 Casey Files:
Unintended Consequences
David Galland
Managing Editor - The
Casey Report
Oct 27, 2008
As you may know, here at Casey
Research we are not optimistic about the outlook for real estate,
that lynchpin of the U.S. economy. This pessimism is evoked by
a number of factors, starting with the simple fact that residential
housing increased by about 50% between 1992 and 2007, massively
outpacing population and income growth over the period. As you
absolutely know, much of that excess inventory is in the hands
of individuals who simply can't afford to pay the freight.
Then there is our hardened
belief that the equivalent of an express train wreck is about
to happen in the 4-6 trillion dollar U.S. commercial real estate
market. There will be a lot less in the way of Ho! Ho! Ho! this
holiday shopping season, and a lot more Oh! Oh! Oh!
And none of it is helped by
the inevitable rise in interest rates, which are today at near
50-year lows. While we might not be quite at the bottom, we're
close... after which we expect a persistent rise as the government
bailouts flow through the inflationary pipeline. Of course, wounded
housing markets react about as well to rising interest rates
as I do to the prospect of my taxes going up in the next administration.
Unfortunately for the housing
market and by extension the U.S. economy, we are already seeing
the ghosts of what's to come. This just in from Bud Conrad:-
"The U.S. government's
conservator status of Fannie and Freddie was supposed to lower
mortgage rates, which it did for a few weeks. But we have now
started to see the unintended consequences of guaranteeing the
banks - namely that investors are moving away from housing-related
debt and investing it in bank debt instead, pushing mortgage
rates up. My sense is that movement by foreigners away from agency
(Fannie Freddie) debt contributed to the half-point rise in mortgage
rate, too. The TIC data confirm that shift.
"The result
is that housing will be further hurt with the higher rates and
will continue to fall in price."
On the same topic, the news
is out this morning that in September, single-family home starts
in the U.S. fell to the lowest level in 26 years. Just 544,000
new homes would be built over the next 12 months (if the trend
were to stabilize here, which it won't).
Just so you have the right
perspective, at the peak of the bubble, annualized housing starts
in the U.S. were running at 2,265,000 units, so we're seeing
about a 75% decrease.
By the time this is over, it
wouldn't surprise me to see housing starts fall to 10% of the
peak.
Of course, housing is far more
than just "another" economic stat. In addition to the
tragic financial and emotional implications of coming up short
on the mortgage on a personal and even societal basis, there
are the direct consequences to the broader economy. No more excess
equity to borrow against to fund shopping sprees, and none to
allow for a comfortable retirement for far too many.
This is, and will continue
to be, a big problem for the economy. While there is no soft
solution at this point, the best we could hope for is that the
damage will be quick to come and quick to pass. But the only
real way for that to happen is for house prices to fall to the
point where ready buyers are available. And that entails workouts
between lenders and borrowers, or outright foreclosures, to clean
up the mess and allow the market to function as it certainly
can, and will again... if left to its own devices.
Unfortunately, the plans now
being bandied about by the government envision pretty much the
polar opposite of letting the market clean itself up. Rather,
they involve taxpayers buying defaulting mortgages and even the
imposition of a moratorium of some duration on foreclosures.
Most people read news such as that and shrug it off. It may help
to view these ideas through a narrower spectrum.
For example, imagine you are
the president of a small bank and you had lent money in good
faith to someone in the neighborhood. We'll call him Joe as that
seems to be a popular name for these sorts of examples these
days.
For reasons only known to him,
Joe has stopped paying on his mortgage, leaving your little bank
on the hook for $200,000. Following procedure, you have Mrs.
Smith down in the lending department send Joe a nice letter asking
him what's up, to which she receives no response. So you personally
send him another letter, this one offering to have him down to
the bank to have a chat and see if you can work things out.
No response, no money.
So, uncomfortable at having
to perform the duty, you give Joe a call and he admits he is
in over his head. When you offer to help him work out a payment
plan, he calls you a blood sucker and hangs up on you.
Pained by the outcome of your
loan, because you'd rather be getting paid back on the agreed-upon
terms, you call up your lawyer and reluctantly authorize the
expense of beginning the foreclosure proceeding. At that point,
you know you will likely spend thousands and the better part
of a year trying to get back your property (and it is your property).
But what choice are you left with?
And then you hear - as does
Joe - that Congress is seriously considering passing a moratorium
on foreclosures, and you reach into the locked drawer of your
desk for the flask you keep there for such occasions. Joe, meantime,
heads down to the local deli for a six pack to celebrate free
rent for the foreseeable future, perhaps paying for his purchase
by selling off the copper pipes he's ripped out of the guest
bathroom.
This exercise is, of course,
little more than the morning musings of a sleep-deprived mind,
and I am well aware that the circumstances surrounding the defaulting
on loans are as varied as humanity itself. Even so, the underlying
principles are the same. There is a contractual agreement between
a lender and a borrower that no one had to be waterboarded to
sign. In the event of a failure to perform on the part of either
party, it is up to the two parties alone to resolve - with the
help of an impartial judiciary if an impasse occurs.
Interjecting an overreaching
government run by perfect-worlders into the process can only
gum up the works. And, I would contend, result in just the sort
of unintended consequences now being reflected in jumping mortgage
rates. Or, for that matter, the entire housing mess in the first
place... much of which is the unintended consequence of Greenspan
ratcheting down interest rates instead of pouring himself a nice
cup of tea and watching as the participants in the dot-com mania
received their just desserts.
Personally, I am shocked by
the rising cacophony of calls for more, not less, government
regulation. Given the widespread chanting now going on in favor
of elevated levels of oversight, retribution, taxation, meddling,
and outright nationalization, it is clearer than ever that the
laissez faire view I just expressed is in a minority. And the
situation is only going to get worse as the next wave of well-intentioned
government operators step up to the controls... controls that
are being firmly bolted onto the machinery of markets.
We are about to enter a dark
period for the free markets. That's the bad news.
The very good news is that,
seeing it coming, you can anticipate where the next unintended
consequences will occur and position yourself to profit.
-David Galland
David Galland is the managing editor of The
Casey Report, the flagship publication of Casey Research,
LLC., which for over 26 years has been providing independent
minded investors with unbiased recommendations on big trends
they can profit from. From as long ago as August 2005, in a lead
article entitled "Profit from the Collapse of Western Civilization"
Casey Research was alerting subscribers to the crash now unfolding
and recommending specific steps to profit. What's next for the
U.S. and global economy? How long will the crisis last? How can
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