I find myself coming back to the same quote from an Interview with Paul Kasriel
Mish: How does inflation start and end?
Kasriel: Inflation starts with expansion of money and credit. Inflation ends when the central bank is no longer able or willing to extend credit and/or when consumers and businesses are no longer willing to borrow because further expansion and /or speculation no longer makes any economic sense.
The two key words in the above paragraph are "able and willing".
Loan Standards
With that in mind please consider Lenders begin to tighten loan standards.
Sunday, December 31, 2006 As more homeowners skip out or fall behind on their mortgage payments, some lenders have started tightening their underwriting standards.
That might not be enough to save them from losses. Mortgage lenders, such as Countrywide Financial Corp., Downey Financial Corp. and FirstFed Financial Corp., try to avoid risky "subprime" borrowers and have become more cautious about whom they lend to in general. Also, they're setting aside more reserves for potential defaults. But the increasing popularity of second mortgages could end up undermining their efforts.
"Mortgages that have a second mortgage behind them run a far higher risk of default," says Zach Gast, a financial analyst in Rockville, Md., for the Center for Financial Research & Analysis, an independent research group. Gast says borrowers' debt-to-income levels are similar for all mortgages, regardless of whether payments are late or current, suggesting the second mortgages are the main culprit tipping borrowers into delinquency or default.
Fannie Mae
On December 20th Fannie Mae announced Selling and Servicing Amendments the most significant of which was "requiring borrowers to be qualified at a fully-indexed rate that assumes a fully-amortizing repayment schedule."
The Washington Post reported on Janunary 2nd States Swift to Warn Mortgage Lenders.
Nineteen states and the District of Columbia have moved quickly to warn state-regulated lenders about the hazards to consumers from nontraditional mortgages.
Tens of thousands of state-licensed lenders and mortgage brokers are affected by the advisories, also known as a "guidance." Such loans include interest-only mortgages and other arrangements where the borrower cuts monthly costs by paying back less than full interest and principal.
The states are following closely behind federal banking regulators, who issued a sternly worded advisory in late September to the lenders they supervise, telling them they should not make these loans to borrowers who may be unable to repay them. Within 24 hours of the federal guidance's release, six states had issued similar warnings to their own lenders, a notable flurry of activity in a field known for its slow-moving bureaucracies.
Significant Shift In Lending Standards
This is an initial but very significant shift in lending psychology and it does not matter whether the 800 lb. gorilla (Fannie Mae) is leading or following. What we clearly see is a change in trend at the national and state levels. Prior to this shift recall that down payments were gradually lowered to zero (and in fact to a negative 25% in some cases via 125% mortgages) and credit standards were lowered and lowered and lowered again. This is the first significant shift in lending psychology that we have seen in ages and it is going to dry up mortgage lending in its wake. Subprime Lending
Immediately prior to this shift we saw three subprime lenders blow up. I talked about Ownit Mortgage in Demise Come Quickly, the Denver Post talked about Sebring Capital Partners in Mortgage bank abruptly closes, and the Seattle Times reported The party's over at Kirkland mortgage company. Those are all recent (December 2006) happenings.
The Wall Street Journal is reporting HSBC Sours on American Loans.
HSBC Holdings PLC is learning that the U.S. lending business may not be so easy.
The London bank is facing rising problems with its U.S. consumer-loans portfolio nearly four years after its acquisition of Household International Inc., a U.S. lender that specialized in subprime loans, or loans to people with spotty credit records. The acquisition has been well-received because it raised HSBC's U.S. profit, complementing its huge Europe and Asia businesses.
Last month, the U.S. unit said a portfolio of consumer loans it acquired recently had quickly soured. This month, HSBC underscored the loan situation was worsening. That has led ... [subscription required for rest of article]
To kick off the new year Reuters is reporting Mortgage Lenders Network stops loans, sets layoffs.
NEW YORK, Jan 2 (Reuters) - Mortgage Lenders Network USA, a large U.S. subprime lender, said it has stopped funding loans and accepting applications for loans, citing deteriorating conditions in the mortgage market, and has temporarily laid off about 80 percent of its 1,800 employees.
The retrenchment is the latest sign of stress among subprime lenders, which make higher-cost loans to people with weaker credit histories. It comes less than a week after similar-sized rival Ownit Mortgage Solutions Inc. filed for Chapter 11 bankruptcy protection.
Unlike most subprime rivals, Mortgage Lenders increased its lending throughout 2006. It made $3.31 billion of subprime loans in the third quarter, ranking 15th nationwide, according to data from National Mortgage News.
The firm, however, said wholesale market conditions have "deteriorated dramatically" in the last two months. Chief Executive Mitchell Heffernan said wholesale broker originations will stop until credit quality and margins return to "acceptable levels." The firm said it plans to maintain its $17.8 billion servicing portfolio.
David Olson, president of Wholesale Access, which tracks the mortgage industry, said Mortgage Lenders' retrenchment was unsurprising in light of subprime lenders' struggles. "Profits are way down, and margins are razor-thin or even negative," he said.
Foreclosures
There is a clear reason for this attitude shift given that a recent Study Predicts Foreclosure for 1 in 5 Subprime Loans.
About one in five subprime mortgages made in the last two years are likely to go into foreclosure, according to a report released yesterday, ending the dream of homeownership for millions of Americans.
At that rate, about 1.1 million homeowners who took out subprime loans in the last two years will lose their houses in the next few years, the report said. The foreclosures will cost those homeowners an estimated $74.6 billion, primarily in equity.
The report, written by the Center for Responsible Lending, a research group in Durham, N.C., was based on data supplied by Moody's Economy.com. Researchers examined more than six million mortgages made from 1998 until the third quarter of 2006; the report is the first nationwide study on the performance of subprime mortgages. It includes projected foreclosure data for all major metropolitan statistical areas. The highest default rates are expected to be in cities in California, Nevada, Michigan and New Jersey as well as Washington, D.C.
The report offers a somber assessment of loans that had helped millions of Americans with blemished credit attain homeownership. About 2.2 million borrowers who took subprime loans from 1998 to 2006 are likely to lose their homes.
Insurance Attitudes
The Sun Journal is reporting It may get harder and harder to get home insurance.
The gist of the above article is that Allstate and State Farm have both moved out of coastal areas but some owners do not seem concerned. What follows now are my comments. Although some owners may be unconcerned (for now), for those on the margin, this is a big deal. Regardless of why it is happening, the inability to get insurance at a reasonable rate can only do one thing to property values.
Here is the pertinent quote from the article: "It's kind of hard to figure out right now what other insurance companies are going to do. The state sets the rate, and I don't see a large increase in premiums, but it might be more difficult to find insurance."
Given that corporations are becoming more risk adverse, as long as the "state sets the rate" it is going to be increasingly difficult to find insurance. That is to the detriment of property owners in the riskiest areas.
Is Downsizing the Next Trend?
The LA Times is reporting What was supersized may one day be downsized.
The size of the average American house more than doubled between 1950 and 1999, according to U.S. Census Bureau statistics. From 1982 to 2004, the typical new single-family house grew about 40% from 1,690 square feet to 2,366 square feet. In the face of these increases, however, the size of the average American household has shrunk from 3.3 to 2.6 people.
This seeming paradox betrays the trend toward ever-larger houses for what it is: a real estate fashion, and an irrational one at that. And like all fashions, it's doomed to reverse eventually...
Today's McMansions, with their overbearing scale and frenetic ornamentation, are a pretty close match for Victorian excess.
And after their inevitable fall from grace, time won't be treating them any better.
We have yet to see a shift in attitude on home sizes, but as boomers retire does anyone doubt it is coming?
Behavioral Psychology
I discussed other aspects of psychology in How Will Deflation Play Out?
Behavioral Psychology
- There will be shift away from consumption to saving
- There will be a shift away from risky assets to less risky assets (and lower returns)
- There will be changes in retirement plans
- There will be a shift in mentality from "have to have it now" towards some semblance of planning.
Those are good things actually and they will allow for replenishment of the pool of real savings that has now been completely exhausted.
In response to the above, Robert Campbell chimed in with "There will be willingness of consumers to pay off their existing debt as opposed to taking on more new debt."
Bingo. I certainly agree with Campbell and we can also add a shift towards downsizing to the list as well. However, I do need to correct a statement that I made in that article. I said "Deflation will cause a pronounced shift in consumer behavior and investment psychology." That sentence should actually be reversed. It will primarily be changes in psychology that fuel deflation as opposed to the other way around.
As evidence please remember summer of 2005 when investors were camping out overnight and entering lotteries just to buy Florida condos. Prices were rising every month leading up to that point. What happened was an abrupt change in investor psychology. It was only months later that condo prices declined substantially. Thus it was not price changes that caused changing attitudes. It was changing attitudes that led to declining demands for mortgage credit which in turn was followed by price declines. Since then we have seen dramatic declines in the prices of condos even as long term mortgage rates were essentially unchanged.
Truck Tonnage
One of the arguments that inflationists have long posed is as follows: Consumers will always be willing to borrow and banks will always be willing to lend. We now have the second crack (one from each side) that suggests both ideas may be false. Here is a third factor to consider.
The American Trucking Association (ATA) is reporting Truck Tonnage Index Plummeted 3.6 percent in November.
Wednesday, Dec. 27, 2006
The American Trucking Associations' advanced seasonally adjusted for-hire Truck Tonnage Index plunged 3.6 percent in November after falling 1.9 percent in October.
"November 2006 marked the single worst month for for-hire truck tonnage since the last recession," said ATA Chief Economist Bob Costello. "Both the month-to-month and year-over-year decreases indicate that the economic slowdown is in full gear. The most troubling number is the 8.8 percent contraction from November 2005, despite the fact that year-over-year comparisons are difficult due to the very robust volumes during the same month last year. One month certainly doesn't make a trend, but if we continue to see year-over-year reductions of similar magnitudes in the next couple of months, it could indicate a greater economic slowdown than economists are projecting at this point."
Trucking serves as a barometer of the U.S. economy because it represents nearly 70 percent of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods.
Home Depot
Trucking is just further confirmation of other sudden abrupt trend changes most notably at Home Depot where Sales Falloff Kills Staff Increase Plan.
November 30, 2006 -- Home Depot abruptly shelved a much-touted plan to improve customer service by hiring more store-level employees - just a month after rolling it out. The about-face appears to be the result of a sales slowdown that is far more severe than the company anticipated, sources said. Rather than hiring additional employees, all stores - even those $40-million-plus high-volume locations - were told to cut staff hours by 200 per week because of falling sales.
The reason? Sales were falling short of internal projections, the result of a housing market that had stopped booming.
Will Printing Presses Stop Deflation?
Time and time again I am told that the Fed will "Print its way out of deflation". Except for a few diehard deflationists like me, that is the near universal opinion. Yet no inflationist that I am aware of has ever addressed shifts in psychology. No matter how hard Japan tried, the Japanese Central Bank could not get consumers to spend. The US is different we are told time and time again. Are we?
Six Questions
- Can the Fed create jobs?
- Can the Fed raise wages?
- Can the Fed revive the housing bubble?
- Can the Fed put money directly into consumer pockets?
- Can the Fed reverse consumer psychology?
- Is the Fed willing to cause hyperinflation?
Hopefully it is clear that the Fed can not create jobs or raise wages. History suggests that a reversal of a housing bubble takes a long time and this was no ordinary bubble but rather the largest on record in terms of prices to wages and prices to rent.
The answer to 4 is the Fed can not put money into consumer pockets thus the "helicopter drop" theory is a bluff at least as far as the Fed is concerned. Congress could "drop money" (or start job work programs or raise the minimum wage) but that leads to many other questions: 4a) Will they? 4b) To the right people? 4c) At a fast enough rate to matter? 4d) Without hurting the private sector in some other fashion? 4e) Would helicopter drop money IF offered lead to an expansion of credit and money faster than bankruptcies and debt repayments? 4f) Would banks stand for it?
Congress could also do something totally inane like pass something similar to the Smoot Hawley Tariff act which would increase the deflationary downturn just as it did in the great depression. With all those IF's in question number 4 above, inflationists sure have a tough row to hoe and they still have to face questions number 5 and 6 which I believe are both a resounding no.
Attitudes can only go so far before they reverse course. When consumers were camping out overnight to buy condos and knocking on strangers' doors and getting into bidding wars to buy houses, that trend was bound to reverse. With negative savings rates for 18 consecutive months that trend is bound to reverse. The belief that nothing can shatter US consumer spending habits will be the next bubble to burst. Given that consumer spending is 75% of the economy, a massive reversal in consumer and lending psychology spells trouble for the economy regardless of what the Fed does. That reversal is at hand.
