The ever deteriorating real estate market is gradually, patiently weeding its way through the economy. In my judgment, the slowness is becoming a consequence of the attempts by the central banks and federal government to stave off the inevitable. As tautologic as it sounds, yet for whatever reason is constantly in need of recollection, the inevitable cannot be prevented. But the results could not not come soon enough. The rising foreclosure levels have undoubtedly reached epidemic levels. The number of REOs (that is, homes that have been repossessed by banks) has been skyrocketing since August.
On top of this, we see several sectors of employment growth breaking down. Fewer and fewer sectors are contributing to growth, and in a few words, this summarizes the anemic, but not yet negative, job growth we're seeing. Picture it like this: at ground level, the surface appears to be quivering, but is not eroding so much. We suspect some tensions taking place, but it seems benevolent. However, beneath this layer, the bottom is constantly eroding. The erosion is making its way to the top, and is poised to breach the surface.
The two biggest stories that landed on the mainstream media last week were the so-called "Hope Now" mortgage relief package as well as the Friday jobs report. Depending on your perspective, the stories could have been read as either positive news or not. But to be a careful speculator of this unfolding crisis, it's crucial to examine the "devil in the details." And needless to say, media are not always so good at this. They have a tendency to glide over details, while focusing on the surface, for better or worse.
Take, for instance, the November employment report. Though the headline said 94,000 jobs were created in November, reports in the press seemed less interested in noting that September's employment numbers were slashed by more than half, from 96,000 to just 44,000 (the weakest showing February 2004.) But this, too, is only a part of the bigger issue. One of the more haunting parts about these reports is how terrible the financial sector is doing. In short, financial jobs are now down on a year over year basis in the advent of the November numbers. The last time this happened was in 1995 and before that in 1991. But in addition, there is an accelerated downturn in the number of credit-related financial jobs.
The peak in the number of credit related jobs was in February, just as the subprime crisis entered the mainstream.
Real estate related financial jobs peaked a little later, in May 2007. Now that both sectors are dropping at considerable rates, it's no surprise that the financial sector is reducing payrolls by about 20,000 a month now.
The vapid presentation of the Hope Now plan and its lukewarm reception spoke volumes about how confident the country is in the current strategy to approach this matter. President Bush could not even get the hotline number correct, as he fumbled the "1-888" with "1-800", a sign perhaps a sign that the plan is not so sincere. The few who are rallying around the plan demonstrates another ominous signal. There is a tragic realization that the plan inherently narrows the number of borrowers it will reach.
It sounds to me as though the plan came as too little, too late. Estimates vary, but the consensus is that only a sliver of the mortgage industry will see any tangible benefit. At best, foreclsoures will be up sharply going in 2008. The next wave, perhaps even more aggressive than the subprime angle of this, will come in 2010 and 2011 when a surge of Option ARMs will reset.
The number of homes that have entered the foreclosure process since late 2005 stands at 3 million, of which over 600,000 were repossessed by lenders. By the end of 2008, this figure could exceed 2 million. As this graph shows, the number of REOs has soared since August. This chart is pretty freaky.
Which is why it is comical when groups like the National Assocation of Realtors, whom the media has been guilty of constantly treating as a neutral, reliable source of information, say the housing market will bottom soon (as in 2008.) This was also the same organization that didn't defend its views so much as parrot them continuously, for as each month passed in 2007, they asserted a bottom was "in sight." A dead cat bounce in home sales would leave pundits like Larry Kudlow grasping for straws. At best, we're not going to see the end of this cyclone's brunt until at least 2012. The crisis is the one-two punch of declining home values and the mortgage resets that are forecasted. As home sales drop, inventories rise, months to sell inventory rise, home values fall, and homeowners are less able to refinance.
This will theoretically become a vicious cycle, with the potential to spiral into a tizzy. As more homeowners fall into foreclosure, neighborhoods will decline severely in value, as home vacancies (already at all-time highs) will lift and a negative stigma persists. Down and down go the home prices; down and down goes home equity; down and down goes the home ownership rate. Homeowners will have less equity, and therefore will contribute less to consumer spending. The result is, at best, a very slow economy. Even as mortage equity withdrawals continue to rise, equity is drying up as MEWs continue and home prices move in a negative direction.
More here
Of course, there was a violent stream of bad news that was crammed through the Fed Reserve Request Box (i.e. "we're dumping all of our bad news on the Monday prior to the Fed meeting... so, please give us a 50bps cut, oh Sir Bernanke.") One such article was the sharp $10 billion writedown that UBS admitted to overnight. Then, Bank of America halted a $12 billion market fund. Later in the day, after the bell closed on Wall Street, Washington Mutual slashes its dividend and announces plans to cut 3,100 workers. Earlier in the day, Morgan Stanley drops this one off:
We expect domestic demand to contract by an average 1% annualized in each of the next three quarters, no growth in overall GDP for the year ending in the third quarter of 2008 and corporate earnings to contract by 5-10% over that longer period.
It should be no surprise by now that we're looking at what appears to be a bear market. In a healthy bull market, you would not see the DOW climbing 1,000 points over the course of two weeks. This is especially so in the context of the series of downer news that has come trickling in. It does, however, almost perfectly fit the mold of a triple top in formation. At this point, the "bullishness" of many of these banks is less than sincere. What we witness is a preparation for troubled waters ahead. My guess is that the "Santa Claus rally" is a work of fiction, not genuine good news. It is about as reliable as when Countrywide spun the news of its first loss in two decades as a "return to profitability" in 2008 and its shares soared 32% that same day.
Consider, the rally began after Citigroup sold a $7.5 billion stake to Abu Dhabi (but with a whopping 11% interest rate attached.) MBIA, the largest credit insurer, now stands at risk of losing its AAA rating, whose signifance cannot be exaggerated. Such a downgrade would be quite ominous.
This graph presents itself as two cycles. The first was in late July when the credit crunch emerged and bone chilling warnings of economic slowdown floored stocks. The DOW was down as much as 450 on July 26th and 400 on August 16th. Jim Cramer exploded on the air and would use the (-4,000) August jobs report to leverage his support for rate cuts. Stocks in general rose on sheer hope by August 17th. The year's biggest one-day rally occurred on September 18th, eleven days after the August jobs report. October 9th capped the first cycle and the ensuing downturn began the second cycle. The second cycle brought forth an even more vicious round of sell-offs. Writedowns came frequently (some were surprising, others not so much), corporations announced large losses, and the September-October stock rally was exposed for the facade it was. It was a rally based on hope. Now the December rally will continue and once it caps, so will begin the third cycle. And this rally, too, shall be exposed for the facade it is. (I wrote the above paragaph on Monday, before the Federal Reserve's 25 bps rate cut from Tuesday. Stocks were not pleased by the Fed's warnings of economic slowdown. The DOW fell nearly 300.)
Today, the Fed announced it would hold two auctions (one on Monday and one in January) that would supposedly stabilize credit markets by placing billions of dollars in liquidity into the financial system. But the problem is likely beyond liquidity. The roots sink deeper in the Earth than the happy machines wish us to believe. This is, after all, a credit/debt crisis, one that eclipses economic decline. Nevertheless, let's see how this could look:
"The Fed has not only opened its vault doors to the banking industry, they are now trucking it to their place of business. If that doesn't get the banks excited about lending again, nothing will, and the battle to forestall recession is already lost," wrote Scott A. Anderson, senior economist at Wells Fargo Economics.
Link
Granted, the financial system will likely continue getting paddled as real estate conditions worsen, so the markets will have to invest all of their energy just getting out of the quicksand before they can talk about returning to normalcy. Housing is moving in the wrong direction.
The term "soft landing" has all but completely vanished from most media outlets and corporate reports, a quiet admission to the seriousness of the crisis. But still, saying "recession" is almost derogatory. And this is where we should notice the disconnect: who is blowing the whistle? If people are serious about a slowdown, but not a recession, is it conditional to the Fed responding before things get out of hand... er.... worse than "out of hand?" Yet, even after the Feds cut rates in October, stocks sputtered. Now of course, many economists are coming around, dropping their "soft landing" talk, yet hesitant to say recession. At the same time, there is little admission of overoptimism having contributed to more widespread complacency.
But the debate now should focus less and less on whether we will have a recession and instead move on to its characteristics and how to manage it responsibly, so we don't end up with a generation of bubbles following bubbles. In my view, we have already entered recession (probably in either August or September) and it is a kind of recession that demands more attention than such lousy indicators as the GDP. An economy is about people, something the GDP is not so good at measuring anymore. I would perhaps point to you the poverty rate and the foreclosure rate, for instance, to get a more accurate understanding. Items such as these should indicate, and better predict, the direction of our country. I promise you that boarded-up, foreclosed homes and persistent poverty are not signs of an economy growing at a 5% annual rate.