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Next Phase of Credit Crisis Begins to Emerge

by NBBooks Sun Jun 15th, 2008 at 12:01:15 AM EST

Over at The Agonist, Numerian, who is one of the keener observers of the financial markets, and, I suspect, has a bit too much vested interest in the financial markets his- or her-self, has an excellent summary of the rapidly approaching next phase of the credit market crunch and its impact on the economy:
Don't Be Fooled by Wall Street's Happy Talk



Wall Street continues to underestimate the spreading default carnage that is going to bring down a few more financial powerhouses before this crisis is over. The big story emerging in the housing markets is the galloping number of foreclosures affecting "decent ordinary folks" with prime mortgages (as opposed to the sub-prime customer species that kicked off the housing market crisis). Defaults and foreclosures on alt-A and prime mortgages are jumping to record levels.

SNIP

Congress can pass all the legislation it wants to provide relief from foreclosure for these homeowners, but it will be mostly fruitless. The securitization of mortgages in the past eight years has legally and practically destroyed the ability for the financial industry to come through with any accommodations, so the homeowner is ejected and the banks wind up owning the property.

The banks now own so many homes through foreclosure that cities across the U.S. are suing them to force them to keep the properties in decent shape. It most places it costs thousands of dollars to get the lawn mowed and trash picked up, and there are many circumstances where the home has been vandalized, costing the banks much more. The banks are learning a terrible lesson last experienced in the Depression - foreclosure is something to be avoided at all costs. It doesn't just destroy the profit a bank may have had in the mortgage - it can destroy the bank.

SNIP

Stage two is underway with deterioration in corporate debt, starting with the bonds issued by real estate developers, but spreading now to the high yield securities and bank loans of poorly capitalized and over-leveraged corporations. Well over 50% of all the corporate debt issued in the past eight years has been rated as junk debt, meaning it is not even investment grade (Baa rated or higher) and it has a very high probability of default.

SNIP

The high price of oil is now clearly affecting all facets of the global economy, with one exception: wages. Workers are not being given pay increases, but instead are being pressed to put in longer hours, which is always management's way of coping at first with an economic downturn. But usually around six months into a recession, companies cave in to reality and start letting people go. We've just passed the six month mark for this downturn, so expect the unemployment data to noticeably deteriorate; last month the unemployment rate jumped up ½% of a percentage point alone.

SNIP

the third thing you should watch for: large-scale layoffs in the public and private sector, with significant second order economic effects on consumer spending. This is all part of the vicious cycle common with recessions - stressed out employers let staff go, leading to declines in consumer spending, leading to yet more pressure on corporations and government to fire even more workers. The difference now is that the viciousness of this cycle will far outweigh whatever pain was experienced in the last oil recession of 1974. This recession will be lucky to avoid being labeled as a depression when it is over.

I am deliberately leaving out some very good parts, so that you go and read it all:Don't Be Fooled by Wall Street's Happy Talk

Display:
The Banks are in denial I think.

A classic case was this

UBS financed 75 percent of the funding used by U.S. asset manager BlackRock to buy a $15 billion portfolio of distressed U.S. real estate assets from UBS, the bank said on Wednesday.

UBS completed the deal by providing $11.25 billion in loans to BlackRock, the Swiss-based bank said in a statement.

BlackRock raised $3.75 billion in equity from investors to pay for the rest of the package, UBS said.

a month or so ago.

Sell off your crap

The deal means that UBS receives 68 cents on the dollar against the value of the securities.

at 68p in the £, and lend them the money to buy it.

You really could not make it up.

What on earth makes UBS think further price falls are not going to wipe out this new loan as well?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Jun 15th, 2008 at 06:19:23 AM EST
As a certain detective would tell Watson, indubitably! Still, it's hard to believe they've gone so crazy. But, really, what other option do they have other than admitting to the Anglo disease, and wholesale surrender of their control over the financial system?
by NBBooks on Tue Jun 17th, 2008 at 07:23:28 PM EST
[ Parent ]
The banks now own so many homes through foreclosure that cities across the U.S. are suing them to force them to keep the properties in decent shape. It most places it costs thousands of dollars to get the lawn mowed and trash picked up, and there are many circumstances where the home has been vandalized, costing the banks much more.

What if the banks converted all these foreclosed properties into rental properties and rented them out to the current inhabitants, if they keep them in good repair (if not they will be vacated)? That would fix the maintenance issues, and even though it would provide horrible incentives ("screw up your mortage with no or small downpayment and then just keep living as nothing happened") this is an extraordinary situation which will not be repeated, so there will be no moral hazard and it will not encourage repeating bad behaviour, as there will be no chance of repeating it. At least until everyone has forgotten these lessons in 80 years time.

Then in some years when this situation has stabilized, the banks can spin off these huge real estate portfolios into new real estate companies.

This would be something of a bail-out of the mortage-holders, but there has already been something of a bailout of the finacial industry. I am sure we can eventually figure out a rough compensation for the demographic groups who have not been foreclosed on or profit from the financial industry. Maybe my favourite, higher capital gains taxes combined with a big discount before these steep taxes start apply? ;)

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Sun Jun 15th, 2008 at 09:09:49 AM EST
of some elements of the ruling class. They are just 'playing the game' with their usual amoral lust to determine winners and losers (Calvinism at its logical conclusion).

In my small county, which contains less than 4.000 homes, the editor of our local paper told me that she is publishing 4 to 5 foreclosure notices per week. Not so long ago the local banks - and they were literally local banks - would be working with the 'owners'. Now the 'local' banks are part of bank chains, and, besides, they all sell their mortgages to Wells Fargo, Bank of America, Washington Mutual, etc. So here we are.

As usual, though, these events can play out in interesting directions.

paul spencer

by paul spencer (spencerinthegorge AT yahoo DOT com) on Sun Jun 15th, 2008 at 11:51:25 AM EST
[ Parent ]
The banks can't afford to hold on to foreclosed properties. In fact most banks have sold off the mortgages and so have no current stake in the properties other than being the collection agent for the loan.

Those who bought the bundled mortgages now have to unwind the ownership chain if they want to take possession. There have been some (rare) cases of judges throwing out foreclosure attempts when the plaintiff couldn't prove they actually had title to the property.

Renting means someone has to be willing to accept payment over a long period of time in exchange for the capital they put up at the beginning. No one is clear if this can be done.

My guess is that the federal government will have to set up a special agency to finance the losses as the did with the S&L disaster of the 1980's. I don't see this happening until after the Dems take control in January.

Right now communities are having enough trouble finding out who should be paying for upkeep on empty properties so that they don't blight the neighborhoods.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sun Jun 15th, 2008 at 06:17:00 PM EST
[ Parent ]
US cities can condemn properties, take them over, and fine the owner(s) the cost of repair, maintainance, or destruction under Attractive Nuisance and other municipal ordinances.  If the owner(s) don't pay-up the properties can be auctioned and the title transfered to recoup all monies -- including legal fees -- spent.

One good example of beneficial results from this practice can be seen -- as I understand it -- on Manhattan Island in NYC.  In the late 70s an abandoned building could be claimed, for $1, by anyone who promised to fix it up and move in.  It took a while for the benefits to occur but now -- as I understand it -- free-fire/no-go areas (anything east of Ave C) have been turned into rather nice neighborhoods.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Mon Jun 16th, 2008 at 01:33:49 PM EST
[ Parent ]
YES!

"The laws of the land were written in the interests of the petty real estate speculator." TB Veblen

As someone with a background in neighborhood redevelopment, I have seen up close the results of nice neighborhoods becoming dumps and then rising again.  The interaction between human sociology, location, general economic conditions, energy costs, etc. that determine the "value" of real estate are complex and fascinating.  The costs and availability of credit are important but hardly critical.

Compared to the big problems like climate change and peak oil, the credit "crunch" is pretty small potatoes.  Damn near irrelevant, in fact.  Let's say the worst happens and 25 of the 50 world's largest banks fail, virtually no one would notice except for the employees.  The banks would like the rest of us to believe this would be the end of the world, but I do NOT agree.  And I, for one, would not at all be unhappy of some of these rich investors lose their fortunes.  Those who seek their fortunes in real estate tend to be the most conservative and backward.  The less influence they have, the better for the rest of us.  And when their fortunes disappear, so does their influence.

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Tue Jun 17th, 2008 at 02:23:12 AM EST
[ Parent ]
in determining the value of real estate--aesthetics!!!!

Same building.  Same neighborhood.

Before.  $6000 per rowhouse.  Most dangerous neighborhood in the city. HUGE city revenue liability.

Now.  $400,000 per rowhouse.  Most fashionable neighborhood in the city populated by "creative class" professionals.  Solid support for city tax base.

Aesthetics means as much to real estate as sex.  
(this was my first project out of college as a freshly minted city planner)

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Tue Jun 17th, 2008 at 02:41:24 AM EST
[ Parent ]
You're a city planner?

Coooool. :)

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Jun 17th, 2008 at 06:23:33 AM EST
[ Parent ]
WAS
Planning is considered a commie plot here in USA.  Most planning (such as it is) is done by the petty real estate speculators.  So planning, as it is done in the Nordic countries, is something I only wish I could have done.

"Remember the I35W bridge--who needs terrorists when there are Republicans"
by techno (reply@elegant-technology.com) on Tue Jun 17th, 2008 at 07:45:34 AM EST
[ Parent ]
techno:
So planning, as it is done in the Nordic countries, is something I only wish I could have done.

Never say never.

I reckon communities can take matters into their own hands.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Jun 17th, 2008 at 11:41:38 AM EST
[ Parent ]
These days, I am flattered when the woman in my life asks my opinion on the color of paint to use in the basement ;-)  Besides, I figure it will take at least a decade for the current real estate inventory to work through the system so a planned community is a LONG ways away.

"Remember the I35W bridge--who needs terrorists when there are Republicans"
by techno (reply@elegant-technology.com) on Tue Jun 17th, 2008 at 11:50:20 AM EST
[ Parent ]
are just amazing! Please take the time sometime to get your story about this project onto the tubes!
by NBBooks on Tue Jun 17th, 2008 at 07:18:29 PM EST
[ Parent ]
The story of this restoration effort--as told by me--can be found at:

http://elegant-technology.com/resource/DAYTON.pdf

The write-up in the September 3, 1978 Minneapolis Tribune:

http://elegant-technology.com/resource/STRIB.PDF

I was pretty young when this happened and it was a LOT of work.  It was a VERY idealistic effort.  The outcome was wasn't perfect, but I learned a lot from the effort.

(PDF alert.  The first file is 5.6 megs and the second is 1.1 megs.)

"Remember the I35W bridge--who needs terrorists when there are Republicans"

by techno (reply@elegant-technology.com) on Tue Jun 17th, 2008 at 09:12:33 PM EST
[ Parent ]
What if the banks converted all these foreclosed properties into rental properties and rented them out to the current inhabitants, if they keep them in good repair (if not they will be vacated)?

The problem is that if the current inhabitants can't afford the mortgage payments then they can afford the same payment amount as rent. And if the banks don't get the required cash flowing in they ave to make up the difference or foreclose.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Sun Jun 15th, 2008 at 06:22:33 PM EST
[ Parent ]
As far as I know the US, unlike Sweden, doesn't suffer from the horrible disease called rent control. The rents would have to be decided on the market - that is - what people are ready to pay. Which might not be very much during a real estate crash.

It would still be a good deal for banks to get the houses maintained and at least some cashflow, rather than having the houses ruined. Especially if they had given out loans to many people in the same area as vandalism will lower the value of all houses, even those that haven't been vandalized.

Furthermore, this would spare people from dislocation and generally cool down and stabilize the situation a bit. And if the banks won't play ball: nationalize the houses and do it anyway. The banks have already had their fair share of bailouts, and I won't cry my eyes out if they get burnt when they try obstructing against the common good.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Jun 16th, 2008 at 03:19:46 AM EST
[ Parent ]
There is rent control in NYC.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
by Migeru (migeru at eurotrib dot com) on Mon Jun 16th, 2008 at 03:26:07 AM EST
[ Parent ]
Rent control was abolished in the seventies, there are still a few thousand apartments grandfathered in, but that's marginal. What we have is rent stabilization a complicated system which basically sharply limits rent increases for tenants (the commission calculates how much costs have increased, and that's it), but allows for large increases on vacancy (20%) and allows landlords to pass on the costs of improvements, though not legally mandated maintenance, to the tenants. Once the rent rises above $2000 a month the apartment becomes decontrolled if the tenants make above a certain income (I think it's currently $250,000). I personally favour scrapping the $2000 limit while keeping a household size adjusted income one and allowing for rents to reset to market levels at vacancy.  

The idea that rent stabilization with market rates for new construction limits construction in areas like NYC, or keeps rents higher overall, is a myth. If anything it does the reverse since the two sets of housing compete in the same market. (the old very rigid system did create problems, but that's long gone) In any case, I'd be a lot more sympathetic if rent were tax deductible and property taxes weren't capped. Plus, it's interesting how pro-market types are somehow a lot more sympathetic to expensive suburbs imposing strict zoning laws that ban multi-unit housing, but not ones that impose rent stabilization.

by MarekNYC on Mon Jun 16th, 2008 at 03:47:34 AM EST
[ Parent ]
The problem in Sweden is that people want to live in rental housing, but none is built. Why is none built? Because rents are contolled depending on the standard of the apartment. This, absurdly enough, excludes location of the apartment.

It means that an inner city apartment from the late 19th century with 3,4 metres to the roof might have the same rent as some crappy anti-human 1970's housing project full of criminals and addict far away in some remote forgotten suburb. The idea is that there shouldn't be segregation based on income. The reality is that people with contacts, savvy, wealth etc manages to snag the good contracts in all kinds of illict ways, and adding insult to injury their rents are subsidized by the poor people in the suburbs.

The market for for privately owned apartments is free which means that companies only build these and never rental properties, as it is is impossible to turn a profit when building new rental properties.

The market should be liberalized ASAP.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Jun 16th, 2008 at 12:29:41 PM EST
[ Parent ]
Or nationalised.

If there are not enough rental apartments, then there is no reason that the government cannot build more rental apartments. Maybe not in the city centres for lack of space, but improvements in the public infrastructure can make it much less critical to be in or near the city centre.

And one overlooked advantage of rationing by nepotism instead of rationing by price is that it limits the amount of money one can borrow against the house and therefore limits speculative bubbles.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Jun 16th, 2008 at 12:40:33 PM EST
[ Parent ]
The Swedish goverment has a terrible track record when it comes to building housing, not to mention tearing down housing. I would never ever have them build houses again. Never!

The private companies have on the other hand delivered very good houses for the last 15-20 years. Beautiful, attractive and affordable apartments people actually really enjoy living in.

Sometimes, markets do work.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Jun 16th, 2008 at 12:47:31 PM EST
[ Parent ]
I'd like to add that state initiatives work best when you have large centralised technical systems. Then the state can do better than the market. But homes are the opposite of this, and when indeed the concept mentioned above is used for housing, disaster follows. As has been show many times in many nations, including Sweden.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Jun 16th, 2008 at 12:49:29 PM EST
[ Parent ]
You have to have the government on board somehow, if for no other reason then because city planning is an example of a large, technical system that the government handles better than the market.

While constructing houses should probably not be a job for the government, that does not mean that the government cannot - say - take over houses that are foreclosed upon for a set rate (say, half or three quarters of the official value of the house) and rent them out, thus moving them from the owner's market to the rental market.

And remind me to make a photo-diary of the Copenhagen waterfront when I get back to Denmark... The real estate prices were so high that the municipality and the state sold it off to cash in, and since then the venture capitalists have been using it as their playground.

The only good thing to be said about that is that it has firmly immunised most Copenhageners against ever trusting private enterprise to shape the architecture in the historical part of the city.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Jun 16th, 2008 at 01:05:25 PM EST
[ Parent ]
Ah, I knew you were going to say that! I even considered adding it at the end of the last post. City-planning is indeed a governmental job, without which, well, disaster follows. Urban sprawl. (Except back in the 60's and 70's Swedish city planning was to a large degree about giant housing projects and urban sprawl).

I have no problem with the state stepping in and taking over foreclosed houses the way you mention, indeed I mentioned it myself earlier in this thread.

And I agree you can't have capitalists screwing around in historical city centres, even if the state has been even worse in Sweden. Plain and simple, no one should be allowed to screw around there.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Jun 16th, 2008 at 01:54:13 PM EST
[ Parent ]
Ugh, I mean they can't afford the rent.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
by Migeru (migeru at eurotrib dot com) on Mon Jun 16th, 2008 at 03:25:33 AM EST
[ Parent ]
Back in the depression banks were often willing to accept rent payments much lower than mortgage payments simply because tenants kept up the property and provided some income stream. Plus they save some of the foreclosure expenses. I was reading that banks are now also increasingly bidding below the outstanding primary mortgage amount at auction (second mortgages and Helocs are de facto not secured if the house isn't worth more than the primary mortgage).
by MarekNYC on Mon Jun 16th, 2008 at 03:53:48 AM EST
[ Parent ]
Yes, but with securitization the banks are not in a position to renegotiate the loans. So if they want to avoid having to foreclose they have to accept lower payments from the "tenants" and make up the difference to the investors downstream.

If what you have is people with equity in their houses and good credid who don't want to walk away from the property unlike people with no equity or negative equity, then something along the lines of Chris Cook's ideas might work. The occupier/mertgagee would pay what they can afford and top it up with an "equity transfer" to the bank.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Mon Jun 16th, 2008 at 06:42:22 AM EST
[ Parent ]
My proposition was exactly what Marek said above, but I haden't thought of this:

Yes, but with securitization the banks are not in a position to renegotiate the loans. So if they want to avoid having to foreclose they have to accept lower payments from the "tenants" and make up the difference to the investors downstream.
Ouch... Securitization comes back and gives us yet another kiss of death.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Jun 16th, 2008 at 12:29:25 PM EST
[ Parent ]
That's what I think it means when the diary quotes
The securitization of mortgages in the past eight years has legally and practically destroyed the ability for the financial industry to come through with any accommodations, so the homeowner is ejected and the banks wind up owning the property.


When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
by Migeru (migeru at eurotrib dot com) on Mon Jun 16th, 2008 at 01:26:35 PM EST
[ Parent ]
But Wall St and The City don't care if the market is falling or rising, so long as there are trades. they are bookies, not punters and make a crust whatever happens.

so it is in their interest to promote dealing, any form of dealing, however stupid, "there's one born every day" is their credo. If they destroy the economy in order to get their umpty million dollar bonus, well who gives a stuff ?? they after all, have the money in a nice Bahamian condo.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Sun Jun 15th, 2008 at 10:21:26 AM EST

Not the Worst of All Financial Worlds,
But Bad Enough

By RANDALL W. FORSYTH  

Policy makers are boxed in by bad choices. But how much worse can it get for financial stocks?

MEET DR. PANGLOSS' EVIL TWIN.

If this isn't the worst of all financial worlds, it will do until the real thing comes along.

Unlike Dr. Pangloss in Voltaire's Candide, who declared this to be the best of all possible worlds, Wall Street again had to confront a toxic cocktail of plunging financial stocks while central banks shift their focus from the credit crisis to worsening inflation, raising expectations for interest-rate increases around the globe.

Stocks took another header as a result Wednesday.....with Lehman Brothers again taking the worst hit with another monster loss of 14% and Washington Mutual sliding 9.3%.

Skip

"Policy makers appear increasingly 'trapped in a box', with few clear options for escape," writes Ken Hackel, strategist for RBS Greenwich Capital. Inflation expectations have jumped, to over 2.5% (based on the Treasury Inflation Protected Securities market), from 2% previously, and in excess of the Federal Open Market Committee's acceptable threshold. That's happened even as the economy looks to barely slog along through 2008 and possibly well into next year, he adds.

Skip

Little wonder that both Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson have been talking up the dollar. The only problem is that the traditional response to a weak currency and higher inflation -- an increase in the Fed's target rate for federal funds, to restrain demand -- isn't feasible.

Skip.

Bespoke says the financials need another 8.6% decline (to 276 on the S&P Financial index) be the biggest on record, and its analysts look for a significant rally "somewhere between now and those levels."

Perhaps. Another 10% drop (from the peak), to around the 250 level on the S&P Financials would bring the total decline to 50%, which would virtually wipe out the 103.6% gain from the 2002 bear market lows to the 2007 highs....

But the biggest credit bubble in history should at least see the biggest bust. That rationally would mean a wipe-out of the bubble gains, and then some. And though the woes of the banks and brokers are well-advertised, the extent seems to get ever worse as additional layers of the onion are peeled away.

Still, the optimistic view is that financial stocks are closer to their lows than their peaks. Which means that they aren't likely to fall a total of 90% from their highs. Dr. Pangloss would be pleased.

So, a bottom at -90%!  At least for financials.  Is the Great Depression is beginning to look good, in comparison?  Back then "cash was king."  Now perhaps the dollar will be "King of the Hobos."

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jun 15th, 2008 at 05:16:28 PM EST
From Barron's 6-14-'08 Behind subscription wall.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jun 15th, 2008 at 05:17:34 PM EST
[ Parent ]


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