February 23, 2009
Good afternoon. There was continued market fallout in the last week’s holiday shortened week, with the SPY down an additional $5.44, or 6.6%. That brings the decline this year to 14.2%, and it is only the middle of February! The XLF, the financial sector of the S&P 500, was down 16% on the week to a total decline of 40.6% so far this year. All this is after a late day rally on Friday after a White House statement saying privately owned banks were the proper structure going forward. Before that statement the market had been virtually overrun by rumors that the nationalization of the banking system was imminent (of course the blog crazies and rumor mongers were somewhat light on the detail of how the government could effectively nationalize thousands of banks). It did not help that the White House waited almost a week to come up with even that bland statement.
This morning everything looks a little more positive, with the futures up some (it is early) on the story that the government may take a bigger stake in Citigroup, thus acting to prop up one of the weakest (and biggest) banks. Does it make anyone else nervous that the same government geniuses thought this same bank, Citigroup, which is now virtually on the slab, was healthy enough a few short weeks ago to take over Wachovia? As much as I have found many good things in the stimulus package (such as educational benefits, boosts to home ownership and home remodeling, and some tax breaks) I still question the overall talent of the people being recycled to make these very important decisions. Let’s hope I am wrong on that assessment.
It was an interesting week for a lot of reasons. We were able to witness the increasing backlash against helping people out with housing problems, orchestrated mainly by the group on CNBC, coming to a head with the now widely seen rant by CNBC’s Rick Santelli in the bond pit at the CME. The argument goes along the lines that the majority of people are still paying their mortgages, the people that aren’t are “losers” that do not understand risk and the capitalist system, and need to “learn” without benefit of any assistance from the “real” people. Also, what about the people who have lost fortunes in the market or in other businesses due to the current downturn, why should homeowner’s be singled out for help, especially since a lot of them had not much equity at risk in the first place. It is a tough argument, and easy to argue from both sides.
There is an interesting book, I think still in print, which to me sheds some light on the current feelings of the various groups. The book is Armand Hammer, by Armand Hammer. Once Mr. Hammer buys Occidental Petroleum (where most of you will recognize the name) you can stop reading, but the first part is an amazing period piece about growing up and doing business during the Great Depression. Right now the short version of that history is that the market crashed, the Fed guys were all idiots and let the money supply rapidly decline, people had no access to their savings, times were tough but eventually the programs of the New Deal and the War brought us out of it, and everyone remained true to the cause on a political and social level. If fact, that shortened view leaves a lot out. There is, which should be no surprise to anyone, a very short distance between economics, politics, psychology, and sociology. In fact the 30’s showed tremendous amounts of questioning of our “Capitalist” system, and it was not at all clear as the Depression continued year after year whether we needed to find a new economic “system” because the current one had led us to this catastrophe. This came to a head in Washington when thousands of WWI veterans camped out across from the White House demanding their WWI pensions early just so they could feed their families. When the Army eventually forced these people out (Army guys using force on Veterans) it was clearly not capitalism’s (or democracy’s) finest hour.
The good news is that our system (still the best) survived, with all its warts. Let’s explore in a little more detail the root causes of the current housing problems. Cause number one is that housing prices were increasing at a rate far in excess of average income growth; in some areas the gap was mind-boggling. Income was increasing on average in the 2-3% range during the roughly 10-year period from 1996-2006, while housing prices (varying by area) could have been going up 5-10%. Interest rates were low, and for a while people were able to “chase” higher prices with the help of lower rates, meaning their monthly payments did not suffer as much as the higher prices might indicate. The state and municipal thieves, who obscenely raised taxes on people without any care to the lagging income figures, also gleefully greeted the higher prices. So if you wanted a house, still a big part of the American Dream, you essentially had to pay up, taking on way more risk than historically present in the purchase of a single family home.
So how did you get the financing? You did it any number of ways, depending on your station in life. If you had been a homeowner for a number of years you were able to participate in the pricing upswing, so when you went to trade for a new house, you were essentially just trading high priced assets, with no problems with down payments. The trick bag here is the amazing growth of home equity loans, used for any number of reasons, such as remodeling, increasing cost (out of control) of education, general consumption, etc. Your house became your piggy bank, and all sorts of people were anxious for you to take out loans.
New buyers had it worse. No way could just working hard keep pace, on average, with the increased prices. Waiting a year and saving like mad for a down payment just put you further behind. The same idiots that now call these people “losers” (and unclear on the risk concept) at the time were saying how great the increased pricing was “The market is never wrong” or “It just shows the faith people have in the future.” Blah! Blah! The fact is that if you wanted to own a home (with all the feelings of security and permanency that go with it) you had to find a way to “jump on.” How did you do it? Various ways. If your family had money (and you were speaking to your family) an awful lot of wealth transferred early for help in down payments. What grandmother was unwilling to open up the inheritance a little early so the daughter and the grandchild had a home like they always had? What percentage of the wealth of the WWII generation has been decimated by helping their kids out with down payments that are now effectively gone?
If you did not have the “sugar parents” you were probably forced into some sort of creative finance thing, which could be low or no down payment, some sort of teaser loan, balloon type loan, etc. People are creative; in the last real estate crisis (my day) people would borrow some of the down payment from the seller without revealing it to the lender. There have always been ways, and there was always risk people were willing to take. But the amount of that risk, as judged by people, has its limits. No one really assumes the very worst. People assume, maybe wrongly in this case, that in America things are always going to “bump” along to the positive. People believe that if you work hard you will, over the long haul, generally remain employed and gain in income over time. The price of assets, especially housing, has virtually always had general upward curve. You won’t find too many people, even the idiots calling others “losers” right now, that would generally say that stocks and housing will be 25% less in value 10 years from now. In regards to risk, how would anyone expect, especially after seeing real estate prices do nothing but go up, that in two years you may be out of work, your house will not appraise for even 60% of what you paid for it, and a mortgage to replace yours would be impossible to find. That is not the America people think of.
The odd part of this growing “class warfare” over helping people is that I was one of the few people I know that said that real estate was overpriced and ready for a fall the whole way. I remember countless arguments with friends (especially my significant other real estate lady) regarding the absurd risk people were taking with real estate at those levels, but I can’t say I won many of those arguments. I also never made any money from that view; I just did not lose any. I had dinner with one friend this weekend who owns a condo in Florida, which he purchased a couple of years ago for $347,000. He tells me that he looked for a long time, kept getting priced out, and finally found someone who had to sell. Initially the other owners were unhappy with him, as the previous sales were around $375,000. Now he figures the worth to be $150,000. He says the market was the market, how would anyone guess that we would end up here (he is still paying the mortgage)? Anyway, it really does not make me feel good to have been “right” and see all these people hurting.
One final thought about helping those who acted maybe foolishly and were stomped on. It is always the case that the careful (or lucky) help the reckless (or unlucky). The careful skier always stops and spends time he paid for to help the person with the broken leg. That is just the way civilized life is. Maybe we who can help need to have five martinis and bitch for a night about how we should not be called upon to help those less fortunate or those who did not assume the worst, as long as we wake up, cure the hangover, and start helping. That is what makes us Americans, not calling “those” people “losers” on national TV.
As for the market, I don’t see how anyone can play the short side here. I see some glimmers of hope in that some of the out of the money put volatility in the most beaten down stocks is shrinking a little. I am not calling for a rally of consequence, but I think the days of just being just short and winning might be nearing an end. Just as in a bull market, those making money by an up market drive it too far, the same happens in a bear market. Keep focused on the little clues of when this spiraling down will end, I think we are getting close, and if a decent plan for the banks (like relaxing mark to market for a while) surfaces you will not want to be short. It may be of interest that the attendance at the Chicago Auto Show was higher this year than last. Don’t buy GM or F just yet, but interesting. I think $7 on the XLF is a price we can live with for a while. Let’s stay careful, but start dipping another toe.