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The Invisible Hand is At Your Throat

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Re: The Invisible Hand is At Your Throat

Unread postby aflurry » Thu 31 Jan 2008, 13:30:39

$this->bbcode_second_pass_quote('MrBill', 'W')hich is great because it gets the financial risk off the bank's balance sheet, so it lowers the cost of capital and frees up additional capital to make more loans.
why is this good? when the cost of capital shrinks, the price of the house skyrockets. people may nominally own the house, but they the terms of the loans they have to take to be able to make that purchase, what they own is more debt than house. sure, they can refinance, if 1. their house has appreciated, and 2. interest rates have remained low.

no one is making that 25% down fixed mortgage because no one can afford those terms when housing is so expensive. and housing is so expensive because of all those extra loans that the bank is able to create. so the real effect is people cannot afford sane terms anymore.

yes. it seems to be working out great. that's sarcasm.

you are forgetting also, that this is bad debt, that the bank had no interest in validating. oh, but that's ok, right? it's what they get insurance for. look, i'm not saying we shouldn't finance anything. I am just saying that banks (or loan "originators" as they seem to be calling them now) switching over to a strictly transaction based model has problems. improvements need to be put into place.

i'm not sure what the best methods are for putting these improvements into place. i suspect they will be investor driven. no one is buying these securities now because the default risk is finally hitting with a vengeance. someone is going to start demanding that the loan originator retain some risk, to keep them honest. once that clause is constructed into the securities, it will eventually become standard boilerplate. but the tradeoff will be that the cost of capital stays high because the banks aren't suckers. which is fine, it will just mean housing prices stay sane.
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Re: The Invisible Hand is At Your Throat

Unread postby MrBill » Fri 01 Feb 2008, 05:57:32

aflurry wrote:
$this->bbcode_second_pass_quote('', 'y')ou are forgetting also,


I rarely forget anything, but I try to limit my posts to 10.000 words instead of 10.000 pages! ; - )

Look I hate falling back on well-worn hackney phrases, but you can use a sharp knife to slice vegetable or stab your spouse! Do we ban sharp knives just because they can be misused?

House prices reflect total demand plus some multiple of earnings. Ironically, as the central bank brought inflation under control, interest rate fell and therefore the cost of financing also dropped.

Ironically, instead of paying $500 per month for their mortgage as opposed to $1000 before, homeowners (collectively) decided that they could now not only afford the $1000 as before, but because houses were such a good bet that they could stretch to $1500.

I really do not undertand how you blame the banks for this because it is the consumer wanting to pay more for the house, and more each month, while the government is officially encouraging them to do exactly that by insuring home loans and giving interest payment tax deductions!

I do not know if you have ever personally sat down with a financial planner. But usually they go through a list of what you own, what you owe, your income and your investment horizon. The general rule of thumb is that you can spend X amount of your net income on a mortgage. It is pretty standard. If someone 'has to' pay more then they really are putting themselves at risk.

I will tell you a little story. I met a waiter the other day while having drinks with a banker friend of mine from London. We were talking about property prices and how they simply do not reflect reality anymore. So anyway, this waiter tells me about his Cypriot brother who is married to a Russian lady. They inherited some land from their family, but they then sold it to buy a new Porshce Cayenne and a new Mercedes. They now rent a house, but own no home. What should I do as a banker? Water board the guy? Slap him silly until he realizes how stupid he is? Shoot his wife?

The saddest thing is that this story is not even unique. It is being played out on a large scale here in Cyprus everyday. A generation ago Limassol was a small town and its residents rode around on donkies. Three or four years ago they were driving in pick-ups held together with duct tape. Today everyone either has a new SLK 200 convertible or some sort of luxury SUV. It is getting embarassing to drive around in my used Honda Civic. No one can take me seriously. But the difference is I have money in the bank and they are either living off credit and/or sold off their family land to project that illusion of wealth. In another 5-7 years they won't have FCK all other than a used car! Ironically, then they will probably blame the foreigners for coming to Cyprus and stealing their land!!

Well, in any case, you cannot blame securitization for lowering the cost of capital and making the system more efficient. But if it makes you feel any better there are some discussions - preliminary - that would for example make banks issue bonds and hold other bank's bonds as a part of their capital adequacy ratios (CAD). The idea being that solid banks could issue debt cheaper, and that banks would not want to hold the bonds of shakey of unstable banks due to the default risk.

But really this is not the answer. Theoretically, I can already sell the shares of an unstable bank or even short their stock, and cheap banks make good take-over targets by their better capitalized and stronger rivals. The answer to complexity is not another layer of complexity! You can bet that banks are no longer making NINJA loans, and you can bet that insurance companies are no longer blindly buying CDOs with no idea what assets are backing those securities. Fingers burned. Problem solved! ; - )
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Re: The Invisible Hand is At Your Throat

Unread postby mkwin » Fri 01 Feb 2008, 09:04:42

$this->bbcode_second_pass_quote('', 'I') really do not undertand how you blame the banks for this because it is the consumer wanting to pay more for the house, and more each month, while the government is officially encouraging them to do exactly that by insuring home loans and giving interest payment tax deductions!



The income elasticity of demand of property is well established. A structural reduction in interest rates due to low inflation (caused by globalization rather than central banks?) should have been recognised by central bankers and bankers alike as a risk.

It seems to me that boom-bust cycles are simply human nature. Normally the bust would be because inflation choked off the boom. On this occasion, the inflation level has been so low but excesses of the boom have grown so high so we are hitting the same limits. For example, in the UK, at the height of the last boom, houses were costing 30% of household income to service. Property prices were far lower but interest rate were far higher, now they are at or around 30% of income again but interest rates are far lower, however, the price element of the equation has increased until it has hit the brick wall.

Structuralized debt is fine if they are rated effectively. I heard S&P were rating RMBS and CMBS with the assumption the values would continue rising at 2% forever! A criminal failure of risk management.
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Re: The Invisible Hand is At Your Throat

Unread postby MrBill » Fri 01 Feb 2008, 09:41:11

Well, exactly mkwin! As rates fell from 20% or so in the US - less dramatic in the UK - then consumers could afford more house for the same monthly payment. Unfortunately, 5% is not 20%, but it is a lot higher than 3-4% p.a..

If borrowers stretched to buy then regardless of whether initial rates were 10-, 5- or 2.5% they would have overpaid relative to their incomes because they wanted to buy more house than they could afford.

It sounds trite, but even a principle only - with no interest - loan has to be repaid. On a $500.000 loan that is $1667 per month over 25-years with zero down. The interest just gets added on top. On some of those liar loans I doubt the homeowners could even pay back the principle in full given the risk of unemployment, illness or divorce at some point in time over the life of the loan.

By the way, while we're on the subject, I thought house/property prices were most closely correlated with employment/unemployment? Any thoughts? Thanks.
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Re: The Invisible Hand is At Your Throat

Unread postby mkwin » Fri 01 Feb 2008, 10:17:32

$this->bbcode_second_pass_quote('MrBill', 'B')y the way, while we're on the subject, I thought house/property prices were most closely correlated with employment/unemployment? Any thoughts? Thanks.
The last time I did a econometric model on house prices in the UK the best fitting formula was as follows:
London House prices = -24.46330884*REPO(-1) + 3.610606361*GDP + 3.09730269 + 2.934702494*INCOME

REPO(-1) = Lagged repossession rate
GDP = National GDP
Income= Real income growth

There is no statistically significant supply variable, which as someone who likes to utilise theory as well as quants is not ideal, but that is a common factor in most real estate price/rent econometric modeling. There was also no explicit interest/inflation rate variable but the affects of interest/inflation rates factor into both the repo rate and the real income growth variable.

The modal called 2006 almost on the money and was pretty close on 2007.
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Re: The Invisible Hand is At Your Throat

Unread postby MrBill » Fri 01 Feb 2008, 10:33:37

The repo rate being a percentage and the income and GDP being in Sterling sums? What's the 3.09730269 - a fudge factor?
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Re: The Invisible Hand is At Your Throat

Unread postby mkwin » Fri 01 Feb 2008, 10:49:41

$this->bbcode_second_pass_quote('MrBill', 'T')he repo rate being a percentage and the income and GDP being in Sterling sums? What's the 3.09730269 - a fudge factor?
The repo rate = % of total properties.
Income and GDP = a annual percentage increase/decrease.
The price = shows growth on last years price
3.097 is the constant or 'fudge' factor :)
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Re: The Invisible Hand is At Your Throat

Unread postby MrBill » Fri 01 Feb 2008, 11:03:37

$this->bbcode_second_pass_quote('mkwin', '[')b]3.097 is the constant or 'fudge' factor :)

As in the average UK house price is GBP 230,474. but we can round it up to GBP 230.477 and 9p? ; - ))
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Re: The Invisible Hand is At Your Throat

Unread postby aflurry » Fri 01 Feb 2008, 15:15:45

$this->bbcode_second_pass_quote('cube', '')$this->bbcode_second_pass_quote('threadbear', 'F')ree markets are like "free love" as espoused by a purveyor of porn. Appeals to the libertarian who ignores that, in reality, if often just means someone's getting screwed.
Do you have another economic system you'd like to propose threadbear where there's less people getting screwed? :wink:


i think the point is that the term "free market" is actually a meaningless slogan. it is certainly not an economic system.

that is to say, the market is always manipulated. putting the term "free" in there is just a rhetorical ploy to try to get your economic interests aligned in people's minds with American Freedom (tm).
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Re: The Invisible Hand is At Your Throat

Unread postby mkwin » Fri 01 Feb 2008, 16:37:27

The market is always manipulated by whom? If the market is truely liberal it should have little manipulation. In certain industries barriers to entry might restrict competition but generally the balance of supply/demand sets the market price.
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Re: The Invisible Hand is At Your Throat

Unread postby aflurry » Fri 01 Feb 2008, 17:57:53

$this->bbcode_second_pass_quote('MrBill', 'D')o we ban sharp knives just because they can be misused?

Who said anything about banning anything? But to extend your metaphor, sometimes yes. We ban sharp knives in certain situation, say on airplanes. And we ban other dangerous things much more broadly, like say assault rifles. So, while this metaphor is so stretched it has lost most of its instructiveness, the answer with certain types of securities is that regulation or even outright banning is never out of the question. But I never said that should be done with these securities. regulation can be done well or badly just like anything else.

Anyway, just because I am not talikng about banning them, I can't point out the flaws in securitization? To me is seems healthy that bad investment should be punished with losses, the quicker the better. This is a kind of efficiency i can get my head around. like predation, it keeps the herd healthy. These securities contributed to a situation where punishment for bad investment was avoided, delayed , and hidden by many parties involved in the creation of the investment.

Perhaps this was a one-time event. As you say below, it may well be a case of fingers burned, problem solved, from the investor's point of view. But is it verboten to speak of the calamity that has occurred in the meantime?
$this->bbcode_second_pass_quote('MrBill', 'H')ouse prices reflect total demand plus some multiple of earnings.
plus the relative ease of getting credit, which is what is under discussion here.$this->bbcode_second_pass_quote('MrBill', 'I')ronically, instead of paying $500 per month for their mortgage as opposed to $1000 before, homeowners (collectively) decided that they could now not only afford the $1000 as before, but because houses were such a good bet that they could stretch to $1500.
Nothing changed about houses. The only thing that changed was the financing. Houses only became a good bet because they were getting more expensive. They were only getting more expensive because of the flood of new financing.

you have yourself pointed out the inflation adjusted stability of home prices for the 100 years prior to this asset bubble. i am saying that nothing changed about the relative attractiveness of the houses themselves to make this happen. what changed was the "financial innovation" that first created a flood of cheap capital to fund borrowers, and second encouraged or enabled traditional lenders to insulate themselves from the risk in the loans they were writing. so, the consequences of these securities were liar loans, fraudulent repackaging, habitual marking to model

$this->bbcode_second_pass_quote('MrBill', 'I') really do not undertand how you blame the banks for this because it is the consumer wanting to pay more for the house, and more each month, while the government is officially encouraging them to do exactly that by insuring home loans and giving interest payment tax deductions!


wait, what? i am at times a consumer, and i have never in my life said, "you know what? i'd like to pay more for that item on the shelf." they were WILLING to pay more because at the same time the trajectory of housing prices was moving upward, so even though they were paying higher monthly payments and at the same time eating into less of the loan principle, they were still making money because of the equity gained in price appreciation.

these are a very specific and by nature short term, set of circumstances. they briefly changed the nature of housing as an investment. no longer a hedge against inflation, it was now an instrument for leveraged short term gain.

this change is the investment status of houses was not the result of bad collective decision making. on the contrary, because of these circumstances, houses actually were, briefly, a different kind of investment. buying and selling one at the right times would have been a good investment.

so anyway... blah blah blah. but i guess all i am saying is that if the effect of financial innovation is to change the role of something with such an important non-investment component, we should look at it more closely. because the house-as-stable-inflation-hedge has immense value outside of mere investment.

the bankers do hold some culpability. what about that one guy who went in an got a loan he could afford for a nice new home in Sacto, CA? then his nice new neighborhood closes down around him because of the massive foreclosures and the meth addicts move into the abandoned properties and he has to move out because he has a young daughter but no one wants to buy the house anymore because it's in the middle of a cesspool. how do you blame this borrower when it was the banks that created the means for this boom/bust cycle while at the same time insulating themselves from any repercussions?

the banks need to remain invested in the communities they serve. what that means is that they remain on the hook for the investments they create.

these securities are like Walmart coming into a small town. sure, everything is cheaper. suddenly everyone is coming home with new BBQ's, bales of Huggies, gallons of mayonaise, etc. but after a while you see the destruction as local businesses close and everyone is forced to move out ofr get a job at the company store.

$this->bbcode_second_pass_quote('MrBill', 'T')he general rule of thumb is that you can spend X amount of your net income on a mortgage. It is pretty standard.

this says nothing about the level of leverage that X is supporting. the price of the home relative to X depends on financing. It's no coincidence that lending standards got washed away with the flood of investment capital. the housing price jump and the lowered cost of capital are two sides of the same coin.
$this->bbcode_second_pass_quote('MrBill', 'W')e were talking about property prices and how they simply do not reflect reality anymore.... They now rent a house, but own no home. What should I do as a banker? Water board the guy? Slap him silly until he realizes how stupid he is? Shoot his wife?there is no absolute scale for home prices. they always reflect reality, given the financing of the day. why not go over to thehousingbubbleblog.com and talk to some happy renters? while this particular person may be an idiot, that doesn't mean that owning a home is always a good thing.
$this->bbcode_second_pass_quote('MrBill', 'N')o one can take me seriously. But the difference is I have money in the bank and they are either living off credit and/or sold off their family land to project that illusion of wealth.but see, this is where we have a disconnect. because what i see are the people who went out and bought houses on cheap credit, in fact, as you describe above, bought the $1500 mortgage, rather than the $500, because there was so much credit sloshing around, they could... basically taking your advice, unless i am misunderstanding. anyway, those are the people with no money in the bank, paying for gas with their credit cards and planning to use that stimulus check for one final mortgage payment at least to get them into summer and better weather for the move back in with ma and pa. and the very house itself is what they using to project the illusion of wealth. that's what the term "McMansion" means. as happens so often with financing issues, everything gets flipped on it's ear. it's the renters who have money in the bank.
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Re: The Invisible Hand is At Your Throat

Unread postby aflurry » Fri 01 Feb 2008, 18:31:12

$this->bbcode_second_pass_quote('mkwin', 'T')he market is always manipulated by whom? If the market is truely liberal it should have little manipulation. In certain industries barriers to entry might restrict competition but generally the balance of supply/demand sets the market price.


by anyone with a vested interest in making money, that is to say, everyone in the market.

for instance, if a piece of legislation is put into place to promote transparency or discourage fraud it may limit or impinge upon free trade in the market, but the market will be more free because of it because investors will have the safeguards against misrepresentation. the market will also be more successful and create more general overall wealth because of the confidence these safeguards promote.

and yet plenty of people who have been making money off this misrepresentation will take the stand that the regulations qua regulation is against the free market and so on those grounds alone should be dismissed. and to try to convince people of this they will appeal to their patriotism or some shit.
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Re: The Invisible Hand is At Your Throat

Unread postby MrBill » Mon 04 Feb 2008, 06:45:31

$this->bbcode_second_pass_quote('aflurry', ']')wait, what? i am at times a consumer, and i have never in my life said, "you know what? i'd like to pay more for that item on the shelf." --snip-- they briefly changed the nature of housing as an investment. no longer a hedge against inflation, it was now an instrument for leveraged short term gain.
this change is the investment status of houses was not the result of bad collective decision making. on the contrary, because of these circumstances, houses actually were, briefly, a different kind of investment. buying and selling one at the right times would have been a good investment.
I read your whole post, but I will not re-post it all here except that I do not really disagree with anything you said, but in response to the term 'free market' this is a specific term - used for simplicity - to imply that 'choices are free and left to the market' as opposed to being a 'centrally planned economy' where production decisions are made by central planners and demand is rationed by dictat and not the economics of supply & demand.

We obviously live in 'a mixed economy' where standards and practices are controlled by rules and regulations imposed and enforced by governments and their agents. It is by no means free. It is just a term.
wait, what? i am at times a consumer, and i have never in my life said, "you know what? i'd like to pay more for that item on the shelf."
I bet you have? This is essentially what happens everytime you buy branded goods and pay more than a generic. Or when you decide to buy something - like a house - at or above the offered price instead of submitting a lower bid, and risk losing that asset to someone else who is willing to pay more for that object. And that is okay, it is normal consumer behavior. We rarely pay the absolute minimum for our own purchases, but instead are subjects of our own desires, wants, fears and preferences.

they briefly changed the nature of housing as an investment. no longer a hedge against inflation, it was now an instrument for leveraged short term gain.

Clearly in a housing bubble - or a stock market bubble for that matter - that collectively investors do make mistakes by overpaying for those assets. In the case of housing this can be paying too much in the expectation that prices will increase in the future; or paying too much relative to the reality of price and interest rate changes; or buying too much house. Or more house than you need. Mostly, those reflect a set of personal values and do not have a lot to do with a house as a future store of equity.

If housing prices historically increase by 3% over time then you are much better off to buy a $250.000 house and invest the other $250.000 in the stock market that returns approximately 8% over time than to invest $500.000 in a house in the expectation that it will appreciate faster than its long-run average. If you do, you are speculating. If you are speculating then you have to accept losses if you are wrong or get your timing wrong. The term is buy low and sell high, and not buy high and hope to sell higher. That is a market view and has nothing to do with a house being your personal residence as opposed to an investment vehicle.

houses actually were, briefly, a different kind of investment. buying and selling one at the right times would have been a good investment.

And now they are not! ; - ) $this->bbcode_second_pass_quote('', 'W')hile a 25% decline is unprecedented in modern times, some economists are beginning to talk about it. "We now see potential for another 25% to 30% downside over the next two years," says David A. Rosenberg, North American economist for Merrill Lynch (MER), who until recently had expected a much smaller slide.

Shocking though it might seem, a decline of 25% from here would merely reverse the market's spectacular appreciation during the boom. It would put the national price level right back on its long-term growth trend line, a surprisingly modest 0.4% a year after inflation. There's a recent model for this kind of return to normalcy after the bursting of a financial bubble. The stock market decline that began in 2000 erased most of the gains of the boom of the second half of the 1990s, leaving investors with ordinary-sized returns.
Why home prices could drop 25% more on average before the market finally hits bottom
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Re: The Invisible Hand is At Your Throat

Unread postby cube » Mon 04 Feb 2008, 09:00:38

$this->bbcode_second_pass_quote('aflurry', 'i') think the point is that the term "free market" is actually a meaningless slogan. it is certainly not an economic system.

that is to say, the market is always manipulated. putting the term "free" in there is just a rhetorical ploy to try to get your economic interests aligned in people's minds with American Freedom (tm).
Much of the "manipulation" is due to popular demand. :)
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Re: The Invisible Hand is At Your Throat

Unread postby Outcast_Searcher » Sun 21 Feb 2010, 13:24:20

$this->bbcode_second_pass_quote('mattduke', 'T')he more you study, read, and learn, the crazier you seem to typical people.
+1 matt Actually, I have no problem, in principle, with "Concerned" disagreeing with you - it's the tone and the total LACK of substance that is telling.
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