Sunday, September 28, 2008

Election confusion

This is one election that I am not looking forward to, indeed, I doubt it makes any difference as there isn't a true leader out there. There are the tax cut and the spending promises, but I have news for you, there isn't more money to spend and thanks to Harper's narrow view Canada's got its first deficit in what, 10 years? When the year is up expect it to be in the range of $6 billion.

So Layton is promising a bigger child tax credit, to $400 per month. Layton obvious can't add or subtract either. Giving the parent the money to spend now that has to be borrowed is a really lousy idea and ensures those children will only know really high taxes for their lives.

I am not against supporting children, but not with tax money that isn't there. Additionally, you get a huge increase in the birth rate with something like this so it way more expensive then anticipated, and you can end up with people having kids for the wrong reasons. In Britain the teenage pregnancy rate is through the roof. A teenage without much education's best prospects is to have a baby.

Who is going to balance the budget? Right now cuts are required, not spending and I haven't seen a thing that gives me confidence that our next leader won't take us down the kind of path the Bush has taken the Americans, spending money you don't and making the children pay it back.

And we haven't seen any news what-so-ever on our Canada Pension Fund, which is invested in this dire market. It was $120 billion. Any bets that it is worth $90 billion now?

Children haters.

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Monday, August 04, 2008

Where Did The Perception That Banks Were Good Investments Come From?

There is no question that if you look at banks historically you can see the factors that investors promote when looking for a "good" investment. My friend that encouraged me to invest at the time was waiting for a huge market correction. That was back in 2006 and he was already more then half cash. One that he mentioned he wanted to pick up was HSBC, and his price was in the $65 range. The reasons, years of growing dividend, expanding into emerging economies, steady in their years of showing growth, etc. There is a list somewhere, I am sure.

He also talked about how dividend stocks tend to bounce back better after a downturn, at least that's what happened with the last down turn.

There is no question that banks had a very good run, but I doubt what was known to be true historically is going continue to be true moving forward.

When I look at where the increasing profits came from a see a sector that will have years upon years of disappointment to investors that fail to think this through.

You have the maestro idiot who for more than a generation gradually stepped interest rates down. So, what exactly does that do for bank profits? Consider that the dollar value of loans have been increasing over the years much more then wages. Banks are increasing their profits as that dollar value of loans increased. This has gone on since the 80s. It has enabled some troubled borrowers to refinance at lower rates and avoid the messy businesses of defaults, and of course there is an enormous fee that goes with this. Heck, there were borrowers that weren't in trouble that refinanced and just paid the penalty. I did so twice as it was in my interest to do so, and there was up to 3 months interest penalty on my mortgage each time.

Banks also added those fancy securitization products which they made a bundle on.

Well, now that there is a rate reversal in progres, so just what are all the ways that banks will lose out on in terms of how they were increasing their profits?

Loans aren't going to be getting bigger. Wages will finally have to catch up. Just how many years do you think this will take? A decade or two would not surprise me. Moving forward banks will have decreasing values of loans. Trying to increase profits through increasing rate spreads will simply increase this effect. So years of declining loan values is a given.

And, now that interest rates pretty much went as low as they could go, well, just how are those troubled borrowers going to refinance? I suppose those with massive credit card debt at high rates might be able to, but what about troubled mortgage borrowers? Or over extended big car loan borrowers? Now some of the defaults that were traditionally avoided by refinancing aren't going to be avoided. I suspect it will be years of higher defaults then historically. There will be a large wave to start and then a much higher steady stream as life's challenges hit people that were doing their best but had no room for those life's challenges -- relationship break-up, job loss, unexpected pregnancy, illness, natural disaster and so on... So, years of higher defaults for banks is a given.

You think the securitization of debt market is ever going to be as profitable again? I don't. So years of reduced profits from secutitization is a given.

Then of course there is the massive dilution of stock as banks work to raise capital. So, you have this declining profit environment on this growing equity base.

It seems to me that there is going to be a move to less debt in this environment, so not only will loan values be smaller, people will go back to the "old fashioned" way of making purchases, saving a good portion before borrowing. If you think it through what the stepping down of rates did to housing, well, it increased the loan amount that people qualified for and the responsible saver who wanted 20 or 25% down was forever finding that out of their reach. It lead to the masses jumping in early in terms of saving for a down payment because you could never earn in wages what you'd lose in equity as home values went up. They watched the market go up for 2-3 years they were wanting to buy and finally jumped in. It is what happens to young people.

Generations just young enough to miss this massive bubble will learn from the financial hardships they see around them. Many will wait and they will save for a proper down payment.

So, where do I see banks? I think loan values will cut in half and raising equity to cover losses will double the number of shares out there.

I can't see the business sector of banks doing much better.

And then there is the investment side of it. I think so many people are going to be hit hard by the markets there will be a trend back to safer investments. My idiot investment advisor argued with me over an investment I wanted to make and then I was charged $400 on the one trade. This garbage is already on the decline. Look at all the competition for $10 trades now.

So, no kidding banks were a good investment. There many things happening in their favor that whoever was running them would have to be worse then Bush to screw it up. But now the reversal comes and it isn't just reach a bottom and go back to business as usual. Moving forward the business environment is going to have those things that worked in banks favor working against them, and it is going be years of challenges and little opportunity for profit growth.

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Friday, July 25, 2008

Harper - Trudeau the second

Harper's a moron. He is destroying all of Canadian's hard work and saying no to unaffordable spending to make Canada a strong country.

Thanks to a moron named Trudeau I entered adulthood in an environment of high taxes and a sluggish economy for years to pay for his excesses.

Harper is screwing young people today as much as Trudeau screwed my generation.

Congratulations Harper, you managed to undo 24 years of Canadian pride in controlling our deficit in record speed. The deficit is massive. You had no business reducing taxes we were all used to paying and mortgaging the next generation's future. Trudeau screwed my generation over royally. We've spent our lives paying the taxes that weren't paid in the 70s.

This is an exert from an unanswered letter to this moron that I wrote at the beginning of October last year. Unfortunately these morons do things and the time it takes for their gross incompetence to show up, well, usually it is the next guy being blamed, much like Mulroney is unrecognized for what he did for Canada in working to clean up Trudeau's mess.


I read the linked article, http://www.ft.com/cms/s/0/e24d696a-6d33-11dc-ab19-0000779fd2ac.html , where it implies that you have indicated there will be a round of tax cuts and I became grossly concerned.

We have come so far in Canada and I have always felt that Brian Mulroney was our greatest Prime Minister for setting the stage so that there would one day be surplus budgets again. This is his victory, not yours and to reduce taxes would be to undo that which is once again liberating Canadians from debt.

We have an aging population and if anything, we need to further reduce spending. We have a tax system that has indoctrinated into a beliefs a system of draconian policy that takes away from youth and gives to age. It has resulted in gross division of wealth.


It is already a hard economy and Harper is ensuring that those coming of age will have a much harder time.

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Saturday, June 28, 2008

Do You Remember Where Your Career Was 28 Years Ago?

It looks like Big Picture is my favorite blog of the day today. In a post he mentions the 28 year low on sentiment, or I guess 1980.

If you are old enough, do you remember where you were in your career 28 years ago?

I graduated high school in 1979, and my age cohort was the largest of the baby boomers. Birth rates increased until 1961 and then they started to decline, so I entered the job market with a double whammy against me, the largest numbers of entry level workers ever, and the lowest job sentiment in years, and going into what turned out to be fairly hard economic times, at least here in Vancouver the economy was very bad, also hit with massive government cut backs.

Writing and looking back at my own personal history has really helped me to understand things that were completely out of my control, and to actually be quite shocked about what the economy was for me. For example, not a single business that I worked for between 1979 and 1986 is around today. What are the odds of that? I knew that my work references seemed to be dissolving almost as quickly as I moved on to another job, but I never considered how utterly shocking it is to have a 7 year work history at several companies just disappear.

The working environments were not pleasant, you knew the businesses were in trouble and it meant that I faced declining wages pretty much while I was still an entry level or very early level worker. I was making more in 1981 then in 1985. And, this was happening in an era where you were negatively labelled for job hopping if you didn't have a reasonable length of employment time with a business, yet when I look back, the nature of the economy left you lucky to have a job and moving kept you one step ahead of being laid off or coming to work and seeing a sheriff's "closed" sign on the door, and that did happen as well in my job history.

It was awful, and something that was never recognized for the extreme challenges that new young workers of my generation faced. I remember far more sentiment that "today's youth was lazy and unwilling to work," yet I also remember every job competition for low paying jobs had dozens of applications for each job.

The media was sympathetic to "age discrimination" against older workers, but what a farce that analysis was. Older workers were being replaced with workers willing to work for less. There was no age discrimination there what-so-ever. Any older worker willing to work for 30% less, wages equal to what younger workers were getting, had a job. Employers obviously did not value the "experience" to the degree that the older workers valued it.

I truly see the economy going into the same kind of scenario, only on a much, much bigger scale. Only this time the older workers have already been working with less disposable income and less wealth building ability so it isn't so easy for employers to just slash wages by 30%. So, today's older workers, while better off than those climbing the economy chain below them, are already below the economic security level of workers above them. The wage cuts will be less because there is less padding and their tighter economic situation means they will be more motivated to continue working.

It's going to be very, very ugly for younger workers. The least that the rest of us can do is not blame them for their unfortunate position in the pecking order in the economic food chain.

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Sunday, May 11, 2008

Hudbay Mineral - A $6 stock priced at $18

I first looked at Hudbay Mineral when I contrasted it to Blue Note just over a year ago. I saw nothing but downside to it, although I wasn't overly critical, yet. Blue Note that I liked has yet to perform, and with the retraction of zinc price it is unlikely to perform.

I anticipated a retraction of zinc prices, but simply not to the degree that they have retracted. Zinc was at $1.53/lb and the Canadian US dollar means that was about $$1.80 Canadian. It was $1.18 for the last quarter and it is now down to $0.96.

I made a prediction on Hudbay in the fall, and I specifically said the problems would not show up until this quarter.

Hudbay minerals looked to be valued at about 2-3x the valuation of Blue Note when I looked at them together. Today Hudbay's earning look to me like they are heading to the 50c/share for a full year range, and that won't show up on the next quarter, but Q1 2008 would have earnings in the 10-13c/share range based on today's metal prices and exchange rates. Q4 already has some better metal prices rounded into the quarter. I saw some serious reasons to see earnings declines when I reported on this stock and they have shown up and further declines will likely happen.


I missed on my prediction as they came in at 17c/share. It looks like they did well on their silver, "silver production increased 24.0% owing to higher silver content in the purchased concentrates processed in Q1 2008." That would account for about 2c that I'm out. They also produced 23,000 ounces of gold and an extra say $200/oz is an extra $4.6 million, so the gold and silver holdings off set the reductions I predicted.

So, gold, silver and zinc are all down right now compared to Q1, so expect earnings to go lower. Just to give some reference for how far Hudbay has fallen, news on the 4th quarter showed:

Canada's third-biggest zinc and copper producer earned C$28.5 million, or 22 Canadian cents a share, in the quarter ended Dec. 31, down from C$165.8 million, or C$1.29 a share, a year earlier.

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The Problem With Storage

The enormous problems in the US housing market has an even sadder story about what to do with your stuff while you try to get back on your feet, as featured in this news story.

I put my stuff in storage while I was in university and went to jobs in Ontario and Alberta. What started as a 4 month plan turned into 2 years. It was probably a good learning experience in that I would strongly advise selling and tossing stuff as opposed to storing it.

You pull the stuff out in two years and much of it you didn't miss, so why have it? And then unless your stuff is high quality, just sell it and buy something used to replace it when you need it.

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Thursday, May 08, 2008

The Problem With Housing Development Fees

I have previous written about the unfairness of development fees and now many municipalities find themselves in trouble trying to balance budgets because of their gross irresponsibility in leveling fair taxation.

Without going back and pulling actual figures, I know that in my area (and certainly my reading of news from other areas indicates the same problem) the percent of municipal budgets coming from development fees has been increasing. New developments are paying the whole shot to bring a neighbourhood up to a certain standard on those developments at the same time taxes are paying for similar upgrades to other areas. The new developments are essentially being double taxed because these fees are so excessive.

The fees are tacked on the cost of a home. So, in Vancouver developers have claimed up to $60k of a home is development fees. Does this hurt the established home owner? Hardly, the entire stock of homes goes up a proportional amount. New and existing homes are not priced differently based on the older homes didn't have the excessive development fees and costs to build, but rather relative pricing as to what you get. So, new homes get more expensive, but so do existing homes. The established home owner re-coops that increase through the sale of their home.

The first time buyer see the cost of housing up the full cost of development fees. $60k over 30 years a 6% is $129,600. It is an extra $360/month. This is the burden transfer essentially to younger people. It would probably only cost existing home owners an extra $25-50/month to pay their fair share and not transfer this burden to youth.

But hey, youth are going to be able to pay that, their enormous student loans, the increased tax burden due to an aging population, that extra $25-50/month in property taxes that's going to come now anyways, and while we are at it, we can give them a lecture on their social responsibility while they feed their kids Kraft dinner.

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Monday, May 05, 2008

Aging Population, Canada Vs US

I was looking around on this census data site. Canada and the US are fairly similar right?

Well, what I found kind of shocked me. I started by looking at the US data and I found that the ratio of working age (20-64) to retirement age (65+) people was increasing slightly in the US from around 1995 and that in 2007 the percent was essentially the same.

The graph below actually has the US data offset by one year because I don't know how fix that in excel. A one year offset doesn't change the picture that much. With all we constantly hear about an aging population I expected that ratio to be continuously declining in both the US and Canada. It looks very bad for the US that their finances have so grossly declined and they haven't even begun to be hit by an increasing percent of their population in retirement age.


Click on graph for bigger image.

That left me extremely curious about what Canada's projections look like. At first I just looked from 1996 to 2006 and I found that the percent 65+ had increased from 12.47% to 14.6% of the population, a 17% increase. To Canada's credit, not only was this enormous increase to social programs absorbed, but $100 billion of federal debt was repaid.

But, then later I went back to look at the longer term projections. That was cause to feel ill. Canada's declining birth rate is going to be a killer in terms of supporting our aging population. If you look ahead to 2026 or 2025 in the US that ratio of about 2.4 for Canada versus 3.1 for the US means the burden per working age person is about 1/3rd more in Canada than the US.

Disaster is an understatement. Fantasy would be a good expression for people's expectation of collecting any thing near what they think they are getting in their pension.

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Sunday, May 04, 2008

Where'd the Dock Go?

You know those warning sirens you hear in the movies for warning of a bombing raid? Those kind of sirens were going in town today and I didn't know what they were for. They were going for about 30 minutes. I looked around and didn't see anything.

Well, the ice in the river broke last night and it brought about 7-10 meters thick of ice filling up the river, and it over flowed the banks for a while and flooded the homes right on the river. The sirens were to warn people to get their stuff out of the basement fast. Apparently if they come in three blasts we are supposed to evacuate the town.

I found out earlier in the week that I live in a flood plain and that it can be interesting to watch the river break up. That was amazing to me because I was down by the river looking for a place to climb down to the bank last weekend. The banks were so high I couldn't imagine them ever being filled. Well, now they are filled with ice.

This picture is where there is a driving dock to load boats. I know it is there because I saw it last week.

Ice Debris

These are a few other pictures. I kid you not, last week I was wondering if the river was going to go dry, it was so low and still covered with ice. The places I could see I figured the ice was sitting on mud and there didn't appear to be many places that looked like there could be running water.

Ice Debris

Ice Debris

Ft Laird

And, not to be undone, I guess the week before last I told students to get pictures around the school for the year book. You never know what kids will come back with...

Snow Dung

UPDATE: One day later, the ice has broken and the river is flowing...


Ft Laird

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Saturday, May 03, 2008

Super Artists



My students are super artists. We are working on a yearbook and I thought I'd share some of the artwork they've made for putting students heads onto. I am in a very small school. We have 5 graduates this year, and the above picture will hold their mug shots.


Below is a sampling of other art work that will have student mug shots.

The boy who drew this one is in his later teens. He is amazing in the ideas he comes up with.










And we have a third artist who drew this one.

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Friday, May 02, 2008

The Pawn Shop Memories

Mish had a post that hit me hard for how it reminded me of the challenges of my youth.

The post features two links, one about how the pawnshop business is booming as people hand over things to get instant cash.

"We never saw so many people in here 30 and younger," Society Hill associate Damien Robinson said. He spoke as a 22-year-old Neumann College graduate walked out with a $75 loan on her Dell laptop computer. "What are young people going to do for rent now that apartments are so expensive?"


I never got cash for things from a pawn shop in my youth, but I have had to sell furnishing to pay the rent and buy food in the past. The stress of living like that is incredible, and that was happening to me in the later 80s.

Being down on your luck is hard, but the attitude in the economy when I was young was very much to blame young people for the position they found themselves in. The position I found myself in was because my mother had died when I was a child and I held some illiquid assets I had bought with insurance money. It made me ineligible for student loans. After I had sold everything in my home that I could, I was forced to make a choice between quitting university or selling those assets for 40c on the dollar.

Dealing with this kind of thing is hard enough on its own, but it was tied to my mother, who died tragically at age 32. Dealing with it brought all the pain and grief of losing her as if it had been yesterday. It was like she died twice.

But, like I said, there was a lot of blame. I was an emotional wreck. I ended up dropping one class, finding a part-time job, but I was too distraught to manage everything. I let one class slide figuring I could bring it back up when I was better able to handle it. I failed the first test miserably. My professor, Dr. Slessor, had joked with me before class daily until that test. After I was greeted with a coldness that could save the world from global warming.

After about six weeks I was getting through the days without breaking down like you do when you are in the midst of tragic grief. I suppose I'd pulled it together enough to pull an 80 on my next exam with that prof. He'd heard I was having a rough time and he apologized for his abominable behaviour, but getting that kind of kick when you are down, and from a professor that has been a recipient of an award for excellence in teaching, it really didn't undo the damage. What was the apology for, to suggest it would have been OK behaviour had I not been in distress?

And then there was the guy that helped me put my sign up on my property. I heard through someone else that lived in the neighbourhood that he'd been bragging he took my sign down as soon as I drove away as he knew I was in a forced sale position and figured he could squeeze me for an even lower price if I had no interested buyers.

So, for me, reading that post brings back the memories of selling my TV, my early generation computer games - colecovision, and all the pain that goes with it. I supposed I managed to sell enough stuff to pay the bills for about a month, but then it gets to what do you do for the next month? I got the part-time job, I had a credit card and I planned to finish my semester and then wait until I saved enough for each semester.

I've been an advocate for how bad things are for young people since the 97 census. I worked that census and I saw 3 single young people living one bedroom apartments due to under employment and low wages. I always managed to have a home where I had my own room, yet for over 11 years there has been young people who have not managed to do this, and never mind sharing a 1 bedroom unit, there were several with 3 people sharing. There are 11 years of this kind of thing getting worse.

I constantly run into people who talk about how they had to get 2 jobs when they were young to get where they are today and they fail to see the wealth of opportunity they had simply because jobs were abundant. The wages these people are making means you probably need more than 2 jobs to make ends meet.

It is interesting the comment of the woman trading her watch in for $20 for gas. She is not poor, but "middle-class."

I tend to think she grew up middle class, but her standard of living has declined.

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Saturday, March 22, 2008

I'll Bite, I'll Blog About It

A line in the song suggested blogging about it...



While I'm at it, another wonderful song, Bubbleman:

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Thursday, March 20, 2008

Flush Tax Money Down the Toilet

First, my last post is incredibly long, but it is one worth reading and studying, imho. There simply are too many faulty and disasterous beliefs around low interest debt and too much looking at it from a perspective that is so narrow, well, collectively society will be paying for this blatant ignorance most likely for the next generation. I think it is worthwhile to understand how the "experts" were so shallow in their understanding of how low interest debt plays out from a micro-household perspective.

Today in the news is a story advocating Ottawa spend another billion stuffing language policy down our throats.

I admire people who speak more than one language and I think it is important, but this kind of crap is a gross mis-allocation of tax payer resources. What ought to be driving language is personal beliefs around it, plain and simple. Learning language should be because you believe in it and paying government wages to government workers to go to school for 6 months or a year to learn a second language is a gross negligence of managing tax payers' money.

I went to school for self-improvement and I paid for it both through lost opportunity of wages and tuition. This BS is paying government workers full salary and don't even factor in the pension benefits because they were "working." There are enough people who value this and take it upon themselves to educate themselves this way. Hire those people instead.

I speak on this issue with thinking about a dear friend who has instead of going to her job gone to language school at full pay. This isn't anything against my friend, but this is a grossly wrong way to be using our tax dollars.

There are a hell of a lot of young people who have taken language immersion programs their whole lives and devoted enormous other personal resources for this kind of training, have huge student loans, and we flush our tax payer dollars down the toilet instead of giving these people a chance?

In Mexico people want their children to learn as many languages as possible. They don't spend tax payer money promoting it. It is driven by culture and values and that's the way it ought to be here.

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Wednesday, February 27, 2008

Six Degrees of Leverage

I wrote most of this a couple months ago, but I've done some edits to update.

"Pricing-to-market" long term debt or credit is really quite a shocking concept, as the numbers will show, yet this appears to be a common practice.

I had a look quick look at the numbers for this and it got me thinking about some bonds my financial adviser had me in. When I bought rate of return to maturity was around 6% and when I sold it was around 4.5%. It had about 10 years to maturity when I bought it and 6 years left when I sold it. This was actually one of the better investments from my adviser because of the leverage of the interest rate and the bond pricing itself down to a lower rate of return. To make the example simple, say in 2012 it pays $10,000 at maturity. The easiest way to calculate the buy price at each year is to just divide by 1 plus the rate, as I have done for the table at both 6% and 4.5%.

Year 6% PV
4.5% PV
2002 5,584 6,438
2003 5,919 6,729
2004 6,274 7,032
2005 6,651 7,348
2006 7,050 7,679
2007 7,473 8,025
2008 7,921 8,386
2009 8,396 8,763
2010 8,900 9,157
2011 9,434 9,569
2012 10,000 10,000

So, in 2002 with it paying 6% I’d have been able to buy the bond at $5,584 and in 2006 with it priced to 4.5% I’d have been able to sell it for $7,679. My return for the 4 years would have been about 37.5% or 8.3% annualized. My rate of return ended up being 38% higher than I expected (8.3/6 – 1), and for me, that was a leveraged advantage of that bond due to the number of years left on it and how the market priced itself down to lower rates of return.

In the declining interest rate market since the early 1980s buying longer term debt at a higher rate and selling later when rates decline would increase the return due to this kind of "pricing-to-market."

It got me thinking, just how much leverage of debt has the banking system added with not only low interest rates, but also the packaging of mortgages and selling them as bonds? The M2 money supply has been increasing dramatically relative to the M1 money supply. To what degree can the activity of banks explain this?

First, a graph of M1 and M2 money supply:

M1 and M2 Money


I am not sure about all of the calculations of the M1 money supply, but the Federal Reserve's printing press increases the money supply and then the banks have always taken that money supply and when they loan it out, it is leveraged. Traditionally the leverage was 12.5 to 1. Apparently the leverage is now about 30 to 1 and that has implications of nightmares. The “OMG, what have they done? How could they be so irresponsible and negligent?” questions are so long overdue, I personally don’t see how anyone can escape this nightmare without some serious hurting here.

Seriously, if knowing that the leverage has increased this much hasn’t raise enormous concerns in you, you are probably in big, big trouble with your investments.

I also did a graph of the ratio of M2 to M1:

M2 to M1 Ratio

Responsible monetary policy would show this graph as a horizontal line, not something heading into the stratosphere. Where the ratio was close to 2 fifty years ago it is now 5.4. Think of this as increased risk, because that is the implications of it. That’s 270% of increased risk. Think of those mortgage bonds causing the liquidity problems as part of that risk.

So, do I know where all this leverage is coming from? No, but the leverage from my little 10-year example is but one small example. I don’t think that example is particularly serious for the economy. The type of company was very stable and although uncertainty increases with increased time, a 10-year window isn’t too bad.

But, they’ve packaged these bonds with 30-year mortgages based on people’s personal lives. That is so much different than 10-years with ongoing businesses like utility companies.

First, how different are families from utilities?

There is an implied trust that payment streams will continue from families until the debt is repaid. What’s the relative difference in risk?

I did a blog, “Bad Feeling Good Times,” which was inspired by how the employment world, and standard of living has been changing. Workers born between 1957 and 1964 have held an average of 10.5 jobs and I think that is probably getting worse, not better. Add in that mortgages are based on family incomes and families sometimes fail. A utility company isn’t going to get a divorce, cancer or have an unexpected pregnancy.

And homes have been priced to family income based on low interest rates. This is another form of leverage. Traditionally mortgages were granted so that only 30% of your gross income could be used for the mortgage payments and property taxes. It seems to me that when I worked in banking mortgages were over 25 years, not 30, but I will use 30 years because this is what is being sold. Heaven forbid, a blog I read somewhere this week was talking about mortgages that had been granted allowing 50% of income for debt servicing. Seriously, this is economic slavery. There is no hope ever of digging out of that level of debt.

So, in how many ways is mortgage leverage playing out in the economy that it can collapse?

Take a household income of $100k lets have a look at how much mortgage they qualify for at different interest rates and difference percentages of income. To simplify this calculation I assume only mortgage payment, and no property taxes for this 30-year table.

Rate / % income
30% 35% 40% 45% 50%
2% 676,000 789,000 902,000 1,015,000 1,127,000
3% 592,000 691,000 790,000 889,000 988,000
4% 524,000 611,000 698,000 785,000 873,000
5% 465,000 543,000 621,000 699,000 776,000
6% 416,000 486,000 556,000 625,000 695,000
7% 375,000 438,000 501,000 564,000 626,000
8% 340,000 397,000 454,000 511,000 568,000
9% 310,000 362,000 414,000 466,000 518,000
10% 285,000 332,000 380,000 427,000 475,000
11% 262,000 306,000 350,000 394,000 438,000
12% 243,000 284,000 324,000 365,000 405,000

First, the fact that this is a 30-year table means that it already has debt amortized over an excessive amount of time. It means that it is already not conservative in any way, shape or form. Because it has become a social norm does not mean it has prudence built into it.

In the Great Depression the fed was able to do something because 15 year mortgages could be extended to 30 years. Borrowing at 8% interest over 15 years would allow the 100k family to borrow $262k versus the $340k they can borrow over 30 years. If you then need to increase the payment to be over 30 years, you can reduce payments by 23%, $578. You only reduce payments by . Changing that 30 year mortgage to 40 years and you reduce payments by a piddly 6%, $140. Read the numbers, no amount of refinancing can fix this.

Set the qualifying standards to 30% of income at 12% as the maximum for a prime loan over 30 years and now you have prudence built into lending. It is insane and grossly ignorant to have allowed mortgage amounts to have increased to an identical percentage of income as rates declined. It is applying a linear standard to a concept with exponential properties. It is an exponential addition of risk.

And then a larger degree of insanity was added when the allowable percent of income was increased. And this has been referred to as progress and even a good thing by calling it “modernization” of loans?

It isn’t a good thing, a wise thing, or modern innovation; it is an innovation of mass economic destruction that lines the pockets of a few for a relatively short period at the economic peril of the masses for a long term and has enormous spill over costs that are already being felt around the world, for example, Yukon has $36 million of this mortgage debt frozen, a bunch of Norway small towns have lost half this year's budget, including the school budgets, etc.

The degree of leverage, or money creation as that table goes from prudent at 12% and 30% of income to Master of Snake Oil finances at 2% and 50% of income is 464%. To see the same income qualify from a low of $243k to a high of $1.1 million is an absurd range with an absurd level of increased risk.

Add to that risk how second mortgage terms have changed, which have again increased leverage and risk.

When I look back to the 70s and my mother’s second mortgage, well, paying the debt back was a shorter term – a 10-year time frame. And what have the Snake Oil Financial Wizards of the 21st century done? They’ve issued second mortgages that span 30 years and have the first five years as interest only payments! Lending standards of the 70s allowed up to an additional 8% of income to be going towards this shorter-term debt, which included car loans and student loans. For this example we'll assume no student loans or other debt. The table shows how much second mortgage a $100k income could support with a 10-year repayment plan and the insane 30-year repayment plan with 8% of income for a household with $100k of family income.

Rate 10 Year Mort
30 Year Mort
2% 72,000 180,000
3% 69,000 158,000
4% 66,000 140,000
5% 63,000 124,000
6% 60,000 111,000
7% 57,000 100,000
8% 55,000 91,000
9% 52,000 83,000
10% 50,000 76,000
11% 48,000 70,000
12% 47,000 65,000

It is interesting to note the total level of mortgage debt a $100k household income could carry with prudent lending standards -- 30% of income @12% -- in comparison to what is considered an affordable home. You have a $243k first mortgage and at the same12% an additional $47k, for a total of $290k. Affordable housing is defined as being 3 or less for median home price over median income. If you look what prudent lending standards of the past allowed, well, they would only allowed you to buy a home you could afford! And make no mistake here; household budgets are tight when paying for homes at three times household income.

By increasing the length of repayment on the second mortgage the borrower ends up with $160k more in debt servicing costs, $8k x 10 years = $80k versus $8k x 30 years = $240k. It is a disaster in terms of people’s ability to get ahead of the debt. With 30-year second mortgages there is no 10-years of hardship and then life gets easier. They won’t be freeing up cash flow for when their car needs replacing with their 30-year second mortgage and forget about saving for retirement or their children’s education.

If you want true economic strength from low interest rates you set a prudent standard and then if rates are lower, well the family spends a smaller percent of their income on debt servicing. The family then has options to save for retirement, pay down debt faster, and to spend money in the economy on other goods and services. The economy isn't then crippled, or in this case, slaughtered, if it slows.

Lower Interest Rates Do Not Stimulate the Economy.

The analysis or suggestion that lower interest rates stimulated the economy is grossly incompetent and a very shallow, short term view.

In the shorter term, if you consider the masses that were already homeowners, well, they were able to reduce debt-servicing costs by refinancing and they were indeed able to stimulate the economy by spending that money elsewhere. However, because of the insane lending standards, as rates declined, housing prices were bid up to what families could afford with 30% of their income at the lower rates, as in the table. They were also bid up by increase the amount of income qualifying. Over time, the ratio of those who can benefit from lower rates declines. Further, the ratio of savings from reduced rates declines. Those who are trapped with a different kind of debt and little hope of relief increases. Low interest debt is a very different animal, than high interest debt, as analysis further down shows.

Low Interest Rates: The Dr. Jekyll and Mr. Hyde of Debt Management.

Rate / % income
30% 35% 40% 45% 50%
2% 676,000 789,000 902,000 1,015,000 1,127,000
3% 592,000 691,000 790,000 889,000 988,000
4% 524,000 611,000 698,000 785,000 873,000
5% 465,000 543,000 621,000 699,000 776,000
6% 416,000 486,000 556,000 625,000 695,000
7% 375,000 438,000 501,000 564,000 626,000
8% 340,000 397,000 454,000 511,000 568,000
9% 310,000 362,000 414,000 466,000 518,000
10% 285,000 332,000 380,000 427,000 475,000
11% 262,000 306,000 350,000 394,000 438,000
12% 243,000 284,000 324,000 365,000 405,000

Looking at the above chart again, consider a 5% decline in interest rate, from 12% to 7%. Originally the $100k of income qualified for $243k, but it increase to $375k. The second mortgage goes from $47k to $100k. The $290k has been bid up to $475k, but there isn't an extra $185k of value or cost inputs into that home.

It helps to explain how it is that builders have been getting compensation increases for their work that is out of line with the realities of the rest of us. At the management level way too many are getting paid a million a year for the same kind of skill set that others in other types of companies make perhaps $100-250k.

One of the many reasons the economy is only stimulated short term from rate cuts is that as time goes by you have more and more first-time homeowners that initially borrowed at lower rates and simply have higher debt to income ratios. These people are not benefiting from lower interest rates because their debt servicing costs have not been reduced, instead, they have sky rocketing principal repayment demands.

They are experiencing a reduced leverage ability to get ahead, which I outline below, and this is a huge reason for why low interest rates hurt more than they help. Newer homeowners started at the maximum debt servicing allowed at lower interest rates. You also end up with people who upgrade and also bid up their debt servicing costs so they are no longer a part of the benefiting population. In Canada, where you mortgage rate renews every 3-5 years there is also way more upside risk to interest rates than potential downside gains. Homebuilders who bought land cheap initially make a killing as home prices are bid up to a faulty qualifying criterion. As time goes by you also have more people refinanced into lower rates, so there is no longer any place for them to increase their disposable income.

This time lowering interest rates does little because people are already maxed out on debt financed at low rates. Fewer have the option of refinancing to reduce repayment burden.

There is enormous extra risk when people have been paralyzed in their ability to reduce their debt burden from housing being bid up to a fixed percent of income as rates have decline. Lending standards might as well have been designed by elementary school children for their lack of analysis and prudence to make adjustments to requirement based on the interest rate rather than the household income. I picked up banking math errors written into law when I was a teenager with only my high school math skills, so I am quite serious to question how bankers can justify that their maths skills exceed that of elementary grade student to have not adjusted lending standards to make sense relative to interest rates. We have yet to bear the brunt of the increased economic risk of what they have done.

Paying back the mortgage with 30% of $100k of income over 30 years means that everyone regardless of the purchase price will pay $900k between paying back principal and interest. For a 10-year second mortgage at 8% they will pay back $80k and at 30 years $240k. The table below shows the distribution of principal and interest at the various rates.

Rate Principal
Interest 10 Yr Prin
10 Yr Int
30 Yr Prin
30 Yr Int
2% 676,000 224,000 72,000 8,000 180,000 60,000
3% 592,000 308,000 69,000 11,000 158,000 82,000
4% 524,000 376,000 66,000 14,000 140,000 100,000
5% 465,000 435,000 63,000 17,000 124,000 116,000
6% 416,000 484,000 60,000 20,000 111,000 129,000
7% 375,000 525,000 57,000 23,000 100,000 140,000
8% 340,000 560,000 55,000 25,000 91,000 149,000
9% 310,000 590,000 52,000 28,000 83,000 157,000
10% 285,000 615,000 50,000 30,000 76,000 164,000
11% 262,000 638,000 48,000 32,000 70,000 170,000
12% 243,000 657,000 47,000 33,000 65,000 175,000

What is important to consider, principal is expected to be paid back 100%. Interest, however, can be modified through increased payments.

First, by increasing the second mortgage from a 10-year term to a 30-year term total payments increase by $160k. So this one change makes the total payment stream change from $980k to $1,140k, or a 19% total increase.

Look at the 12% row. At 12% only 27% of the $900k paid over the 30 years is principal. The rest is interest. The greater the proportion of the repayment schedule being interest the better. Consumers usually have a clause that allows them to prepay a certain amount of the mortgage and that gives an enormous ability to reduce the repayment burden by reducing the amount of interest they pay.

The principal has to be repaid in full, however, because 73% of the repayment burden is interest, there is enormous opportunity to reduce the repayment burden by taking advantage of clauses allowing increased payments.

Rate
no increase
10% increase
savings
20% savings
12% 360 months
216 months
306,000 167 months
399,000
7% 360 months
272 months
152,000 224 months
228,000
2% 360 months
316 months
31,000 282 months
54,000

Say the household increases their monthly payment from 30% of income to 33% of income. A mere 10% increase in mortgage payment changes the repayment of the mortgage from 360 months to 216 months. The total payment stream for the first mortgage changes from $900k to $594k, or total savings of $306k to the homeowner. A highly manageable payment change has reduced the debt burden by more than 1/3rd. An increase to 36% of household income reduces the term to 167 months and $501k, for a total savings of $399k. Notice that the second extra 3% of gross income did little compared to the first extra 3%. So, when homes were priced affordably at 12% interest there was an enormous ability to redistribute the household cash flow to reap enormous benefit, and when I worked in banking in the early 80s this was the behaviour I witnessed. Indeed, there is high motivation to reduce debt and I saw people regularly paying off their mortgages while still in their 30s.

Contrast the example to a home being bid up to 30% of household income at 7%, a rate that many home owners have today, the stuff of the so-called rate freezes in the media today. In this example 42% of the payment stream is principal. $375k is 54% higher than $243k and even though the payment is the same, the home owner’s leverage to get ahead has been grossly marginalized. Increasing payments by the same amount, to 33% of household income, reduces the number of months to 272 and the total payment stream to $748k, a savings of $152k, which is less than half of the savings the same increase in payment gave before. A 20% increase in payment, or going to 36% of gross income reduces payments to 224 months, or $672k or total savings of $228k. In order to save the same $306k in interest as the homeowner who qualified at 12%, the 7% qualifier would have to increase payments to 41.5% of their household income, a highly unlikely feat to manage.

Finally, consider the 2% debt. The benefit from increasing payments by 10% or 20% is almost negligible. Where's the hope of getting ahead? Additionally with a 2% teaser second mortgage over 30 years versus 10 years the extra principal the homeowner gets saddled with is $108k.

By changing the second mortgage standard from 10-years to 30-years very little money ends up going to principal. At 30 years for $100k at 7% about $73 of a $667 payment goes to principal compared to about $330 going to principal when the mortgage is restricted to 10 years and $57k. At the end of a year the prudent lending standard has the homeowner roughly $4k less indebted with the second mortgage. This is $4k of reduced risk for the mortgage holder. Further, there is no way homes would have been bid up to today's prices and affordable homes are more likely to retain their value than unaffordable homes.

So what you have here simply from interest rates declining and no adjustment of lending standards to account for the gross differences in the consumer’s ability to handle the debt over the long term is a leverage of money supply, the bank is able to loan $475k versus $290k with a decline in interest rate from 12% to 7%.

I saw 12% mortgages when I worked in the bank in the early 80s so it is a generational difference in the level of empowerment to manage debt. Anyone trying to say that higher interest rates were harder has the foulest smelling diarrhea of the mouth. There is huge empowerment to reduce the repayment burden. Further, they had the benefit of seeing rates drop and with it the ability to renegotiate lower rates. Having an already fixed debt and interest rates decline is what made lower interest rates easier for them, and empowered them to stimulate the economy. They are comparing a starfish to a giraffe and ought to be able to see the difference.

Furthermore, the household benefit of seeing lower interest rates and being able to refinance to save money also has reduced leverage as interest rates decline. Take two households 3 years apart, the first had 12% to qualify and the second had 10% to qualify. Say the rate declines 2% for each. So, the home was not bid up for the 12% buyer and the mortgage was $243k and the payments were $2500/month. To simplify, lets say the very next day they homeowner was able to lock in at 10% instead. Keeping their payments the same, they drop down from a 360-month amortization to a 200-month amortization. This is the stuff that stimulated the economy with initially dropping interest rates. That 2% decline in interest with the homeowner just maintaining their payment saves them a whopping $400k of interest.

Now look at the homeowner that came along three years later when rates were 10%. Home price got bid up to $285k, but they get the same lucky deal where the very next day they get to lock in 2% less at 8%. They kept their payment the same as well. They benefit, but their amortization only reduces to 214 months. Their savings in interest is $365k, still very good, but that is almost a 10% decline in leverage for savings. At 8% that declines to 6% the amortization declines to 228 months for $330k savings, and 6% that declines to 4% has an amortization decline to 243 months for a $293k savings.

So, when interest rates first went down there was huge amounts of money to be saved through households easily being able to reduce their total payments due to most of the payment stream being interest. That money was freed up and available to stimulate the economy, but at the same time, anyone not in the market ended up in a housing market that got bid up based on payments that could be paid at lower interest rates.

The lower the interest rates when entering the housing market, the more burdensome the nature of the debt to be repaid. Whereas for existing home owners lower rates offered enormous leverage for savings on mortgage payments and enormous ability to free up capital, the utter opposite is true for those who have entered the housing market later at lower rates. There is a gross decline in leverage to control and tackle debt and there is forever a reduce ability to free up cash for other things. By changing the terms of second mortgages from 10-years to 30-years newer buyers don’t even have eliminating the second mortgage as a source of freeing up cash flow.

Each year this lower-interest-rate with negligent-lending-standards time-bomb has continued it has resulted in more and more people with debt that gives little leverage to improve your financial position and it is the suck-the-life-out-of-your-financial-future-forever kind of debt.

So, the economy is now in a place where there isn’t must left to stimulate the economy from reducing interest rates, but there are an enormous number of homeowners with grossly reduced prospects of managing debt because of all the ways leverage has worked against them:

1) Homes bid up in price due to rate declines

2) Reduced leverage from increasing payments

3) Loss of equity from declining home prices

4) Reduced leverage of saving should rate decline

5) Homes bid up in price due to second mortgage term increasing

6) Homes bid up due to allowing a higher percentage of income to qualify for the loan.

Early homeowners have already reaped the rewards of lower interest rates although some of them have probably painted themselves into the same corner of debt despair and destroyed their economic future as well by saddling themselves with the economic slavery kind of debt in order to upgrade their home or whatever else they might have wanted.

Housing Affordability


To further put this into perspective, out of 159 cities/suburbs in the world ranked for affordability, the US has 14 of the 25 cities in the world deemed to be the most unaffordable, including Los Angeles, San Diego, Honolulu, San Francisco, Ventura County, Stockton, San Jose, Riverside-San Bernardino, Miami, Modesto, Fresno, New York, Sacramento, and Sarasota. Add the population in each city and that is an enormous number of Americans that have potentially become debt slaves. Additionally, median affordability multiple for the US is now 3.7, meaning half the cities looked at have a lower level of affordability and half have a higher level of affordability. Out of the 107 US cities looked at only 35 are affordable, or median home price to median income is 3 or less.

Suffice to say that various leverage of mortgage debt is currently hurting home owners enormously in how home prices have been bid up to what they can “afford” with negligent lending standards. Homeowners have less power to control and reduce debt and that power has been declining as interest rates have been declining. Lower interest rates only helped those with existing debt that were able to refinance at a lower rate. Each percent decline in interest rate provides less leverage for reducing total interest payments when homeowners refinance. Interest rates have been low long enough that dire hazards to homeowners from the many levels of reduce leverage for getting ahead likely out weigh the initial benefits early home owners had in being able to reduce total interest payments and free that money up to spend in the economy.

Today’s newer homeowners have marginal prospects of being able to save for retirement, save for their children’s university, replace their aging vehicles, and indeed keeping their home should unplanned expenses or events happen such a job layoff, marital breakdown, health problems or unexpected pregnancy.

How Have Rates Declined?

For this part my reading took me to a federal report mentioned on Calculated Risk. In the report is a graph showing the weighted average mortgage rates from 1991 to 1994:

Declining Interest Rates

In the 14 years covered you can see the 30 year fixed mortgage rate go from a high of 9.5% to a low of 5.5%. Say a household had $100k of income in 91. They would qualify for about $297k of mortgage. In 2005 they would qualify for about $440k, an increase of 48%.

In 91, 64% of the repayment amount would have been interest, but at 5.5% only 50% is interest. Paying less interest is great when the principal amount is reasonable, but in both examples the repayment amount over the life of the mortgage is $900k and the low interest borrower has reduced leverage for reducing the interest paid from making extra payment.

Over 14 years if you assumed wages have increased by 2.5% per year, then in 1991 that $100k salary today would have been about $70k. So in 1991 the amount of mortgage 30% of income would have qualified for at 9.5% interest would be $208k. With the rate decline and the wage increase over the 14 years then in 2005 that same household would qualify for $440k, an increase of 112%, or 5.5% per year.

In Canada to qualify for an insurance-free mortgage you need 25% down for a 25-year mortgage. In this model, if you consider that decreasing the interest rates and not building in anything for the extra risk due to how the nature of the debt has changed, over 14 years wages only went up about 40%, yet real estate is up 112%. If home prices were to return to that historical standard of debt risk housing would have to come down 30% and that 25% prime mortgage would be 5% under. The old US standard of 20% down and a 30-year mortgage was already a lenient standard.

How Do Low Rates Affect the Down Payment?

To merely go back to the lenient standard of 20% down is enormously different in a low interest rate environment. Say a household is able to save 15% of their gross income per year, which tends to be a fairly aggressive savings rate. In 1991 at $70k per year they could save $10.5k per year. A property that costs $260k would require $52k down and a $208k mortgage. This is a moderately unaffordable home, with a price to income ratio of 3.7. As I stated earlier, made no mistake that qualifying for a mortgage with 30% of income means that family budgets are tight. It would take this household almost 5 years to save the $52k down payment. In that time because of increasing income and declining interest rates, by 1996 the family would qualify for $272k, but the home would have gone up to $340k and now a $68k down payment is required. In 5 years with pay raises and 15% savings the household would be able to save $56k.

Decreasing interest rates "screwed" the potential new home owner yet again.

Fixed Percent Income to Debt Servicing Is a Changing Standard.

The changes to the lending standards, and there is no question that allowing a family to qualify for a mortgage with 30% of household income in a declining rate environment is a changing lending standard that dramatically increases the risk of the loan, punished the responsible in that real estate went up $80k went they were only able to save $56k saving fairly aggressively. Why not just hit the responsible over the head with a sledge hammer? The trend to lower interest rates ultimately punished those who were doing their best to be responsible. It also punished those who were not already in the housing market, a form of transference of wealth from youth to age.

Ultimately, a young family starting their working career in 1991 would need 7 years of saving 15% per year to catch up with the 20% down payment and by 1998 they would be able to afford a $370k home with a mortgage of $296k, and have needed a $74k down payment. So, 25 when you finish university, 32 when you buy your first home, and 62 when you finally pay it off, and in a low inflation fairly flat wage environment, and the increasing costs of perhaps having a growing family, means that money is tight forever. Consumer spending to stimulate the economy has been executed.

Today a family starting out with $100k in income that qualifies for a $440k mortgage because of the insane lending standards needs to save $110k towards a down payment. When the 1991 family would have first did their budget, they would have figured it would take about 5 years to save a down payment. Today's family saving 15% of $100k would need about 7.5 years to save a down payment. A home that costs $550k on a $100k salary is severely unaffordable. By the time this family got $110k saved, without a correction and say homes continuing up at the rate of wage increases, in 7.5 years home prices would increase another 20%, so they would ultimately need about 10 years to save a down payment.

I did not understand the degree to which the rules were being changed prior to my own entry into the housing market. Nor did I understand the degree to which these changing rules have mislead people in their belief about housing. The lowering of interest rates without adjusting either the qualifying term or percent of income was a grossly uneven playing field for the have no home compared to the have a home families. As I have stated previously in my blog, in Vancouver, it has resulted in an enormous division of wealth. I see people getting close to 40 who have not been able to make a dent in their student loans, never mind ever owing a home. The asset price inflation has also resulted in rent increases beyond the rate of wage increases so these people have had no buffer what-so-ever to the cost of living increases.

For 10 years in Vancouver our housing affordability index was probably around 4, maybe just over 4 in 1992-1996 and perhaps as low as 3.6 before our latest housing boom that started around 2001. Our housing prices declined a little from our peak around 1993-1995, and wages went up slightly which resulted in the affordability index declining. What I see in Vancouver's economy is a 10 year window of how unaffordable housing has played out in a relatively flat wage environment.

Additionally, those who had homes had a leverage of disposable income due to being able to refinance debt at lower rates, so renters faced grossly increasing housing costs due to increases in rent whereas home owners saw mortgage payments decline. Probably the difference in Canadian laws prevented Canadians from using their homes like an ATM machines that has occurred in the US.

The median housing affordability index for the US is 3.7. Those that had their homes and had the opportunity to have a buffer against rising costs through home ownership seemed to have squandered that advantage as US data indicates enormous numbers of people have borrowed against their homes despite having had the opportunity to become home owners when housing was affordable. It seems to me that far more people in the US have borrowed to unaffordable levels than what I've seen in Vancouver and I can't see how this does anything but suck the life out of the economy as the burden of dealing with household debt can no longer be put off. Wages can't be anything but flat in this kind of environment, and can be declining. We saw lots of declining wages through that period as well.

We are being warned about losses from mortgage backed securities and it seems to me the analysis of how this will play through the economy is only looking at how business losses have played out through the economy in the past. It does not appear to be looking at how stifled consumers will be for the long term because of the nature of how the debt structure has change, gross reduction of empowerment to pay off debt.

According to Calculated risk there is about $21 trillion in real estate assets, which if there is a 15% overall decline in real estate prices would be about $3 trillion in lost equity.

They also have two graphs in the post, Household Percent Equity, which would decline from 50% to 42% should home prices decline 15%. Equity would decline to 30% should home prices decline 30%.

The other graph shows home values and mortgage as a percentage of GDP. House hold value peaked at about 153% of GDP, whereas as it was typically valued at 80-90% of GDP. Mortgage debt is about 75% of GDP whereas it typically used to be about 30% of GDP prior to the credit bubble being launched in the 1980s. Should homes decline by 15% they would decline to about 130% of GDP.


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Sunday, February 24, 2008

Deflation Convyer Belt

Counterpunch has an article with a quote I like about the monetary system that is an excellent image of deflation at work:

"Imagine a 200 ft. conveyor belt with two burly workers and a mountain-sized pile of money on one end, and a towering bonfire on the other. Every time a home goes into foreclosure; the two workers stack the money that was lost on the transaction, plus all of the cash that was leveraged on the home via "securitization" and derivatives, onto the conveyor-belt where it is fed into the fire. That is precisely what is happening right now and the amount of capital that is being consumed by the flames far exceeds the Fed's paltry increases to the money supply or Bush's projected $168 billion "surplus package". Capital is being sucked out of the system faster than it can be replaced which is apparent by the sudden cramping in the financial system and a more generalized slowdown in consumer spending."

And a quote within the article:

"A year ago $20 million would have gotten Luminent Mortgage Capital Inc. access to $640 million in loans to buy top-rated mortgage-backed securities. Now that much cash gets the firm no more than $80 million. ... (Only) 6 lenders are offering 5 times leverage, while a year ago, 20 banks extended 33 times."

There have been a few debates about inflation/deflation and the definitions are all over the map and inconsistent with each other. There has already been way more "inflation" than we realize, yet the "price increases" due to the inflation have not worked through the system.

To me, inflation and price increases have been used interchangeably for so long, the concise difference is lost, much like many people interchangeably use minus for negative and vise-versa. In most cases it doesn't matter, people know what you are talking about.

You simply can not have a definition of inflation that includes money supply and price increases and have those definitions really describe what is happening in the economy. They mostly work together, but, the price increases are a delayed response to increased money supply and can be caused by other things. To better understand the common misuse of these words, give this a read.

The money supply has already increased to the point that we should all feel utterly sick about it, as the graph shows:

M1 and M2 Money

The developments over the past 10 years in the financial industry have effectively increased the rate of growth of the money supply. I am not sure where the mortgage bonds, etc., show up in the tally of the money supply, and they thwart the intention of regulations that required a level of reserves for credit. So regulations that were intended to control the increase of money supply through credit completely fail and we have the banks acting like Sammy Slimy with his printing press in his basement.

This gross level of increased money supply has only been showing up in a few areas, the cities with homes priced 5-12 times median wages, commodities like copper which was under $1 in 2002 but peaked at over $4 and has ranged between $3-4 since the peak. The same is true for all base metals, and it seems to me with their vast expenditures and need for raising capital to build new mines, well, they are first in the price food chain and responded to the increased money supply early. Sure there is also supply and demand, but the price increases of the 21st century are far beyond any reasonable historical increases and I would suggest the back room banking activities comparable to Sammy Slimy with his illicit printing press in his basement are responsible and the only real commodity that we use everyday and see in our home balance sheets that has adjusted to the increased money supply is oil.

There is no question there are going to be some fairly significant price increases coming, but these are in response to previous inflation, and aren't here yet due to the time delay in working increased money supply into the system.

The US has an increased delay for inflation to translate into price increases because of its status as a world reserve currency. The volume of US dollars sitting in foreign bank accounts effectively takes those dollars out of circulation and prices are as though they don't exist. Some say the US has effectively been exporting their "inflation" because of this practice... Just look at China's double digit inflation...

The trend of foreigners taking US dollars out of circulation is reversing and that's going to show up as price increases, but it is not an increase in the money supply. That has already happened to an extent far beyond the current pricing of goods. There are so many of those dollars out of circulation, well, it has resulted in a totally unrecognized degree of privilege in buying power, and a privilege that has been taken for granted and completely unrecognized as to where it comes from.

Those dollars head home, or the rate they are bought up by foreigners simply slows down or stops, and the privilege ends and the value of American output gets repriced towards the value the rest of the world gets for their output. The stagnant wages despite increases in the money supply suggest that that process has begun, although sectors with first access to the gross increases in money supply have seen wage increases far beyond other sectors of the economy over the last ten years, the financial sector and sectors related to home building would be examples.

And the people who work in the sectors that saw the largest benefit will be the hardest hit with the current deflation of the money supply. Their wages will decline the most and they will have the hardest time adjusting to the lesser lifestyle.

So, there will continue to be price increases due to the current money supply, but the money supply is deflating and there is a highly leveraged effect of this deflation. Right now I'd say the mortgage backed bond holders are taking the largest hit of the current deflation, followed by home owners in bubbled cities, and somewhere in there is the highly leveraged investor, either through direct personal choice, or indirect personal choice of a highly leveraged invest fund of some kind. These price decreases are a result of deflation, or a reduction of money supply due to credit contraction.

Update: Here's a good post, one I recommend having a read.

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