Monday, July 28, 2008

The Banking Crisis - Where will it end?

There has been lots of discussion about the banking crisis for the past year so let's take a look at some of the primary causes of this crisis and what it will take to end it.

First, the banking crisis was caused by lax lending standards and nothing more. Many people were approved for mortgages they never should have received had banks been following traditional underwriting guidelines. This was caused by the global glut of savings looking for some kind of return, however small, with a secondary cause being that banks were more than happy to loan out the money with little to no research into the actual ability of the borrower to repay. Some pundits have cited over-reliance on standard indicators such as a FICO score but to me that's treating the symptom and not the disease - if people want to receive a loan, they should have some kind of skin in the game in the form of a downpayment.

Another contributing factor was the ability of banks to package these toxic loans into securitized assets that received good ratings from the likes of AM Best and S&P.

The real question is when will this crisis end? It will end when all these toxic loans have been written off the balance sheets of the banks. This will require massive (read: trillions of $$) losses from the banks and the best indicator of this will be when the masses begin to believe that it will never get better and banks are giving out very few loans. I cannot begin to predict when that will happen, but as a SWAG I would say sometime in fall 2009 which gives us another 12 months of interesting lessons in history from which people should, but will probably fail to learn from in the future.

Thursday, July 24, 2008

Grad School - The End is Near

Some of you who have followed me for a while know I am finishing up a graduate degree in Economics.


I intially began to study econ in 2002 trying to understand what happened in the dotcom bubble and how to keep it from happening again. Then we had the mother-of-all-bubbles in the housing mess and I was really curious to take my education to a higher level and I joined a Masters program in Econ in fall 2006. Fast forward two years and I am down to my last class. I will not write a memoriam until I complete it all but I can say it seems like just yesterday I was starting and today I am looking at the finish line. My understanding of economics has increased by magnitudes and I have a much more critical mind in determining what is happening in the economy today and actions taken by the various players.


For instance, Hank Paulson has been widely criticized for the Bear Stears bailout--or buyout, however you see it. Media reports that he wanted a very low price ($2) paid to shareholders to force them to take a loss and send a message of moral hazard throughout the markets - i.e. that companies that make bad decisions will have to pay. To the average lay person it looks like some people are walking away with stuffed pockets but sending a message out about losses definately causes a strong market reaction.

Economics has provided me with a large set of tools with which to better understand the markets and why people sometimes act the way they do, or a theory called rational expectations.

Wednesday, July 23, 2008

New Housing Bill Nears Law

Yahoo reports today that President Bush has agreed to sign the housing bill that is moving through Congress. From what I read, the bill does the following things:
- Allows FHA, FreddieMac and FannieMae to guarantee more mortgages, including
- The guaranteed refianance of $300 billion in mortgages

Starting with the first point, one of the problems that got us into this mess is that banks were writing unsound loans knowing they could be sold to the mortgage giant GSE's. Recently the limits were raised on the mortgages from $417,000 to in the $700,000's. Ironically the FDIC has not raised the limits of insured deposits

The second part is the refinance clause. Housing pundits like to believe that allowing someone who is upside down on a home to refinance will fix the issue. With rising gas and utility costs, many of the homes in which people are upside down might not be desirable now. Note that this will also not stop the growing number of 'mortgage walkers', or those who only bought for appreciation purposes or some other reason who won't pay for an asset that has little chance to bring an immediate return.

Mortgage walkers - keep an eye on this in the media as I believe this term will become synonomus with 2009.

I'm disappointed about this housing bill because it does nothing to fix the real problem (price/income ratio) and everything to hopelessly delay the inevitable (price/income ratio back to historical norms).

Tuesday, July 22, 2008

Plight of the American Auto Makers

My last post on the auto makers was in May 2005 where I commented that GMs new truck line was a mistake and not likely to bring the additional revenue they expected because the market was shifting away from large trucks and suvs. Apparently GM and Ford received the same memo sometime early this year and are now scrambling to build as many new cars as possible as the US moves to join our European and Latin counterparts at doing more with smaller vehicles, not less with larger ones.}

Ford announced today it will close the plant that builds the Ford Expedition and Ford Explorer, and start building the Expedition alongside the F150. I do not know where or if they plan to build the Explorer, but my prediction is that the midsize body-on-frame SUV will end. GM is also cutting back production on their SUV models.

We have all heard the automakers want government help to build a new generation of fuel efficient electric cars. I am not convinced it is the job of the government to subsidize these products, and I am also not convinced electric cars are needed in the US. There were concerns that the Internet craze in the 1990s would drag down the nations electric grid - what in the world would happen if everyone was charging cars? We would need all kinds of new power plants along with more efficient transmission lines, both entities that have all sorts of NIMBYs upset. Thus, electric cars really cannot be a feasible option today.

The real solution is more mass transit. Many people will not take mass transit because it is not convenient - but this problem can be rectified by more availability and options for travel. I am not convinced that the US citizens are so much for personal trasit they would turn down the economics of mass transit that would save them a ton of money in gas, car payments, insurance, etc. Matter of fact, I will happily sign up for a convenient mass transit option if one becomes available to me. It is time we as a nation look at the possibilities of mass transit in a positive light, not a negative one.

Saturday, July 12, 2008

IndyMac Failure

We have seen the first large bank failure of the hosuing crisis - IndyMac has failed. IndyMac was once a part of Countrywide Financial, which is now a part of Bank of America. IndyMac specialized in Alt-A mortgages, or those given to people who cannot or (will not) document their income to qualify for mortgages. IndyMac had some bad loans on the books and suffered from an old-fashioned bank run after rumors circulated in the press that the bank was insolvent.

Now we have seen a major ill-effect of the housing bubble. This is just the beginning, as we will soon see a large uptick in people walking away from houses they can afford, we will see an increase in suicides and personal bankruptcies. I hope that society and the lawmakers are prepared to let the market run its course and know that while it will get worse, it will one day get better.

For the record, I don't believe we'll see an uptick in the housing market until spring 2010, and the upturn will include a stable market (no increase or decrease in prices), and will probably stay that way for 12-18 months before small positive ncreases in housing prices return. Soon I will write about the reasons I believe we will see another major housing bust in the future even though there will be no bubble before. This housing bust will likely persist for 15-20 years with some years of increases and some of decreases.

Friday, July 11, 2008

The Real Cost of High Oil - And Why it's a Bubble

I'll go ahead and put myself on a limb here - I believe that oil will be below $100 a barrel by the end of October.



Let's look at the following circumstances:

- Demand is down 5% per day according the CNN

- People are becoming very conscious about oil consumption

- Gas guzzlers are out and small cars are in

- Airlines are cutting 10-20% of their flights (this one alone will save a TON of oil)

- As inflation rises in the US, FFR increases will strengthen the dollar resulting in less usage of oil as an inflation hedge

- The Olympics will be over in China, and China will stop stockpiling diesel oil

- Asian countries are removing their oil subsidies for oil consumers, resulting in increased prices for consumers, likely spurring conservation

Add up all these little pockets of demand that are going to disappear and we have the market forces to push oil back down below $100/brl, but we shall see.

***Since I wrote this article, oil in the past week has dropped $12/brl, the largest one week drop in history. We're now about $133/brl and I expect the drops to continue***