On Christmas Day, Twist popped this story [1] onto the sidebar. It’s by Chinese finance professor Sun Lijian. The opening passage may be one of the sanest and most sensible things I’ve read about debt in a long time.
"I used to tell this story in the first lecture of my finance class every term. It goes like this
An old American lady, who talks with an old Chinese lady in Heaven, boasts that she has long enjoyed living in an apartment purchased with borrowed money. The old Chinese lady seems sad – she spent most of her life saving money – and when she finally bought an apartment there was very little time for her to live in it.
The story has been proved so ‘popular’ and true in China that now there is no need for me to repeat it in my class. Another important reason for me to stop telling the story is that many people have reversed China’s culture of saving. The emerging ‘house slaves,’ ‘car slaves’ and ‘card slaves’ have illustrated the trend."
Professor Sun’s first degree was in mechanical engineering. Could it be that this sort of education helps ground finance types in common sense? As related in episode XI of Safety Net, Fannie’s promising new CFO, Bob Blakely, also holds a bachelor’s degree in mechanical engineering; his from Cornell. Two real engineers involved in debt isn’t a trend, but it is interesting.
Yield on the US Treasury Department’s benchmark 10 year debt has been at historic lows for several years. This was the principle fuel for the housing bubble, but it also had the twin effects of discouraging savers, and encouraging borrowers. In fact the US now has a negative savings rate for the first time since the Great Depression. This is unfortunate since the same low yields make it very hard for pensions to work. Pension managers must invest aggressively so that the funds will grow enough to fund the future payouts to the members. High yields mean high risk, and that risk has begun to bite some funds.
Twist [belated credit to Doomer Bud on this, see comment #3] also found a link [2] to satirical song lyrics supposed to have been composed about a year ago by successful RE magnate Sam Zell. They constitute a (surprisingly accurate) forecast for the past year. The whole thing is supposed to be a joke, but this verse addresses our present discussion.
What lies ahead: we’re old -
The western world is aging, we’ll need income
From our pension funds
Where’s it coming from?
The yields we see won’t fuel the party
Then in yesterday’s Ben’s Bits Bucket,[3] commenter ljaycox related a story that put all this in starkly personal terms.
My dad is retired (15 yrs) and has the old time Machinist Union pension. The pension fund is managed by an insurance company with a name like “Lincoln Mutual” … I [the mother] got the mail Monday and I was flipping though it on the way back to the house–there was a letter from the union and I had a feeling “this is trouble”. The letter said that it was just a reminder that if certain investment conditions occur it could affect our pension benefits. It was long letter with all kinds of technical jargon about future investment scenarios and what percentage of our pensions and survivor benefits we would get under the listed circumstances.” (my paraphrase) She said: ” I think something has already gone wrong and they are getting us ready for cuts coming soon.” (her words) … My parents’ generation had been taught to trust these financial institutions–I know better–but they didn’t. The government can’t fix this–it would be too big.
Sorry folks, no answers today. But I think the above raise some important questions.
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Notes and References
[1]: "Culture of saving gone as spendthrifts reign", by Sun Lijian, Shanghai Daily, December 26, 2006.
[2]: "Capital is raining on my head: a message from Sam Zell", by blogger Alphaville, Financial Times (London), December 20, 2006.
[3]: Bits Bucket And Craigslist Finds For December 26, 2006, The Housing Bubble Blog.
Speaking of reality, I noticed earlier that the links to the Chinese sources weren’t working well. This is likely the result of damage to undersea cables due to a strong earthquake near Taiwan yesterday.[1]
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[1]: “Taiwan quake kills two, undersea cables damaged”, Reuters Alertnet, December 27, 2006.
Yesterday MISH [1] debunked the idea of a “global savings glut”. Below is his “bottom line” on the issue. Those silly NYNY hedgies are living a life like that flying party in “The Hitchhiker’s Guide to the Galaxy”, and will eventually (heaven knows when) come crashing to ground just like in Douglas Adams’ fantasy series.
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[1]: “Global Savings Glut Revisited”, by Michael Shedlock, GlobalEconomicAnalysis blog, December 26, 2006.
John-
Credit to the Sam Zell link goes to reader Bud. Thank you Bud for sending that one in- I loved the video!
John,interesting questions indeed, but perhaps not the ones your thinking of. First, speaking of reality, the MSM financial networks are all a buzz with new evidence of the housing decline moderating, something about new data for Nov. and revisions for Oct..They are not just quoting realtor groups either… I quickly turned to my favorite housing blog and got a lead article telling me MISH is a “must read” and a sidebar with that silly 666 article. As the evidence of a soft landing accumulates at year end do we diverge further from reality into the gold bugs bunker or will we start seeing housing data again soon?
Second, please also note Thomas Sowell’s column today, a cautionary opinion regarding your inability to understand any justification for those “excessive” fund manager salaries. He writes, in relevant part:
“Moreover, if this obsession with income
disparities is to be something more than mere gnashing of teeth, obviously the point is that somebody ought to “do something” to change what you don’t understand.
“Usually that means that the government-
politicians-should impose policies base on your ignorance of what is going on. Can you imagine anything mmore dangerous than allowing politicians to decide how much money each of us can earn?”
“Of course, such political control of incomes is usually advocated only to deal with “the rich”. But when income taxes were imposed in the early 20th centruy, they applied only to “the rich” and took only a very small percentage of their income.”
One final note, letters like those you describe for the retired Machinist Union members son seem to come frequently from the various pension plans I participate in. Are we sure they are harbingers of doom or perhaps just the latest installment of those annual notice requirements that they only just decided to read? Kind of like those mortgage disclosures. And funny how its the Union’s pension fund but the “big financial institution” they don’t trust. Now who was it that negotiated the balance between current compensation and defined, deferred benefits and who selected the fund manager? And could the machinists unrealistic demands for compensation for this semi-skilled type of labor in light of the global availability of persons able to do the same tasks have reduced the pool of supporting participants in their retirement plans because manufacturing moved away from this traditionally radical union’s demands? And even if the benefits prove unsustainable, at the reduced federal pension guarantee levels how much more will the retired machinist recieve per month compared with active duty military pay or the retirement income of a secretary from a small business? Sorry, no tears and no great fears this New Year…but when gold follows copper my Christman present will finally arrive!
Old Mike -
This just in an hour ago, and it looks pretty optimistic. Seems you’re ahead on points so far today.
“U.S. Economy: November New-Home Sales Rise More Than Forecast”, by Bob Willis, Bloomberg, December 27, 2006.
John-
The spin is optimistic- the reality is a different matter- I’ll have the data up in a bit.
John, BTW the Az Republic today, pD-4 has a great little “investment tip” from bankrate.com called “Feeling wealthy can be dangerous”, warning against a more expensive lifestyle based on UNREALIZED capital gains, especially in your home, which it says “should be looked at as a safety net, not a measure of wealth”. Lets make that a standard disclosure on all refi. applications. I await Twists take on todays numbers…it seems overly optimist(cancellations will also be up) to me, a non-expert, but perhaps more than a dead cat bounce. Like a helo landing in 20 knot winds, not time to auto-rotate, no need to panic, but pretty rough with more than one bounce. Airsick bags may be required in a 2007 housing landing.
There are neo-cons and neo-cons, and economic analyst Alex Pollock is one of the best. This reference from a (presumably) right wing site earlier today describes yet another aspect of the how will the baby boom ever retire conundrum.
“Work-to-retirement ratio (refers Alex Pollock)”, National Center for Policy Analysis, December 27, 2006.
John, great catch. Does this mean my social security may not be enough to pay my credit card interest? Guess we are never too old to say “would you like fries with that?” Others of course see a role for government intervention and “economic democracy”.The true conservatives are very concerned about these issues. If you noticed in the study I referenced a few days ago our Northern European friends have a very large percentage of negative net worths in an aging population. Could it be a culture of dependancy is the opposite of personal responsibilty? The struggle continues.
Old Mike -
Took a while but I found the BankRate article. May have whizzed past on the sidebar about a week ago. They don’t really expect sheeple to follow their advice, but now they have been warned(tm). By the way, IIRC 666 Avenue of the Americas was where David Rockefeller and the Council on Foreign Relations used to hang out. That annoyed 1950s vintage conspiracy theorists no end. Maybe that’s where Bonner is coming from.
“Feeling wealthy can make you poor”, by Laura Bruce, Bank Rate dot com, December 22, 2006.
John, we both know that the real conspiracy was hatched in the 1960s a little east of there at the Bottom Line. didn’t I fall over you there once?
Alas, no, but sounds like it was a neat place.
Interesting discussions today.
1. Old Mike, you’re dead right about the pension anecdote. I get annual statements every year from almost every financial institution I use warning me that I may lose money if bad stuff happens. It doesn’t mean “someone already screwed up.” It means “you can’t sue us if the stock market collapses.”
2. All this watching of monthly statistics and all this talk of “stabilization” really seems irrelevant to me. Mortgage payments as a % of income are at an all-time high. It’s almost impossible to buy an investment property with positive cash flow in most markets.
How sales perform against expectations in a particular month doesn’t mean a thing in Washington DC when mortgage payments are 30.0% of median family income, up from 18% in 2003 and 14% in 1998.
3. Whether it’s a soft landing or a hard one, we don’t need to store up canned food, guns, and gold. We do have a dynamic economy, one that’s fraught with risks but also controls and safety valves. Things may suck for a while, but the world’s very different from 1929. When I’m reading a “bubble site,” I try to see right away if the author is a gold bug, or if they’re hand-wringing about derivative markets they don’t understand. If they are, I don’t return.
That’s why I like this site a lot. Keep up the great work, folks.
As for the November rise in new home sales, I’m willing to take them at face value until someone shows me a reason not to. Anyone?
Then again, are cancellations figured into the numbers? Can/will the numbers be revised at some point? And in how many of the loans were the buyers allowed to use their bubble-gum card collection and/or having a pulse as a down payment?
Above all, are there that many people dumb enough to still be buying new homes in this overpriced market? Wow, the builders must be giving away the farm incentive-wise to get these properties off their books by Dec. 31.
When existing home sales start rising, then I’ll agree that the market has “stabilized.”
Seamusfurr, good to hear from you. On the mortgage payment to income change in DC,especially in the 2003-2006 period, how much of that do you think relates to refinance activity? More important, do you know of a good source for that data in other areas? By the way, I understand that rentals in some lower tax areas in Midwestern and border(m/d) states can still cash flow positive, especially “doubles” in larger cities and small, single family homes in smaller towns. Whether owner defaults will put more of this inventory on the market at much lower prices is hard to tell but objectively the prices are already pretty low (on a replacement cost basis) for stuff that is built alot better than newer homes in AZ. I also understand that now in such areas multiple tenants, often recent imigrant working males that share a single house, are providing a steady paying, reliable and “diversified” form of tenant for such rentals, and many do their own repairs (the landlords dream). Catching any area right after(before if you can figure how legally) a major new manufacturing facility is announced is also a strategy I have seen used there. Not me, I’m chicken and collecting rent, making repairs from 1500 miles away just does not work unless you’ve got good local partners. At my age 5 year CDs are my risky play. As far as cash flowing anything in Fla.,its probably like your experience in DC, your lucky to cover property tax and insurance even with Euro rich seasonal renters, or in your case, Congressional “friends”.
Judge-
I just finished my post on the new home sales numbers- basically sales still stink and inventory is still up, but they are trying the usual slight of hand to hide it.
They DO NOT allow for cancellations in the sales numbers. Here is the explanation from the census bureau:
The Census Bureau does not make adjustments to the new home sales figures to account for cancellations of sales contracts. The Survey of Construction (SOC) is the instrument used to collect all data on housing starts, completions, and sales. This survey usually begins by sampling a building permit authorization, which is then tracked to find out when the housing unit starts, completes, and sells. When the owner or builder of a housing unit authorized by a permit is interviewed, one of the questions asked is whether the house is being built for sale. If it is, we then ask if the house has been sold (contract signed or earnest money exchanged). If the respondent reports that the unit has been sold, the survey does not follow up in subsequent months to find out if it is still sold or if the sale was cancelled. The house is removed from the “for sale” inventory and counted as sold for that month. If the house it is not yet started or under construction, it will be followed up until completion and then it will be dropped from the survey. Since we discontinue asking about the sale of the house after we collect a sale date, we never know if the sales contract is cancelled or if the house is ever resold. Therefore, the eventual purchase by a subsequent buyer is not counted in the survey; the same housing unit cannot be sold twice. As a result of our methodology, if conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated. When conditions improve and these cancelled sales materialize as actual sales, our sales would then be underestimated since we did not allow the cases with cancelled sales to re-enter the survey. In the long run, cancellations do not cause the survey to overestimate or underestimate sales.
I disagree with them on the cancellations not skewing sales. If the house sells within a month or two, then they might have a point. If the home isn’t sold within a year- you are obviously overstated in the short term.
Existing home sales are out tomorrow. The NAR is projecting I believe an 8.6% drop. I wouldn’t be surprised if it comes in lower than that- then the NAR can say, “Wow- it’s better than we thought. It’s a recovery!” We’ll see tomorrow.
John-
You shouldn’t tell everyone I was putting links up on Christmas day- you’ll have them thinking I’m hopelessly obsessed here. : )
seamusfur -
I started obsessing about derivatives when Steve Schurr of FT called Fannie Mae $14.4B down on their SFAS 133 accounting prior to their 15Mar04 (was it ‘04?) 10-K. I still understand almost nothing about these things.
What I do understand is that it’s a zero sum game, and selected hedgies and investment banks are making a lot of money off their transactions. Someone has to be losing.
There is a serious need to write up for Doomers a description of derivatives and their relationship with the MBS market, Fannie & Freddie. Any help (insight, links) would be greatly appreciated.
John, why is it a “zero sum game”? Perhaps you have diagnosed the problem and it is a “core belief”. Hard to cure but lets give it a try, Socratic style. Is there only x amount of wealth in the world and therefore the only question is how to divide it “fairly”?
Did Bill Gate’s rapid, and when you think about it amazing rise in net worth, merely subtract from the wealth of others? Does the interest rate I get from my CD and the interest payed to the same institution by a borrower represent me “making alot of money” and them “losing”? Does the fact that the Bank’s CEO makes a very large salary mean he is “taking” from the borrower and me and therefore, in your words, we are “losing”? How many basis points is that anyway?
How does the securitization of asset backed debt represent anything other than a bargained for exchange that increases liquidity and economic reinvestment? Are you seriously arguing that subprime borrowers either would have or should have paid lower mortgage rates without securitiztion? Are most hedge fund managers really jacking up interest rates or stealing from widows and orphans? Are the experiencd investors in hedge funds or purchasers of asset backed securities, given the alternatives investments available, just all stupid …are they the ones “losing”? Would you, for example, be better than the market at allocating risk, reward, capital, labor and fund managers salaries? Should we have a government board of “knowledable” civil servants decide or, elected officials, or perhaps officials of a elite vanguard dedicated only to the peoples welfare?
While Marxist theory liked to put labor and capital in little static boxes, and then pandered to the emotional view of the largely uneducated European laboring mass that one mans fortune only comes at anothers expense, all serious people by now recognize what a foolish, indeed venal view of a modern economy (heck even a barter economy) that represented. BOTH practice and theory show that such a view only leads to static economy of equally poor citizens, excepting only a corrupt political or military elite that control the “sharing” process and allocate the “capital” and “labor” through “planning” in the name of the citizens. Did you really miss when the only true “great leap forward” benefiting large numbers of Chinese and Eastern European citizen began?
That is why I urged you to read the editorial yesterday on “income envy”. The effects of “income envy” are corrosive, even toxic, on otherwise sound thinking. In fact it just stops the thought process, usually with a statement like “the one thing I do know is that (insert favorite bad guy) is making way to much and we all are paying for it..”. When I hear such brain numbing rhetoric from the auto salesman who envies the Doctor’s (or Hedge fund manager’s) new pasta rocket, I generally just ignore it. But when, after all these years, it still comes from guys like you,( who understand chemistry no less) it makes me want to run for the exits.
We will watch Chairman Franks committee to see how far this income envy nonsense goes. I suspect just enough to stir up the troops of school teachers, bored housewives and union employees who think their professional efforts should be treated “more equal” to Mr. Gates, but not far enough to actually hurt Big Media kultursmog or trial lawyer incomes.
I await your explaination of exactly how hedge fund managers or investment banker’s salaries are even statistically significant given the size of the pool of assets they deal with. Please be specific, is it $1000 per $10,000 bond or more like $.10? Is it, for example, more or less than the average union dues compared with average union members income? And then you can explain exactly how you and I are “losing” anything, other than apparently self-esteem, because of their incomes. As the phantom wealth from unrealized, and now unrealizable, housing price gains drain from the average homeowners mental balance sheet, they may be more vulnerable to such appeals to “eat the rich”. They have to blame someone other than themselves. Responsible commentors will think and truly understand what they are talking about before they risk promote such views…not merely feel that they “know it” to be true.
Old Mike -
Yikes! I believe that Fannie’s derivatives are mostly interest rate swaps(?) used to distribute interest rate volatility risk between Fannie and their counterparties. If this isn’t a zero-sum game I’m even more baffled by the derivatives market than I care to admit. How can anything productive be deemed to be coming out of this activity?
Every once in a while a large hedge or bank implodes on losses relating to these things, but other companies dabbling in this market seem to be doing well. I fear there are losses that have not yet shown up in the accounting (privately held companies?)
Financial institutions may be adding value with other things they do, but not this, surely.
I guess I do not understand why you view interest rate swaps or any other transaction involving securitization of asset backed notes as a zero sum game, other than that you do. Any hedge (interest rate or otherwise)or straight sale transaction must be viewed as benefical to the counterparties by the counterparties, either to inhance reward or mitigate risk. Are you saying the Fannie issues, and similar private securities, are just meaningless churn, surely not? And why, again, is a process described in your own words as used to “distribute interest rate volitility risk” between Fannie and counterparties “not productive”? Maybe we have fundamentally different definitions of “productive” but allowing a high liquidity creating, risk spreading system for mortgage debt appears to have become more than zero sum to me. You want to discuss the value of Fannie generally, well thats a whole different issue, but this “zero sum” stuff has me stumped. And, John, of course, the basic issue you avoid is your insistance that if X makes money, y must be losing it, despite the fact the real world pie grows larger everytime you move the knife.
Derivatives are a zero-sum game in that they end with one party giving another party money, just like any other security transaction. This is why they don’t freak me out from a MACRO perspective.
From a MICRO perspective, however, we’ve seen a lot of cases (Orange County comes to mind) where large pension, goverment, or other funds go broke because managers plow cash into derivatives without necessarily understanding them. I’d hate to think my investments or tax dollars were at risk by shoddy management. But that’s my due diligence responsibility, isn’t it?
If the only issue raised by John’s “zero-sum” is that each derivative contract or security closes within it terms by payment one way or the other then I have raised much ado about nothing. I admit to being on a hair trigger whenever John “worrys” about how much the hedge funds and investment banks are making(sorry John). If all he is saying is that, on balance, they are better investors than Orange County officials, and many pension fund managers, I got no problems with that, thats why they can afford those pasta rockets and I can not.