[FoRK] The Insolvency Crisis: How we got here, and what to expect

Jeff Bone <jbone at place.org> on Sun Aug 12 11:14:42 PDT 2007

There's more irony than just that pointed out by the article...

The rise of multi-asset prime banks, cross-bank / cross-asset  
netting, and more efficient / effective means of clearing and  
settling that occurred in the wake of LTCM is in part supposed to  
prevent the kind of double- (or triple-, or more) dipping with  
respect to buying power that played such a big part of the LTCM  
meltdown.  Yet it appears in part that it's the skittishness of these  
same prime banks (many LTCM bailout participants) that has rattled  
the market so much --- NOT fundamentally any sort of longer-term  
insolvency problem or rapid asset depreciation, but rather a sudden  
and mostly-psychological reset with respect to risk tolerance on the  
part of the liquidity providers.

One man's opinion --- and don't take this as any sort of a  
professional opinion or reflective of any opinion or lack thereof on  
the part of my employers --- the present situation looks and feels  
much more dangerous than it probably is.  The extent of the damage  
will be determined by the psychology of market participants and the  
willingness of those with balls and bucks to wade in and punish the  
skittish / take advantage of the situation.  Nothing particularly,  
economically fundamental has changed about the market overall between  
a month ago and now.  The cash infusion by the Fed and the ECB are  
creating more of a stir than is warranted;  in real terms the  
infusions are not very big at all.

Nonetheless, it's a bubble pop, and there will be repercussions.   
Some folks --- particularly those who leveraged their homes to the  
hilt, and who subsequently experience some kind of serious change of  
cashflow to cover those HELOCs --- are going to lose their homes.  My  
own expectation is for a 20-25% nationwide average decline in the  
average home price over the next 12-18 months, with the extent of the  
downturn being in the neighborhood of 3 years.  The depth and length  
of the downturn will be proportional to the "desirability" of the  
location.  The market segment that will be hit the most is those  
McMansion homes in the $500k-$800k range, where the owners are most  
likely to have leveraged the home equity bubble and will have a need  
to sell, coupled with the fact that those on the boundary of just  
barely being able to afford such a home are those most impacted by  
the lack of availability of "jumbo" (>$417k, per Fannie Mae / Freddie  
Mac) loans at reasonable rates.  (Nb:  the jumbo loan rate has soared  
by as much as 1-2% over the last 10 business days for many major  
banks, and underwriters are turning down "A" paper right and left;   
however those who are in a position to put down ~>20%, have low debt- 
to-income ratio, have total financing and debt service of < 45% of  
net income, and / or obtain reasonable secondary financing are still  
able to get loans.  But the pool of buyers for the low-high-end home  
has just decreased dramatically.)

The credit card problem is actually a bigger problem and we haven't  
even started to feel that.  (That's likely to cause serious problems  
for a large part of the middle class, but frankly most people are  
carrying just an insane amount of credit debt anyway and a correction  
is overdue, and hopefully those impacted will learn a valuable lesson  
even if it is at a great cost.)  Similarly, the trade imbalance,  
profligate governmental spending, and dollar devaluation problems are  
much, much bigger --- and more directly the fault of our political  
leadership --- and the first shoe hasn't hit the floor there, much  
less the second.

I'm presently reading The Second Great Depression (Starting 2007,  
Ending 2020) by Warren Brussee.

   http://www.amazon.com/Second-Great-Depression-Warren-Brussee/dp/ 
1591136881/

While my own outlook isn't quite as grim as his, the defensive  
investment advice he gives is well worth the price of admission.   
We're certainly overdue for an ugly little recession, but I think  
(hope) we aren't looking at a real 13-year depression-scale downturn,  
much less a Weimar Republic scenario.  All these sensationalistic  
journalists and armchair historians / economists who are fanning the  
flames of panic in this situation are, IMHO, doing a grave disservice  
to the global economy.  If in fact you look at the reaction of the  
markets lately, you'll find that they are in fact demonstrating very  
obviously how robust and resilient they are, and how effective they  
are at shunting risk around between market sectors and assets.

OTOH, I was "irrationally exuberant" during the last days of the dot- 
bomb disaster, and underestimated (read: misjudged completely) both  
the depth and length of that collapse, as well as its follow-on  
effects in the capital markets.  Still, I do think that this whole  
situation presents some unique opportunities for those that have the  
liquidity and the wherewithal to take advantage of the situation.   
(For that matter, even the dot-bomb situation was lucrative for those  
correctly positioned.)

$0.02,


jb



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