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Fallout from a Housing Bubble

Archived in Investing, Real Estate, Discussions | No Comments

Brad posted the following comment in response to one of my earlier posts:

Worry? As a homeOWNER, you’re right, maybe not so much. Hope you can keep your job, just don’t move, remember to pay your bills, and weather out the storm. But if you’re not in the market you’re completely boned, and if you’ve been flipping houses, it’s TIME to look for a better line of work.

Personally, I agree, I think the local market has played a couple years of catch-up and is now on par with many other major urban centers in Canada. The question is, if oil completely flopped tomorrow, would we still call Edmonton and Calgary major urban centers? Far-fetched hypothetical, I know, but we have put a lot of eggs in one basket, so to speak. Fact is, we’re land-locked and don’t have a water port. We only have a couple piddly little airports. And the railway here would never cut it for any significant manufacturing culture. Infrastructure is pressed to keep up with population, in Calgary in particular, and the only thing driving the economy in any significant way is the wake of oil and CONSTRUCTION. We’re not a self-sustaining society by ANY STRETCH of the imagination. We have a public transportation system that would barely receive a passing grade for a small town in Europe or Asia. Agriculture and food processing is heavily subsidized in dire need of a labour injection. And the bulk of the population is in (bad) debt up to their ears from depreciable, consumer goods.

Take a drive around any new neighborhood and there are $600K homes packed full of cheap IKEA furniture and using bedsheets for drapery, and a brand new BMW in the driveway. I’d wager the majority of those people have less than $25K in the bank — and a significant chunk have nothing or even OWE. Paycheck to paycheck, I think is the term.

Sure, people flocked here from all over to get work, drove a CONSTRUCTION boom, but then take their money and head back East. Many of those “amazing gains” are cashing out and going back to the Maritimes. Good on ‘em for a smart investment, but that money doesn’t come from nowhere: the next guy is paying that, and more and more the next guy is a young Albertan who has a six-figure salary at 21 but barely graduated high school. Watch the market pull back and that’s who’s holding the bag: young families who were lured out of a long term career by the siren call of a steaming hot economy. Then what do you do when someone won’t pay you a hundred grand to drive a truck? What do you do when people want college degrees again?

And big BUSINESS is even more vulnerable. Just because large companies are building processing facilities, plants, factories, and showrooms does not make us a long-term strategic society. Corporations have less to loose: shut the door, walk away, and let the governments and banks fight over who pays the tab.

I suppose if you’re on the right side of the rich-poor gap, you can think there is nothing to worry about. I suppose if you’ve got a stable income and you haven’t squandered you’ll be fine. But then I’ve never lived in a society where a large chunk of the population suddenly goes broke, loses their homes, and gets desperate, so I probably don’t have a clue what the impact on my life will really be.

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Market Commentary | From Digg

Archived in Investing, Finances, Discussions | No Comments

Occasionally I like to post interesting (found) comments from discussions:

The speculators and hedge fund managers who run today’s stock market need market volatility in order to make money. They can’t make enough money if the market stays flat or moves only a bit, so they like extreme and unexpected price movements. They especially like sudden, surprise movements down, when they can make money off stocks they borrow and sell — or, as they say, “sell short.” Money Lust Satisfied That’s what’s been happening the past couple of weeks. But it’s not interesting to say that the speculators are whipping the market around to satisfy their money lust. So the speculators themselves make up reasons for why the market is fluctuating, flog those reasons to the media, and then profit if some other speculators believe the jive reasons and jump in the way the manipulators want them to. Supposedly, the market is “correcting” because of worries about the housing slowdown, and also because of fears that the debt markets that support mergers and acquisitions is drying up. These are interesting theories, and people who don’t know a lot about the stock market or the economy might find them beguiling. What follows are a few truths that show how shallow these “reasons” for the stock market moves are. Housing a Theory Yes, the housing market has slowed from a spectacular bubble level to a simply pretty good level. Housing sales and starts are now about what they were in 2002, and no one thought we were in a housing depression then. In any event, housing is only about 5 percent of the economy. If it falls by 15 percent, that would represent a fall-off of about .75 percent. That’s not trivial, but it’s also not the stuff of which recessions are made. The fact is that there is no recession. The economy is suffering from a labor shortage, not a surplus of unemployment. The Fed is worried about excess demand, not slack demand. Corporate profits set new records every day. Whatever’s happening in residential sales and building is simply not slowing down the economy. Why should a Boeing or a Merck or a Pfizer have any reaction to housing at all? Because the speculators sell everything they can when nervousness sets in — and for no other reason. A Minor Major Mess Subprime is a mess. But it’s a small mess. Subprime mortgages account for roughly 20 percent of mortgages even in the most heavily exposed states. About 20 percent of them are delinquent in some way. That’s 4 percent of mortgages. Of these, maybe half, or 2 percent, will go into foreclosure. There will be roughly 50 percent recovery on sale of these. This is a loss of 1 percent in the mortgage market — a sum the lenders have already made many times over because of the hefty fees on those deals. In the context of the size of the U.S. financial sector, it’s nothing. And why should a crisis in subprime drive down stocks in Mexico and Thailand? Again, because the speculators seek to create panic to make money by selling short, and they sell short everything. There’s simply no connection between subprime and developed or developing nations’ stocks. This by itself shows the thin context of the selling wave late last month. Money’s Still Cheap What about the supposed drying up of loans for mergers and acquisitions by private equity firms? Well, here’s a good, simple test of just how valid that explanation is for stock market moves: The majority of private equity takeovers are financed with junk debt. If there really were a major shortage of funds for these deals, the interest rate on the junk would skyrocket. Instead, while the rate has risen by about 150 basis points in the past month, the spread between junk and investment grade is now about 290 basis points, according to leading junk analyst Martin Fridson. This is a lot lower than the year-end average of the spread from 2002 to 2006, and far below the almost 800 basis point spread during a true interest-rate crunch like the one after the tech meltdown in 2000-2002. So that’s phony, too. Interest rates have risen, but not anything like what they’ve done in real crises. And besides, the Dow fell by about 550 points the week before last, yet not one of the Dow stocks is involved as either acquiror or acquiree in a private equity deal. In short, money is no longer virtually FREE the way it was for private equity deals in the past year. But it’s not expensive by historical standards, either. Spreading the Fear In other words, it’s all the speculators trying to panic us so their sell programs will make money. And they’ll make money as long as they can spread their panic. When they can’t do that any longer, they’ll work the long side — and make up reasons for that, too. In the meantime, the economy is strong. Profits are great, and interest rates are low and will stay that way. Don’t sell. With all the shrieking about the market, it only fell to what it was about five weeks ago — and we didn’t think we were poor then. So let the speculators shout “fire.” As of right now, they’re not blowing anything but smoke.

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