Feb 19, 2008

There is no Housing Crisis

There is no real estate crisis. There is a wash-out of speculators in the areas where prices were driven by that speculation along with a serious lack of interest for property in the great shrinking rust-belt. Quality loans at extremely low rates are readily available to “A” borrowers.

What it should be called is the “bad exotic vehicle bubble”. The investment banks made a ton by repackaging high-risk/high-interest mortgages into a more complicated structured investment vehicles like CDO’s and SIV’s. When a mortgage becomes part of one of these, the normally straight forward mortgage accounting rules get fuzzed-up, allowing the bank to book a greater portion of the anticipated interest as an asset. This became the trough that the fattest of the hogs ate.

The write-downs that are dominating the financial media space are just a reversal of the “profits” that these investments banks have already booked that would of never happened if normal accounting rules had applied in the first place. The 25 top players in this game lost more than $100 billion in 2007 and that number could be doubled if you add in the next 100 or so regional banks, retirement funds and investment trusts that bought into the higher rates that the CDO’s and the SIV’s offered.

As the default rate for exotic mortgages started to increase and the market for these securities dried up, the speculators lost their biggest tool that allowed them to acquire their properties. When the speculators were stymied, housing prices flattened out and in the most active areas, declined. This gave the creators of these investment vehicles, having New York as their play ground, an opportunity to blame their potential negative exposure on a housing crisis.

Our largest investment banks enticed the financial media by leaking the assumption that they had billions in exposure, all because of unscrupulous and corrupt mortgage brokers. The fact that none of these brokers would exist if it weren’t for the eagerness of the investment banks to purchase these loans, with very lucrative commissions attached, from the very brokers they now blamed. With sub-prime, alt-a and jumbo mortgages becoming prohibitively expensive, the housing market produced a constant supply of bad news that eventually sucked in even Congress. As expected they produced a landmark deal with the Treasury that accomplishes nothing, a months grace after three months of non activity is just the solution that will definitively save the market.

The financial media was also instrumental in determining the Feds current disposition. By presenting one economist, guru, potentate and mogul after another calling for rate cuts, they created a public ground swell that anything but substantial cuts would have demonstrated that the Fed was out of touch with the real world. This frenzy to inject liquidation into the economy has little to do with the housing crisis and all to do with the fact that Wall Street loves cheap money. These same investment banks are now able to book enormous profits because their cost of capital has come down so low.

When thecost of money comes down and liquidity is added to our system, the banks have money to put to work and credit standards loosen. The resulting effect of “easy credit” is always an upturn in the default rate and the banks respond by tightening those same standards. Our economy has always had swings from loose credit to tight credit and back again, the difference here is we are just entering a period where credit is starting to tighten and the Fed is literally dumping liquidity on top of a tightening market. At this point it just doesn’t matter how much money is available, if someone doesn’t qualify they will not get the loan.

The credit crunch is definitely spreading; lenders are tightening standards on all types of loans and investors have lost their appetite for “exotic” instruments that can’t be accurately valued. This is just a normal swing that happens after an abuse. The fact that “UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million” should not come as a surprise. In this atmosphere where write-downs are expected there will never be a better time to clean-up your books. They could even be tilting the books to favor future profits; this is not an unknown concept to investment banks.

As far as these write-downs being a forward looking indicator of the future doom that our corporations will experience, is quite a stretch. Our economic slow-down will have it’s casualties but for the most part our corporations are sitting on enormous cash positions, the street anticipates them to start spending these cash hoards providing the impetuses for another growth cycle in our economy.