or even help in paying for mortgages of those who lost their jobs but what about those who rent and lost their jobs?  Who are we helping here really?  If anything, this is a transfer of wealth to banks since many of these people will lose their home anyway.  I’d be curious to see a breakdown of the “official” 15 million unemployed and their housing status.  Trying to keep housing prices at levels that were clearly unsustainable is bad policy going forward and is partly a large reason why the economy is still muddling through.

Most of the parts of this real estate Frankenstein show up in a few common states:

Nearly half of all the latest foreclosure filings came from four states.  The concentration of toxic mortgages in these states and also, the massive jump in prices is still hurting the market years after the bubble burst.  With the employment market weak and anemic, there is little reason to believe (or even hope for) higher housing prices.  This actually hurts those who will buy in the future and commits a large portion of their income to housing moving forward.  This also means they have little money to spend in other areas of this consumer based economy.  So this idea that we need to keep feeding housing is really a preoccupation and obsession that comes from the FIRE economy.  These bad habits are hard to change and so far, little has been done to change this.  Normally it takes drastic circumstances to change people’s behavior.  You would think that the deepest recession since the Great Depression would do that but it hasn’t.  People realize what needs to be done merely by intuition yet we have no Pecora to move the political wheels forward.  The deep capture of our government to Wall Street is stunning.  And because of this, we have a massive real estate Frankenstein walking around our country bumping into taxpayer dollars at every turn of the corner.

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I normally listen to a few financial shows on my iPod but for the last month, took a hiatus from some of the financial media.  As I put on my earphones and listened to shows from early to mid-June, I realize how utterly wrong “analyst” are in predicting trends.  In fact, one show was aired when the DOW was up over 10,500 and they were talking how at the end of the month, only a few days away, we would end at 11,000.  We ended the month at 9,774.  Many in the financial mainstream press are like the shamans trying to heal illness with ritualistic dances.  In this case, the dance involves singing the praises of housing and the inevitable bull market run that is around the corner.

The first chart, shows the collapse in new home sales:

Chart 1 – New Home Sales

Why should we be concerned with the above?  New homes usually sell for a higher price but also create demand for jobs in construction.  With the market falling due to lack of demand (aka people dealing with a poor economy) there is little need for new home construction.  Much of the demand was pulled forward with every imaginable gimmick that the government could muster.  The U.S. Treasury and Federal Reserve have conjured up magical ways to get people to buy but there is only so much that can be done in the longer term.  The drop in new home sales shows us that the second half is going to be a major challenge especially for housing.  Keep in mind that spring and summer are the high selling seasons.  We have roughly two months for spectacular results before entering the weaker fall and winter.

When I talk with colleagues about a double dip we usually have to reflect on where things improved.  Sure, the 401k looks better than early 2009 but most don’t understand why.  They just assume that since the government juiced up Wall Street that somehow this will take care of itself.  Of course, much of the aid has been shifted to crony bankers who use the housing industry as a buffer for their own personal enrichment and at the detriment of society.  New home sales tanking is simply reality coming to a massively subsidized market.

Chart 2 – Employment by Sector

Government has been the big sector out there hiring.  Much of the growth in the last few months has come from temporary hiring by the Census.  As this retreats the private sector will need to pick up the slack but it doesn’t look like it can do it.  Some economist point to 1990 and 2000 with similar trends but 2010 is nothing close to those decades.  During those times, we weren’t dealing with an epic global housing bubble.  We also didn’t have a stock market reacting like the market during the Great Depression.  Right now the government is the housing market, employment market, and best friend to Wall Street.

The ADP report this week showed tepid hiring in the private sector.  This Friday we are expecting a job loss figure but the real data will be on how many jobs are added (or lost) from the private sector.  The trend of artificial stimulus is simply unsustainable.

Chart 3 – Deficit

It cost money to do all that we are doing.  The above chart looks like the balance sheet of many households.  A household with a budget like the above will be at risk of foreclosure and bankruptcy.  Yet for our government, we are supposed to believe that this is somehow good.  In May, we collected $146 billion in receipts.  At the same time we spent $282 billion.  For the current fiscal year we have a $935 billion deficit.  What are we spending this money on?

It would be one thing if we were spending these hundreds of billions in actually creating jobs and industry to put people back to work.  At least that I can stomach.  But we are using money for delusional tax breaks so people can buy homes they can’t afford and using the Federal Reserve as the Fort Knox of buying up mortgage backed securities.  There is something disturbing about the massive wealth transfer that is occurring in our country.  If the funds were actually going to putting people back to work it would be more palatable for the public but when all of it is going to backstop this real life Wall Street monopoly game, people start realizing something is seriously off.

If someone is going to argue about deficit spending they should at least argue that there can be no deficit spending without actually reforming the financial system first.  Otherwise, you simply spend more with the bulk going to financial firms and the tiny bit of crumbs that fall off the plate go to the economy.  It is taxpayer money that is keeping the system afloat yet they are being helped the least.

Chart 4 – Existing Home Sales

Existing home sales are a large reason why new home sales have collapsed.  Why pay that much more when there are tens of thousands of foreclosures to be had at much lower prices?  But even here, we are seeing demand wane as the tax credit euphoria begins to wear off.  This shows us that nationwide housing is in for a challenging second half.  Sure, the government can talk about extending tax credits and other gimmicks but part of the surge was the notion that “this was it” and people had to buy now to take advantage of these offers.  If we are going to have tax credits into perpetuity the market will simply adjust.  If people start seeing that home prices can move sideways and even fall going forward, why would they jump in?

You also need good income with a steady job to buy a home.  Those hundreds of thousands of Census jobs are merely temporary.  They won’t buy homes.  Who will?  Clearly the answer is not many once the air is let out of the balloon.  Going forward we need to have the economy and jobs stabilize before seeing any housing recovery.

Chart 5 – Home Prices

Home prices have moved sideways even with all the government intervention.  With some of this starting to wear off, we are likely to see two scenarios in the second half. The first one is a continuation of the sideways trend.  In other words, prices don’t move up or down.  The more likely case is prices move lower to reflect the demand pulled forward.  Should interest rates rise, this would be another reason to push prices lower.  Of course rates won’t go down because of the Fed but market forces can change dynamics quickly as we have seen in Ireland, Greece, and now Spain.  Certain areas of California are still clearly in housing bubbles.

There is much to be cautious about in the second half.  As I finished listening to the financial Podcasts from a few days ago, it is obvious that the so-called experts have no idea where we are heading.  They merely react to the day to day movements in the market and don’t take a larger macro approach.  The above data combined with massive amounts of shadow inventory and weak hiring tells us the economy needs to brace itself during the second half.  Can’t call it a double dip if most Americans are still in the trench.      

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