Wednesday, August 5, 2009

What green shoots?

The surface news seems to propel the stock market daily while the economy is propped from all angles. But, the news is bullish only if you consider pyric victories positive. Seems the oil markets take every report that is less bad than the prior to mean the surplus that is spilling out into the streets will soon disappear and boost prices ever higher. Some say this is a weak dollar, but the markets haven't been cleared for some time, regardless. The same is occurring in the copper markets, a product that is clearly cornered and stockpiled in massive quantities in China. Much is riding on these two commodities alone, most likely including the future profits of Goldman Sachs and many hedge funds. Should these markets crater, it is quite possible that the too big to fail that are involved, along with the independent producers of oil and the mining companies around the world would need a bailout.

The recent improvement in unemployment claims is being spun as a sign the recession is over, while in fact a recession that supposedly began in December 2007 showed no losses of employment of this size prior to 2009. Thus the economy is still declining at a pace that exceeds any during the first year of the recession, yet the recession is over? Nothing I have seen can be farther from the truth.

I believe the news is being made up as we go along. I recently read Murray Rothbards chapter in the book A New History of Leviathan that the Fed expanded holdings by a factor of 6 between 1929 and 1932 and the inflation did no good. We are told this didn't occur in the modern press as Bernanke does the same thing today. The budget of the US expanded 40% while the receipts of the government collapsed by 50%, making the gap between receipts and expenditures 60%. Still no inflation of prices and no recovery. Nothing could be more similar than the response between 1929 and 1932 and today than what Rothbard wrote here.

The solution in the US is to create an even bigger consumer debt bubble, while the banking industry is under pressure to preserve capital. I recently had my credit lines cut, though I had maintained a perfect record and paid all balances in full. Thank God I don't need the credit at this time. What are they doing for people that are really cashed out?

Then we have the home sales. Home sales never left the bubble stage from what I can deduce from past sales figures I have seen. The speculators have never left the market while the government is recreating a new subprime market with government subsidies and guarantees. In the meantime, the economy collapses while all this is going on. The recent rising new home construction figures were below anything prior to this recession for the past 50 years, yet you would think the financial side of the mortgage market was fixed and new homes were selling like hotcakes with legitimate lending. Nothing could be farther from the truth nor can what is being done at this time be sustained without government props. There is no private housing market in the US today, nor is one likely to appear any time soon.

In the meantime, mid sized banks in the growth areas of the country are now beginning to collapse. Colonial Bank of Montgomery, Alabama, an entity I had done business with in the past is open only because the regulators need the money to close it. The same is evidently true of Guaranty Bank, a former division of Temple Inland, another entity my family dealt with in the 1990's. There is another I am not familiar with, a bank that starts with C, I believe in Florida. I believe much of this is prime mortgage related lending along with failed housing projects. My dealing with Colonial was in the conforming mortgage market. These 3 failures alone will wipe out the FDIC.

The problems with the FDIC are why they had to construct the TARP fund. I believe Citi alone is a $400 billion hole and it is a lot easier to hope than to pay. This wasn't the first time Citi was broke. Much of what was missing has been covered up by government guaranteed financing for companies from Goldman Sachs to General Electric and everything inbetween.

Those playing in the mortgage business need to take a haircut and they can't. From what I understand, most of the foreclosed properties are being withheld from the market for 2 purposes. One to keep the weak market from being glutted and the other to keep the effects of the suspension of mark to market intact. Should the properties be sold, the losses would have to be recognized and there would be more banks to bail out, not to mention other financial entities. Those hoping for massive gains from holding housing in the next few years are going to be disappointed. In fact, I wouldn't be surprised to see a rent war break out if the highly likely weak recovery transpires. So much of the next economic wave depends on a resumption of real estate construction and I find it highly unlikely for anything near the bubble trend to ever return, nor anything close to the old peaks prior to the bubble. The same holds true for the commercial side of the game as well, as I expect retail real estate to be a disaster along with much of the other commercial property as well. I have attempted to last through a real estate bust and witnessed an entire metropolitan area of real estate related investment and construction businesses go broke. In the 1980's, the 2 largest home builders in the US, both based in Houston, imploded. Despite the size of this bust, I have yet to hear of a large builder going bust. My guess is that either the bubble was so big that even at reduced prices there was profit in the inventory or they are being carried as well under the label,too big for their creditors to let fail. Nothing here measures up to me. The bust will take longer to work out than even the least optimistic of analysts because the bubble was so much larger than prior bubbles and the market is growing so much slower than it was in 1980 or 1990.

All of these problems in the real estate market not only threaten the solvency of the financial system, but they do something few understand at this time, deprive the system of future loan collateral. This is going to be the real impact of this bubble going forward, the inability to tap home equity by the masses for a long time to come for things like retirement income, consumer spending, stock market investment and debt retirement along with all other major forms of spending. Also gone is a major portion of the move up housing market. We have only seen the tip of the iceberg here.

There is much more to the housing market that is beyond fix. For one, the market is saturated. Second, high interest rates penned up demand in the 1980's and much inflation wasn't passed on. As rates fell, FNMA developed more and more programs of qualification and the securitization of the mortgage market, demand erupted for housing against a fixed supply. As time passed, housing wasn't built for occupation, but for speculation. When I entered the real estate business in the late 1970's, much the same thing was going on, except Volker and inflation caught up with the cashflow market and put a damper on the bubble market. Underlying demand from the boomer generation was such that a collapse in the price of housing didn't transpire then. What did go on was people were paying extra over and above rents to get ahead of inflation as home owners or reap appreciation as speculative investors. The investor games didn't go on for long unless the borrowers were real pros with pockets deep enough to stay in the game.

What followed this bubble up is no longer present. There isn't a pent up demand from excessively high interest rates or a fast growing home buying age public. Thus there is an owner occupied percentage in the US that is likely higher than can be sustained along with interest rates that can only go up from here, unless there is no recovery. Then prices of homes will continue to sink.

The last green shoot comes from China. The Chinese recovery is more a flood of money pushed into the streets along with doctored statistics. I have read some things about the Chinese real estate market, which has to be 4 or 5 times the size of the normal US market, but only for a temporary period of time. The real business in China is building, not manufacturing and I am reading of entire cities of empty buildings. Thus, once this surplus is exposed, once the speculative bubble bursts and once the truth about the Chinese economy comes to the surface, the whole game washes out. It appears that the Chinese housing game has about 5 to 10 years left then the dance stops. I don't mean it slows down, but just flat stops. They have enough housing under construction right now for about 70 million people and enough capacity to build about 50 million worth of housing annually. There are only about 300 million people left to move from the rural areas, thus 6 years minus what is already sitting around vacant and the game is done. I don't even bring up the fact that the Chinese population is set to start expiring at a massive rate in a few years as the 1 child policy begins to take its toll. This is not good news for the mining industry and for those that believe in peak oil as already being reached. It is good news for the rest of us, save the fact that the economic impact on the world is going to be great.

So you have it. Green shoots is one of the biggest fairy tales in economic history. I think we had a muddle through economy a few years ago. This time, we are likely to see a just lay there economy. The effect of this on economic growth and corporate profits is going to be devastating. Stocks and retirement funds are going to shrink to next to nothing and life as we know it is going to change. It would be very beneficial to all if I am wrong here, but I don't believe that is going to be the case. I look for the Dow to possibly touch 10,000, maybe even a little higher, then the bear to come out again, stronger than he was the first time. The government will forget about saving the banks this time and start working to save itself.

1 comment:

HMT said...

It's Sad I had to Agree with you