Apparently Barry Bonds and Angelo Mazillo have the same spin doctor. Those close to Bonds are supposed to have told the press that he took steroids to keep up with home-run slugger Mark McGwire, who Bonds believed was using illegal enhancement substances. Now Mazillo is telling the LATimes:
"Most of the large bank lenders, as well as Countrywide, were limited, slow, reluctant followers behind the lenders who most aggressively relaxed underwriting guidelines," the company said in a written response to a question from The Times.
In other words, the McGwire's of the lending world were offering juiced-up packages, so Countrywide (CFC) was forced to as well. The company says that banks wouldn't loan them money if they didn't sell the juiced-up stuff along with the prime stuff.
A childish response, we know. Angelo, if you saw the other kids jumping off a bridge, would you do it too? Society isn't going to buy it.
But there are similarities between the regulating authorities, the ones we trusted to keep the games safe. In baseball, the commissioner's office had dismissed steroid abuse with a wink-and-a-nod for years. It was good for the game when home-run records were being trashed. Now we know why. The commissioner's lax policies allowed dishonesty to flourish.
Same in the housing markets. The Fed was asleep on the job, both in regulating mortgage sellers and in calculating the rate of inflation without properly considering housing appreciation. The lack of regulation allowed the market to flourish, and the lack of assessment in regards to housing prices led them to keep rates too low too long.
In both instances, the regulatory authorities appear to have been co-opted by the people who own the franchises. Who would trust either of them now?
Monday, September 3, 2007
"Observed Price Movements:" Buying High and Selling Low
I got into an on-line argument the yesterday with a guy who said the Case/Shiller numbers and the OFEO numbers were inconsistent, so you should ignore both. I couldn't believe the guy, an investment manager, could even compare pencil-pushing government figures with data from a brilliant Ivy League professor acknowledged to be at the top of his profession. I think Shiller is great, and I take every opportunity to read anything he produces.
For a quality article on how the government's inflation figures would look if Case/Shiller replaced rent-equivalency in the calculations, see http://www.iaconoresearch.com/. As usual, the government's numbers suck. Interestingly, the article shows that inflation was running at about 10% with Case/Shiller included, but that now it's dropped to negative if you include the Case/Shiller figures. A much more informative statistic than the one the government offers.
But it got us to thinking about one of Robert Shiller's best books, Market Volatility ('89). So we checked in on the chapter called The Behavior of Buyers in Boom and Pre-Boom Markets. In 1988, the authors sent about 20-page questionnaires to 500 people in four cities. Two of the cities, Anahiem and San Francisco, had booming real-estate markets at the time. One city, Boston, was starting to fall after it's boom. And the other town, Milwaukee, was neither boom nor bust.
Here's one of the main questions the authors wanted to answer:
1) "What causes sudden and often dramatic and sustained price movements? Although questionnaire survey methods can never provide a definitive answer to such a question, they can provide information that helps us begin to understand the process: What are home buyers thinking about, and what sources of information are used to decide how much to pay for a house? How motivated are they by investment considerations, and how do they assess investment potential? Is destabilizing speculation affecting house prices?"
Sounds like what we just went through, doesn't it? Remember, this was written almost 20 years ago. I'll check this week to see if they've done an updated study. Just check out the authors' conclusions. and see if those don't fit this time around, too. It should influence your opinion about where we're headed.
"First, virtually every buyer in our California cities and the vast majority of buyers in Boston and Milwaukee believe that prices will rise...The average annual increase for buyers in California was in the 15% range, while for Milwaukee and Boston, the figure was roughly half as high... Even in Boston, 77.8% reported that it was a good time to buy because prices were likely to rise in the future. For Milwaukee the figure was 84.8%, while it was well over 90% in both California cities."
Again, sounds like our situation. In California, prices took a turn for the worse the next couple years after this article. Now, over the 15 years since, I bet we've reached those expected returns (not compounded). For now. It took an amazing run the last few years to get there, and now we're due to give some back. Back then, they didn't have the loan-quality problems we're facing now. Here's more:
"Since most people expressed a strong investment motive, one would assume significant knowledge of underlying market fundamentals. The efficient markets hypothesis assumes that asset buyers make rational decisions based on all available information and based on a consistent model of underlying market forces...The survey reveals little knowledge of, or agreement about, the underlying causes of price movements. Rather than citing any concrete evidence, people retreat into cliches and images."
"In all four cities, interest rate changes are cited as a major factor...It is hard to understand how price changes in all four cities can be driven by interest rates."
"Second in overall frequency were general comments about the local economy, such as 'strong local economy' or 'growing regional economy'...The response to questions in this section leave the strong impression that people look to observed price movements to form their expectations and then look around for a logic to explain and reinforce their beliefs...Irrelevant stories that make a vivid impression tend to be cited."
"Among the most popular cliches were 'The region is a good place to live' and 'There is not enough land.' Neither of these is news and neither could explain the sudden boom...Very few people mentioned these cliches in Milwaukee."
You can expect Shiller's conclusion to hold when the housing market starts to retreat. When home prices start to fall, the "observed price movements" will cause more selling. Most people buy high, and sell low. Once this phenomenon starts spreading to the housing market, you'll see that we have a serious problem on our hands. We've done the buy high, there's only sell low left.
For a quality article on how the government's inflation figures would look if Case/Shiller replaced rent-equivalency in the calculations, see http://www.iaconoresearch.com/. As usual, the government's numbers suck. Interestingly, the article shows that inflation was running at about 10% with Case/Shiller included, but that now it's dropped to negative if you include the Case/Shiller figures. A much more informative statistic than the one the government offers.
But it got us to thinking about one of Robert Shiller's best books, Market Volatility ('89). So we checked in on the chapter called The Behavior of Buyers in Boom and Pre-Boom Markets. In 1988, the authors sent about 20-page questionnaires to 500 people in four cities. Two of the cities, Anahiem and San Francisco, had booming real-estate markets at the time. One city, Boston, was starting to fall after it's boom. And the other town, Milwaukee, was neither boom nor bust.
Here's one of the main questions the authors wanted to answer:
1) "What causes sudden and often dramatic and sustained price movements? Although questionnaire survey methods can never provide a definitive answer to such a question, they can provide information that helps us begin to understand the process: What are home buyers thinking about, and what sources of information are used to decide how much to pay for a house? How motivated are they by investment considerations, and how do they assess investment potential? Is destabilizing speculation affecting house prices?"
Sounds like what we just went through, doesn't it? Remember, this was written almost 20 years ago. I'll check this week to see if they've done an updated study. Just check out the authors' conclusions. and see if those don't fit this time around, too. It should influence your opinion about where we're headed.
"First, virtually every buyer in our California cities and the vast majority of buyers in Boston and Milwaukee believe that prices will rise...The average annual increase for buyers in California was in the 15% range, while for Milwaukee and Boston, the figure was roughly half as high... Even in Boston, 77.8% reported that it was a good time to buy because prices were likely to rise in the future. For Milwaukee the figure was 84.8%, while it was well over 90% in both California cities."
Again, sounds like our situation. In California, prices took a turn for the worse the next couple years after this article. Now, over the 15 years since, I bet we've reached those expected returns (not compounded). For now. It took an amazing run the last few years to get there, and now we're due to give some back. Back then, they didn't have the loan-quality problems we're facing now. Here's more:
"Since most people expressed a strong investment motive, one would assume significant knowledge of underlying market fundamentals. The efficient markets hypothesis assumes that asset buyers make rational decisions based on all available information and based on a consistent model of underlying market forces...The survey reveals little knowledge of, or agreement about, the underlying causes of price movements. Rather than citing any concrete evidence, people retreat into cliches and images."
"In all four cities, interest rate changes are cited as a major factor...It is hard to understand how price changes in all four cities can be driven by interest rates."
"Second in overall frequency were general comments about the local economy, such as 'strong local economy' or 'growing regional economy'...The response to questions in this section leave the strong impression that people look to observed price movements to form their expectations and then look around for a logic to explain and reinforce their beliefs...Irrelevant stories that make a vivid impression tend to be cited."
"Among the most popular cliches were 'The region is a good place to live' and 'There is not enough land.' Neither of these is news and neither could explain the sudden boom...Very few people mentioned these cliches in Milwaukee."
You can expect Shiller's conclusion to hold when the housing market starts to retreat. When home prices start to fall, the "observed price movements" will cause more selling. Most people buy high, and sell low. Once this phenomenon starts spreading to the housing market, you'll see that we have a serious problem on our hands. We've done the buy high, there's only sell low left.
Genie Is Out of the Bottle
Haven't you wondered how the market could keep going up for four straight years, with barely a correction? No, you haven't. I understand, you've just been riding it. No concern about risk. Heck, you wouldn't even recognize stock-market risk if you saw it walking down the street.
I'm here to tell you that the risk genie has been let out of its bottle. Risk is back in the market, and at some point fairly soon it's going to be realized. You better start preparing now.
By lowering the Fed funds rate to 1%, the Fed allowed the risk in the stock market to be bottled up. Low rates let you borrow money to invest in long-term debt, which provides the collateral to let you sell short-term debt. You make the difference between the long-term debt you buy and the short-term debt you sell. Arbitrage allows you to deny the effects of risk for a period of time. When the arbitrages unwind, look out below.
Here's an example. The muni-bond market has been crushed. Funny, you'd think that investors would be running to those low-risk, no-tax funds as risk has increased. But it turns out that many funds were buying long-term munis so they could sell short-term collateralized debt obligations (CDOs). Now these funds can't sell short-term debt, so they don't need (and can't afford) the long-term debt. Down go munis.
Muni-bond sellers are telling you that munis are a bargain now. Some muni yields are higher than treasury yields. Muni-bond sellers are telling you that the market is somehow wrong. Who do you believe, the muni pushers or the market? The market is telling you to watch out. States and municipalities issued a record number of munis last year, 25% above the previous year's rate. In areas where foreclosures are highest, municipalities are cutting back on services left and right. You don't get paid enough by munis to take the risk of default. Stay away from munis at least until you start hearing about muni-bond defaults coming out of California.
Munis deserved to plunge, because the riskless arbitrage play that was responsible for at least part of their increased values no longer exists. That's a fundamental change to the value of those entities. Now you have to evaluate the securities based upon their own merits. And them merits are looking worse and worse each day.
Same thing is going to happen to stocks. The funds tell you it's a liquidity situation -- if we had more money (or could borrow more money), we'd support these prices. Money's gone. There is no more. So they're selling the things in their portfolio that have value right now. We see it differently. Risk is now seeping back into their portfolios, so they no longer are able to leverage their positions to the hilt. Banks see the risk, and they won't lend them the money.
As risk seeps back into the market, it will cause a repricing of assets going forward. And they won't be pricing these assets higher. Time to shake hands with the genie.
I'm here to tell you that the risk genie has been let out of its bottle. Risk is back in the market, and at some point fairly soon it's going to be realized. You better start preparing now.
By lowering the Fed funds rate to 1%, the Fed allowed the risk in the stock market to be bottled up. Low rates let you borrow money to invest in long-term debt, which provides the collateral to let you sell short-term debt. You make the difference between the long-term debt you buy and the short-term debt you sell. Arbitrage allows you to deny the effects of risk for a period of time. When the arbitrages unwind, look out below.
Here's an example. The muni-bond market has been crushed. Funny, you'd think that investors would be running to those low-risk, no-tax funds as risk has increased. But it turns out that many funds were buying long-term munis so they could sell short-term collateralized debt obligations (CDOs). Now these funds can't sell short-term debt, so they don't need (and can't afford) the long-term debt. Down go munis.
Muni-bond sellers are telling you that munis are a bargain now. Some muni yields are higher than treasury yields. Muni-bond sellers are telling you that the market is somehow wrong. Who do you believe, the muni pushers or the market? The market is telling you to watch out. States and municipalities issued a record number of munis last year, 25% above the previous year's rate. In areas where foreclosures are highest, municipalities are cutting back on services left and right. You don't get paid enough by munis to take the risk of default. Stay away from munis at least until you start hearing about muni-bond defaults coming out of California.
Munis deserved to plunge, because the riskless arbitrage play that was responsible for at least part of their increased values no longer exists. That's a fundamental change to the value of those entities. Now you have to evaluate the securities based upon their own merits. And them merits are looking worse and worse each day.
Same thing is going to happen to stocks. The funds tell you it's a liquidity situation -- if we had more money (or could borrow more money), we'd support these prices. Money's gone. There is no more. So they're selling the things in their portfolio that have value right now. We see it differently. Risk is now seeping back into their portfolios, so they no longer are able to leverage their positions to the hilt. Banks see the risk, and they won't lend them the money.
As risk seeps back into the market, it will cause a repricing of assets going forward. And they won't be pricing these assets higher. Time to shake hands with the genie.
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