The Oil Drum: Canada | The Round-Up: December 12th 2006

14 comments on The Round-Up: December 12th 2006

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Stoneleigh on December 12, 2006 - 9:24pm

I really don't see any way in which this could end up being a soft landing I'm afraid. The US housing market, which has been propping up much of the economy in recent years, has only just started to slump in earnest. We still haven't seen the fallout from that yet, and it could be carnage. The markets seems to be close to topping as well. I would say demand for all sorts of consumer goods will be well down next year. I've been discussing the scope of the financial problem I think we're facing at Thomas Homer-Dixon's forum.

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jografy on December 12, 2006 - 11:12pm

I agree Stoneleigh. I have just read Kunstler's discusson of the US mortgage market and the roll of Fanny Mae in holding the secondary mortgage oblgations, thus transfering a lot of the potential loss in a crash to the US government. I am no expert and I am sure Kunstler isn't either but it seems plausable and in light of what you said in the above link, the US government wont be able to bail out the defaults.
In my thinking, given a sudden financial crash the only option is for the federal government (Canadian) to freeze all debt so that defaulters, especially mortgage defaulters will not face sudden destruction. At the same time it would make sense to pass a "right of possession" law that would in effect say that those living in a dwelling had lawfull possession of the dwelling pending resolution of the crisis. This would make more sense than having hords of displaced people on the loose and abandoned properties that had no resale value and no one carring to maintain them. After all is said and done most would probably house desperate squaters anyway. In a sense, in Canada, all of this would be equivalent to nationalizing the banks. Therefore, as rational as this or some similar measure seems to me, I don't have any hope it would happen that way. If we see a slow moving recession we will gradually get a build up of dispossesed people and abandoned property. Like the boiling frog story, no action will be taken until the problem is beyond control and many people have sufferd a great deal. At the moment my thinking tends to be, if we are going to have a disaster, better a quick sudden one than a slow one. Unfortunately, like war, once it starts you can't predict anything.
Do you have any comments or links relating to dealing with the disaster at the maco level, assuming it can no longer be prevented? We are already working on localization ideas, Heinberg's lifeboat. Can we assume that central authority and rule of law can survive this?
Thanks again for keeping this forum going.

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Stoneleigh on December 13, 2006 - 8:29am

I had a long and interesting chat with Jim Kunstler about exactly this topic when he was up in my neck of the woods for a presentation of his work. In my view, a credit deflation cannot be prevented once a credit bubble has formed, and this one is one for the record books. The central banks postponed the inevitable over the last four years by flooding the world with liquidity, but all they have achieved is to raise us to a higher (leveraged) height from which to fall. Such a strategy would be unlikely to succeed again, even temporarily in my opinion. There are simply too many dollars (and other currencies) chasing too few profitable opportunities. The Dollar Crisis by Richard Duncan (not the same Richard Duncan associated with the Olduvai crisis) covers this very throughly, at least from an American perspective.

I would also recommend The Great Wave: Price Revolutions and the Rhythm of History by David Hackett Fischer, Conquer the Crash by Robert Prechter, Empire of Debt by Bill Bonner and Addison Wiggin and And the Money Kept Rolling In (and Out) by Paul Blustein (on the debt crisis in Argentina). Although it's now a little dated, The Great Reckoning by James Dale Davidson and William Rees Mogg (published in 1994) also has some interesting insights. Bonner and Wiggin at Agora Financial also publish several free journals which are worth reading - Whiskey and Gunpowder, The Rude Awakening and The Daily Reckoning, all of which I have linked to in Round-Up stories. I also read Prechter's Elliottwave Theorist and Steve Hochberg's Financial Forecast, but those require a subscription (http://www.elliottwave.com).

Fannie Mae is not underwritten by the US government, so there is no obligation to bail it out. Allowing it to fail would precipitate a financial disaster, but bailing it out would make the S&L crisis look like peanuts. I'm not convinced that a bail out would be on the table given the scale of the liablity. I don't think deposit insurance will be worth the paper it's written on either.

I think we're looking at a situation that has the potential to unfold very quickly, which would amount to people having the rug abruptly pulled out from under their feet (ie all their assumptions invalidated at once). I don't pretend to know exactly how that would play out in practice, but my approach to dealing with it has been to develop a measure of self-sufficiency.

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ggg71 on December 13, 2006 - 1:21pm

I definitly see housing deflation on the horizon. Probably 2-4 years worth with an eventual 15-30% decline in prices. This will probably result in a recession.

Except for localized markets, I don't see housing as being that bad... Here in Boston, yes it's expensive, but people make good wages too. A lot of the price increases are the result of lower interest rates on 30 year mortgages. A $200,000 mortgage at 8% has the same cost as a $250,000 mortgage at 5.75%.

If immigration continues at the rates of the past 4 years it will act to stem the housing deflation as well.

A recession (and the lower interest rates that go with it) will also act to support housing prices.

But it's all interconnected, so who knows...

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Stoneleigh on December 13, 2006 - 1:43pm

So many of the houses bought recently in the US were bought as investments, not as somewhere to live. When investors realize that, not only can they not the flip the property for a profit, but they can't rent it out either, most of those properties are going to end up on the market as surplus inventory depressing prices, quite likely for years to come. As many were bought on margin by investors not expecting to have to pay the inflated mortgage over the long-term, many properties will be foreclosed upon, lowering prices still further.

I would be incredibly surprised if housing only fell by only 15-30% - ultimately I would expect in excess of 90% (just like dotcom stocks), although that may be quite a long way off. I don't think we'll ever see property prices like these again in our lifetimes - in real terms at least (nominal terms are another matter if we end up with hyperinflation after the deflationary impulse has run its course). After all, it took over 1500 years for property prices in Rome to regain their value after the fall of the Roman empire.

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ggg71 on December 13, 2006 - 2:29pm

So $300,000 houses today are going to be selling for $30,000 in what, the next 5-10 years? Come on! It costs more then that in materials just to build the house. Never mind the fact that commodities are getting more expensive all the time.

I realize there was a lot of mortgage hocus pocus over the last few years to help support the boom, and I'll gladly agree that we need a correction, but 90%? There's still way too much liquidity out there for that to happen.

I read recently that over the past year the housing market has gone from 35% ARM to 24% ARM as people realized that interest rates were rising and refinanced to more traditional 30 year mortgages.

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Stoneleigh on December 13, 2006 - 2:57pm

There's way too much liquidty out there now, but I doubt if there will be in 10 years time. My own view, which takes in a lot more than just the impending housing market crash, is that we're headed towards a liqudity crunch. The primary reason for that, IMO, will be a crash in the derivatives market - likely triggered by a string of exploding hedge funds and emerging market debt. The derivatives market is a giant Enron waiting to happen - a pyramid scheme in which the value is already being cashed out by insiders (who sold $63 dollars of stock for every dollar they bought in November), leaving the public holding the empty bag. I would be surprised if the stock market doesn't fall flat on its face in the New Year, perhaps even quite early in the New Year.

I'm expecting the real estate market to go almost completely illiquid at some point, as real estate is one of the most difficult markets to extract oneself from (voluntarily) during a depression. For a while, houses may well be worth less than the raw materials it would take to build them, even though the cost of those materials would also have fallen. After all, suburbia has been a great experiment in negative added value in recent years.

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ggg71 on December 13, 2006 - 4:00pm

Derivatives have a lot of negative potential. No doubt. But then perhaps you're discounting the effect of the PPT (plunge protection team). They seem to be holding things together ok so far.

So far we seem to be getting the soft landing. Retail spending is down, but job growth is still strong. I know there's a serious tech and biotech boom going on here in Boston right now. There's construction on almost every block of East Cambridge. Unemployment is at what, 4.5%? Energy prices have moderated from the hurricane induced highs of last year... Everybody I know is doing ok.

I'm not saying the big crash can't happen. It's just I've been watching (and reading) that it's gonna happen "next month" for the last 4 years.

We'll see.

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Stoneleigh on December 13, 2006 - 5:52pm

I don't think the 'plunge protection team' has any value in practical terms - their (temporary) value is psychological IMO, in that their existence may sustain confidence for a little longer. In 1929, there were rumours that a group of powerful bankers would step in to save the market, but it didn't stop the crash then and I don't think it will now. The problem is that the forces arrayed against the Fed completely dwarf its abilities. For one thing, the problem is global so any mitigation would also have to be global. However, even a group of central bankers acting in concert would not have deep enough pockets to bail out the derivatives market and would not be able to act quickly enough once a debt implosion began. Think how fast Enron went under. As I have said before, Ben Bernanke might as well be standing on the shore of the GOM ordering a cat 5 hurricane not to come ashore.

People are doing well at the moment precisely because we are at a peak. The fact that they are doing well tells us more about the past than the future. Unfortunately, a financial market peak is the time when people feel the most relaxed and complacent, so they discount risk and make decisions without due diligence. The consequences of those poor decisions come home to roost later. When those poor decision makers were hedge fund managers taking all manner of leveraged speculative risks in pursuit of unrealistic returns, the consequences cannot help but be severe.

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jografy on December 13, 2006 - 5:38pm

Thanks for the reading list. I will try to get through some of the less technical ones. My financial prowes is limited to avoiding letting the Royal Bank link my line of credit to my house. They sure tried to trick me with an "increase" in the borrowing limit that would have transfered the LC to my house collateral.
I re-read JK p232 of The Long emergency and he does say:

Their mortgages are backed up by the federal government.

I think he assumes the US feds will bail them out.
On this point is CMHC automatically liable for all of the high ratio mortgages in Canada?
In my amature way I am telling friends that anyone with a mortgage of more than 50% of their present "market value" are nuts. I only say 50 as I dont think anyone wants to hear 25%, and the fact that I am still at about 40%.
IMO it isn't only about speculation in Ontario but a lot of people with decent manufacturing jobs did the ATM thing with their mortgages. With the manufacturing sector jobs, especially the automotive about to go away if the financial decline hasnt started first this may do it locally.
I have five years to retirement. Can't you do a Yergan and tell me it will be ok?

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Stoneleigh on December 13, 2006 - 6:22pm

I could tell you that, but if I did I would be telling something I believe to be untrue I'm afraid.

I agree about the refinancing angle (ie using the house as an ATM). They did that in the US to a far greater extent than we did, as they engaged in far more speculation than we did on property prices, which means we should be better off relatively speaking. It probably won't feel like anything to be cheerful about though, in comparison with the golden age of consumerism and choice that we've just lived through.

People will be liable for mortage debts they have incurred even if they walk away from the property or sell it for less than the outstanding mortgage. Owning a home that's worth less than you owe is called being in negative equity, and it will happen to a lot of people very quickly. It's another aspect of a housing market decline that removes liquidity and adds to the vicious circle. Job losses don't help either, and I agree that there will be plenty of those once the US consumers stop spending.

I ususally suggest to friends of mine who are thinking of purchasing a house to rent instead. To anyone with a significant mortgage, I would usually suggest that they sell and rent, or sell and buy something smaller that they can afford outright. If the case of a lifeboat property, I would probably suggest taking in extra people to help pay the mortgage off rather than selling the proerty, as a lot of work may have gone into preparing for self-sufficiency. A communal existence can remove the need for a lot of income as there is a larger pool of talent on tap that doesn't need to be paid. The more you and your group can do for yourselves, the less you will need to earn in order to sustain yourselves. The older you are, the more it makes sense to take in younger people to do the physical work. This is how people live in the third world where there are no pensions or other external supports, and it makes for a resilient system.

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jografy on December 14, 2006 - 7:50pm

Sorry about the delayed reply. Just returned to my work for a "free lunch". I will be back full time in January and so have less time. The free Christmas lunch was to try and help morale after they decimated the group in our building who used to supply automation equipment to the big three. I know we are looking at the initial cracks inside our own corp.
I agreee that people should rent instead and in our situation we are trying to reduce debt, including the mortgage as fast as possible. People are just not ready to hear it.
I know we will all be liable for our debts, but will the government bail out the lenders to keep the banks from going under?
We have a large family with the sons all having building skills with one working as a carpenter. When the crunch comes they are all aware that some sort of old fashoned joint family living arrangement might be necessary. The bright thing too is that this will give us a good core to build larger community action. Dufferin County ON is an exburb of the GTA and so I expect a major reduction in the local population in the early part of the crisis. We are resource poor here and less than ideal farming country so I would expect in my grand kids lifetime a sustainable population of no more than 10,000. There are about 55,000 here now. If we can get solidly organized we might see more but I believe we will need to weather turmoil first. It is personally encouraging that the friends and family we can talk to about this all see the need for the cooperative local approach.

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Stoneleigh on December 14, 2006 - 9:21pm

It sounds to me like your family is far better prepared than most. Having adult children with practical skills, and who are prepared to join your lifeboat, is a real bonus. My children are younger and their skills are less well developed, but we're working on it. They're certainly very well informed.

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