By Guest Author Michael White
The Treasury, the Federal Reserve Bank, and the new administration are making two fundamental mistakes. They are failing to concentrate their minds on the value of our homes. And they are dumbly underestimating the size of the correct response. The first error leads to the second. How could you know what weapon to use when you don’t know what war you are fighting?
After reviewing a history of the relationship between banking crises and property losses (see graph), one reasonably concludes that we are now drowning in a worst case scenario. A nationwide loss in property values of 40% to 50% from the high is now a reasonable guess.
A loss of this magnitude cannot be less than devastating.
Banks in Crisis: Graphic History. The graphic below suggests we are going to incur an enormous and unprecedented loss in property values. We have already far surpassed the great depression in property value loss (measured as a percentage of the peak value). The first red box is total property value loss in the depression. The second red box is our present total loss. Practical steps based upon this projection follow later in the letter. The graph depicts property value losses in 21 different banking crises. Property loss is on the left. Duration of the fall is on the right. We appear to be at an early stage.
In a typical bank crisis, property values fall for six years. We are now 2.5 years into this crisis. Let history be the guide and assume we are half way through the depression. And take great and determined notice of the frightening velocity of our property-value losses. Case-Shiller reports an 18% loss nationwide in 12 months based on comparing sale prices from September 2007 and September 2008 (released Nov 25, 2008).
Obviously the future is unknowable, but there can be reason in history, and the patterns suggest an answer. Better to follow the logic of the pattern than the prejudice and ignorance which guide almost all of us most of the time and in most matters.
The meaning of the pattern is simple.
Painting with a broad brush, assume a 40% loss in property values throughout the entire United States in a period ending in 2010 or 2011. This means eight trillion dollars of equity disappears. That’s a boatload of money to take away from somebody, but turns to catastrophe when you recognize borrowed money purchased this loss.
Assume mortgages of half of the eight trillion disappear. So four trillion dollars of mortgages burn and go away and are never paid and are a complete loss and write off.
This means the banks and other mortgage owners are bankrupt to the tune of $4 trillion dollars. So the owners of the mortgages need $4 trillion dollars of new capital to get back to square one.
The Treasury has thus far given away about $250 billion to commercial banks. I don’t know how much private-source new capital banks have raised during 2008. If it is a trillion dollars I would be shocked.
In any case, we are so far away from having raised $4 trillion of new capital for the banking industry that you must run your finances based upon the assumption that zombies are running the economy. Because if zombies are running the economy then zombies are running the economy. Putting $250 billion into a $4 trillion problem is not taking half measures, it is using a squirt gun on a burning home.
Take these practical steps to protect yourself.
Don’t buy real estate: Avoid buying real estate unless you drive an exceptional bargain and have a minimum ownership period of five years.
Sell real estate: If you are waiting for prices to improve, you may have to wait five or ten years. Assume the price of your home will fall 25% from its value today. Then make the decision of whether or not you should sell today: Do you want to own your home in two years when it is worth 25% less than it is worth today?
Sell stocks: Take all money out of equities unless you treat your stock investments like your budget for gambling and don’t care about losing it. Put your cash in dumb dull places like savings accounts and money markets. Avoid treasuries – the smartest investment by far last year, but far too popular to be stable.
Work hard. Pray for good things for your family and your country and the world. Pray that zombies may be enlightened. We do have a way out. It’s expensive, but smart. You will know the zombies are enlightened when they enact Plan Orange.
Read the details of Plan Orange here:
http://www.thenewmortgagecompany.com/crisissolved.html
Michael White is the Managing Director at The New Mortgage Company in the Chicago Area.
January 19, 2009 at 12:42 pm |
good article and agree with your time line.i think they need to turn the mortgage % deduction into a credit for loans up to $200,000 that would make housing a hot commodity and effectively help to put a stop loss in. also they should fast track citizenship to foreigners for buying a house to help eat up inventory. so far the treasury and the fed have only offered assistance to wallstreet not main street. as a mortgage broker i would also like to say i was a pharmacist not the drug maker…
January 19, 2009 at 3:24 pm |
It appears from your data that the decline of equity in this depression will be unprecedented. However, a decline in equity does NOT mean the banks need to raise capital for that lost equity on a dollar for dollar basis.
Banks lend on leverage. In recent times a bank could lend $20 for every dollar on deposit and maintain adequate loss reserves and equity requirements. Assuming that the leverage factor is reduced going forward, which seems prudent, a bank may only lend a factor of 10 on deposits. So a $400 trillion equity loss could require a $40 trillion increase in deposits. But even that’s not the case.
Banks don’t lose the value of THEIR asset, the mortgage, unless the payments stop. More than 90% of mortgaged homes are still paying on a timely basis. And not all mortgages are leveraged to 100% of the value of the home, and statistics indicate that typical loan to values at time of origination average less than 60%. And not all homes are mortgaged, as the number of unmortgaged homes was recently reported over as over 50% of all homes in the US. So we’re really talking about 10% of the mortgages, which really averaged only 60% of the equity, on less than half of all homes.
So while there are dramatic equity losses, the consequence to the banking institutions may not be quite as dramatic as theorized.
January 19, 2009 at 6:54 pm |
to Steve Schwab:
thank you for your note on the accuracy of the numbers presented in my posting.
i am in complete agreement that my wild guess ($8 trillion of equity loss and $4 trillion of mortgage loss in the US property market) is in need of much more careful consideration. a pro needs to look at what the numbers are.
it is a deeply serious issue and a central issue for the broken housing bubble. if you find better data i hope you will point me in the right direction.
thanks Mike
January 19, 2009 at 6:58 pm |
to: Joe Cahill
i did just happen to look at inventory numbers this weekend. i have data from late last year which suggests we have 20 million unoccupied housing units out of a universe of 130 million housing units. it’s a scary number.
We can use the brain power of foreign nationals and we have room at the Inn.
January 19, 2009 at 11:18 pm |
All of the large national U.S. banks are insolvent, and the trickle-trickle-trickle of government bailouts exacerbates and prolongs the problem. The U.S. government should nationalize these banks and force a reduction in mortgage principle for underwater mortgages in exchange for equity stakes in these homes.
The U.S. housing problem is a symptom of a nation that has relied upon increasing and unsustainable debt for its growth for the past three decades. Our average standard of living must fall as our reliance on debt falls. The young people of America will pay for the excesses of the past 30 years with a permanently lower standard of living, and unless drastic changes increase the international competitiveness of the United States, we are on a path of permanent decline–the end of the era of U.S. dominance of the world economy. Good luck, President Obama.
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