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Strategies & Market Trends : Mish's Global Economic Trend Analysis

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To: Elroy Jetson who wrote (12830)	10/5/2004 1:44:22 AM
From: GraceZ	Read Replies (1) of 116555

You are once again suggesting that this is because interest rates finally declined to that "magic level" where home equity simply had to be borrowed and spent. I made no such suggestion, I was simply clearing up whether or not you had been arguing earlier that the equity extraction had nothing to do with low rates. The equity extraction is a function of a more complicated picture. See if you can hold more than one thing in your mind at once. The low interest rates are both a function of risk avoidance and a collapse in commercial loan demand (three years of declining C&I). As an aside, notice the Fed held short rates low until C&I showed signs of coming out of the three year dive. The recession was not a consumer lead recession, it was an almost total collapse in business investment after a ten year investment binge. Even the dunderhead demand management school economists in force at the Fed wouldn't see a need to boost consumer spending in an investment lead collapse. All a boost in consumer spending would do is pump up China or worse, raise prices across the board. Rising home prices was an unintended side effect of fixing their last blunder. AG tried to put a good face on it by saying that consumers have been able to repair their household balance sheets. Buying RE by the public in lew of equities is just another symptom of risk avoidance (who can blame them after the collapse of the stock markets from 2000-2001?) the same way risk avoidance leads investors to switch out of equities into bonds and cash. Unfortunately you can't separate the bond market from the mortgage market, they are tied together. This surge is followed by rising home prices (constains on supply are slow to be alieviated in the new home market). This provided consumers with record amounts of equity to borrow. They still have record levels of equity at today's prices even accounting for the record levels of mortgage debt. The loose lending standards were due to the fact that other forms of lending disappeared while money was piling up in assets which can only be backed with debt (you say investors are under-estimating the risk and I agree even while it has worked out swimmingly for them thus far- extreme irrational risk avoidance frequent leads to mispricing risk). Couple this with the ease with which you can borrow that equity (same thing happened in 1988-89 with home equity checking accounts) due to automated under-writing and a voracious appetite on the part of Freddie and Fannie (due to the voracious appetite for mortgage backed debt). This made consumers turn to their homes as the first source of borrowing instead of using consumer loans and keeping balances on credit cards (it's easy, it's fast and it's tax deductible and FIXED RATE. It also tempted many to use the home equity to leverage additons and improvements to their homes because they saw their home as their best investment with the best return. The idea was that instead of putting their savings into a declining stock market they'd put their "money" (in the form of unrealized RE gains) into a house and then they could at least get some form of enjoyment out of it and guess what their new payment isn't any higher than their old payment. People are cash flow oriented more than they are net worth oriented but they saw both improving. This of course is followed by the final phase which is, people buying houses for speculation because houses are going up. I had this same discusion back in 1988 with my sister. Ruined a perfectly good Thanksgiving dinner by telling her that the easiest place to borrow money was RE which made it the riskiest place to put your investment at this time. She told me I was nuts, that RE was the most secure investment, blah blah blah. This is of course a year after 1987 and stocks were considered waaaaay too risky. Meanwhile I put my money in the market and three years later she's telling me she'd like to sell their old house to move to a bigger one but nothing is selling in her old neighborhood and she can't go to a closing and bring her check book. She didn't remember what I'd said to her on that Thanksgiving. She's like you, she hears what she wants to hear and disregards the rest.

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