I made this chart today and thought I'd offer it here. It shows the annual real total consumer credit growth (median CPI adjusted) over the years. It paints a rather anemic picture of our supposedly "strong" recovery.

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CR said: "...dc1000, this isn't just a subprime problem. This will impact prime too later this year..."

I sure wish I was smart enough to figure out why.

An analogy:

My next-door neighbor and I bought comparable houses several years ago at $200k (each), with conventional 30-year fixed-rate mortgages.

After several years of modest appreciation, housing prices in our area jumped sharply higher a couple of years ago. As it happens, my neighbor simultaneously got a good job offer out of state, and sold his house here for $300k.

My new neighbor bought the house with a fixed-rate mortgage. Then last year housing prices in our area took another big jump, such that our two houses were appraised at $350k. My new neighbor re-financed with a "shady" ARM and rolled his considerable consumer debt into the new (higher) mortgage.

I refinanced at a lower 30-year fixed rate, but withdrew none of my equity.

His ARM adjusted upwards several months ago, and now he can't make the payments, even though he's still employed. The mortgage lender foreclosed, forcing the sale of the home at $250k, a substantial discount to its previous appraisal price. My new neighbor has now lost both his home and his equity.

So...what does this have to do with me? Why am I at greater risk of foreclosure now, simply because my neighbor ran into trouble with his personal finances? Why are my other neighbors at risk because of this?

Imagine if we were talking about automobile loans. If my neighbor couldn't make his car payment, why should my car be more in danger of re-possession? Or if my neighbor was behind on his credit-card payments, what's that got to do with me if I'm current?

There's an assumption among the housing bears that the subprime woes are going to "spread" to prime, but no reasonable, real-world explanation as to how that's going to happen. I'd like to hear one.

Sebastia

BTW, Tanta, a really excellent explanation (different blog topic) on the foreclosure process.

Sebastia

tj & the bear said: "Am I wrong, or has not CR and/or Tanta previously stated that equity is the biggest determinant of foreclosure risk? If the equity of a "prime" borrower disappears, he's just as likely to walk as an "alt-A" borrower..."

There are separate issues here, I think. When CR/Tanta was talking about that I think they meant equity at loan origination as a determinant.

Loss of employment is the biggest factor overall in foreclosures, I believe, since that pretty much wipes out all your avenues for recovery.

As to walking away at a low-equity level, even if my equity went to zero but my job still payed me enough to make my mortgage I'd have no reason to walk away from a comfortable, affordable place to live. And my equity would almost certainly return over time, even if it took several years.

Sebastia

While I think housing is "Mogambo style doomed" and the rest of the economy may suffer because of it, such as a recession. I don't think the future is so bleak for Americans. I think we Americans will simply go back to doing what we've always done: trading amongst ourselves. Which will eventually lead to us being larger exporters once again. This transitory period may inflict some pain but we'll survive.

AllenM,

Apparently most of our kind was killed off during the 70s. I propose the following motto as a rally cry for our cause.

The Economy Sure Is Scrappy!

("S" stands for stagnant and "crappy" is rather self-evident.)

Zero or negative equity does not mean you will suddenly be unable to make your mortgage payments.

Zero or negative equity means that if you have to get out, you will most likely get out the foreclosure way. That is, the refi or the sale options fall away--quite possibly due to that foreclosed house next door--and so there is only one exit for you if you need an exit.

The problem is that you never know when you'll need an exit. If you're not in the all-expense-paid-corporate-relo class . . .

So is Scrappy better than Sticky?

Mangius Mannus,

So while the price of copper and oil and other commodities rise we have at the same time cheap labour flooding the world, that is not inflationary in any way, the cheaper labour costs far outweight the higher costs for raw materials

And yet the Median CPI (one of the better predictors for future inflation) continues higher even as the credit crunch takes hold (as seen in the lowered rate of consumer credit growth). Care to explain that?

I would argue that the flood of cheap money far outweighed even the cheaper labor. We've been pumping it out for decades. If that money chooses to hoard, as it has been doing for several years so far, oh well.

The key to me is this.

Am I going to be allowed to actually earn money in a bank if the entire economy starts to unravel? Will I somehow grow even more prosperous? I find that very hard to believe. It certainly worked during the Great Depression to hoard money. It didn't work so well in the 1970s though. It will be further exasperated if our dollar falls (should interest rates fall to help out borrowers).

Unless someone can point out how I the government will allow me to reap the benefits of the deflation we deserve, I'm going to consider long and hard Warren Buffett's advice that TIPS (treasury inflation protected securities) are not all that bad of an investment these days. I expect real rates of return to fall. By owning TIPS, I can lock in a real rate of return now.

Even if a serious deflation appears, I'll still be better off than most.

Show me a pure deflationist willing to buy long-term bonds right now. Then maybe you'll convince me. Most seem to be scared to death of them. Prechter has been advising short-term treasuries. Why? That's a stagflationist thing to do, and yes, I own those too.

It is said that real men buy long bonds. I'm am SO cowardly, lol.

Hey, just my opinions for what they are worth.

Tanta,

So is Scrappy better than Sticky?

Scrappy: fond of fighting
Sticky: Mission Accomplished

I think they might be synonyms. I hereby change the rallying cry!

The Economy Sure Is Scrappy & Sticky!

"S" stands for stagnant.

"Crappy" is self-evident.

"Ticky" stands for...

1. Something experiencing a sudden spasmodic contraction (i.e. the housing market).
2. Something infested with numerous bloodsucking creatures (i.e. inflationary politicians, exotic mortgages, Wall Street).

And yet the Median CPI (one of the better predictors for future inflation) continues higher even as the credit crunch takes hold (as seen in the lowered rate of consumer credit growth). Care to explain that?

If we are experiencing deflationary pressures now we wouldn't expect to see them show up in the CPI data for about a year or so.

The CPI kept increasing through the dot.com crash and the ensuing recession. It wasn't until 2002 that the inflation data finally started cooling off culiminating in a "deflation scare" in 2003.

It picked up again once the housing bubble began entraining more money into the economy via an extended period of very low interest rates encouraged by Fed policy.

Sebastian

“Then last year housing prices in our area took another big jump, such that our two houses were appraised at $350k.”

“The mortgage lender foreclosed, forcing the sale of the home at $250k, a substantial discount to its previous appraisal price.”

“Why are my other neighbors at risk because of this?”

On paper you are all 100k poorer then you were a year ago as the comps will adjust downward on your homes.

That would also depend on how many of your neighbors drank the kool-aid and got the new Lexus and a boob job using borrowed money on an (ha, ha, ha) asset that is now falling in value. This isn’t rocket science.

Foreclosures on Yahoo! Real Estate - Foreclosure Information, Trends & more!

The Sarcasm Report

Six Steps to Avoiding Foreclosure
1. Call your lender immediately.

The sooner your lender knows, the sooner your lender can prepare his own bankruptcy filings.

2. Ask to speak to the "loss mitigation" department.

Remind them that you are but a simple turnip and there is very little blood left in you. That should speed them along.

3. Be prepared to review your situation in detail with your lender.

Show him your receipt for the big screen TV. That should get the ball rolling. Don't worry. He's prepared for it.

4. Know the ways your lender can help you avoid foreclosure.

He's already helped you get into a loan you couldn't afford. He's fully prepared to help you in other ways you haven't even dreamt of!

5. Know where to turn if you aren't getting the help you need from your lender.

Do what has worked for you in the past. Turn on the radio. Call the first mortgage ad that says they can work with you regardless of your credit situation. This should take no more than 10 minutes tops, depending on where you are in the music playing cycle. However, this is important, remain seated when the music does stop or someone else will steal your chair!

6. Be aware of the foreclosure process -- and consequences.

Read Calculated Risk now. It isn't sort of like closing the barn door once the horses escape. It is EXACTLY like closing the barn door once the horses escape. Good for you! Who needs pesky horses anyway?

--
"total number of housing units: 74.9 million "

This is false unless it is a very old data or is only on Single Family Homes (some sub-category). The actual number of Total Housing Units as well as Occupied Housing Units is in excess of 100M.

Jas

Negative equity

Another thing to consider is a fall in house prices.

It happened in the early 1990s, when many homeowners found a market downturn tipped them into negative equity.

This is where your home is worth less than the loans secured against it.

Mortgage equity withdrawal is often touted as an easy way of unlocking money from your home to support extravagant lifestyles.

But it is nothing more than a sophisticated debt that allows banks to help themselves to your home, brick by brick.

What's more, they will charge you for taking away the bricks too!

Mortgage equity withdrawal is not a panacea for overspending.

For many consumers, it can cause more problems than provide solutions.

So if no one will give you an unsecured loan, sit down and ask yourself why!

BBC NEWS | Business | Head to head: Using your house as a wallet

Sebastian

If I followed the story, you have 'lost' about 100K in equity based on last sale in the neighbour hood. Thus you are affected.

Does it affect your probability of default, yes it does, because as the equity you have diminishes, your default rate rises. Enough defaults, your home is upside down. So yes, it has affected your probability.

How much is a reasonable question.

Mangius Mannus,

During the last recessin inflation was close to 1%, during the next recession my guess is it could end up below 0%.

Even as a stagflationist, I would certainly not heckle that prediction. I tend to have a bit of short-term deflationist, long-term stagflationist in me.

What will interest rates be? As I look at the historical data real rates of return tend to drop during bad times.

For example, in 2000 I was able to buy I-Bonds that paid 3.4% over inflation. They dropped to 1% at the bottom. Now they pay 1.4% over inflation. I don't sense we'll be seeing 2% plus on those anytime soon. I don't think we'll see I-Bonds pay 3.4% over inflation again unless the economy becomes (or at least appears to be) super strong again. The odds of that happening in the short-term seem to low to calculate these days.

Therefore, do I lock in a real rate of return now buy buying long-term TIPS, or do I wait? I bought.

If a crash truly hits with a vengeance, I expect a wave of money flowing into treasuries. I won't do as well as non-inflation protected securities certainly, but when people flock to safety I'd expect at least a few of them following me.

Take the 400+ point stock market drop recently. My TIP fund had an outstanding day even as gold and silver fell in sympathy.

On the other hand, we might just somehow muddle. In that event, any real rate of return is fine (and TIPS offer that right now).

But hey, what do I know?

Jas,

Yield-Curve, Inflation, and Recessions: Are Recessions Necessary to Control Inflation in the US?

It will be interesting to see what happens in China should the pain hit us hard. They might just have an Olympics in 2008 to match ours in 1932. D'oh!

The good old FED always the last to know.

Maybe they are the first to know and the last to admit.

I offer this as my reasoning.

Since when does the Fed do 17 baby-step eggshell walking interest rate hikes? It has never been done before with such predictability and consistency.

Did they cringe each time? Did they collectively sigh in relief when each one was gleefully accepted by the markets?

As they pushed that last one onto the back of the camel, did one say, "I see wobbly knees. Now we wait."

"The good old FED always the last to know."

Maybe they are the first to know and the last to admit.

Greenspan said, in so many words, if people could figure out what he was thinking from what he said, then he wasn't doing his job.

I heard a recent radio show host complaining that Bernanke was too concerned about inflation and not concerned enough about the slowing economy.

I think that's precisely what the Fed wants people to think... I think.

Stagflationary Mark

The Fed is a reactive organization. They usually lower rates which in the last few years caused a bubble and then raise rates until something breaks in this case housing and then wait to long looking at the data before they lower them thus the boom bust cycles. This time will be no different.

Nice chart, Mark. BTW as of Feb 2007, GMO's 7-year forecast predicts roughly equal real/nominal returns for U.S.Govt/short-term Treasury bonds and TIPs

Kevin,

On the one hand, I've been a bear since 2004 so my timing is not exactly perfect. Heck, I might even be wrong. On the other hand, I did ride physical gold and silver so maybe I wasn't wrong. The government forced me to buy something. Welcome to the Law of Unintended Consequences, lol. Based on the charts of oil and gold, clearly I was not alone.

I tend to invest for the long-term, so my choices are rather limited right now.

I'm actually riding 3 month treasury bills (about 1/3rd of my portfolio) that I keep rolling over. The rest is in I-Bonds, 5 year TIPS and 10 year TIPS purchased directly from Uncle Sam, and a TIPS bond fund (TIP).

I'm too scared of long-term treasury bonds so they're out. I want to be rewarded for the extra risk and I just don't see it. Perhaps if our trade deficit wasn't nearly a trillion dollars and we weren't at war and we had a different president and the government spent within its means and healthcare costs would back off I'd be more tempted.

Stocks seem like they are on borrowed time. The P/Es aren't so bad perhaps but I'd rather buy during a trough of high unemployment and low profit margins, as opposed to what we have right now.

Yet, I'm not comfortable shorting anything, since that didn't work out any better for the bears than it did for the bulls in the 1970s. The casino basically spread the pain evenly.

Real estate? Hahaha!

Copper? No thanks. I heard you need it to build houses. Go figure.

Gold and silver? Unless we have hyperinflation (which seems less likely each day), I'm done with that.

If you had to pick one relatively safe investment right now and hold it for 10 years, what would you buy?

Stagflation for the win! (Barring a short-term deflationary mess perhaps.)

barely- "There's your REAL WORLD prime credit foreclosure. You can reasonably Multiply that by A LOT and there's the wide spread default picture, affecting prime borrowers."

Well said. It can be as simple as that. Credit correlates. Period. The only question is how deeply it ends up being affected.

Oil.

Chances Are Our Economy Is Slick, Scrappy, & Sticky!

In addition to the previous items...

"S" as in stagnant.
"Lick" as in to hit as punishment.

Oh yeah, the stagflationary campaign slogan is complete.

Stagflationary Mark for president!

My promises to you...

1. Exotic Taxes™ (No need to bore you with the details, but let's just say your tax payments will be very low the first year I'm in office.)
2. $10,000 freshly printed cash to the first 150 million who vote for me. (That will only cost $1.5 trillion. That's just a drop in the bucket these days.)
3. Unemployment? We're going to build the biggest pyramid ever! Everyone will have a job! (Tools will be provided!)

Stagflationary Mark

If you had to pick one relatively safe investment right now and hold it for 10 years, what would you buy?

Rest homes or cemeteries.

Seriously Mark I'm a speculator and a trader long term for me is about 2 weeks although I do have silver I bought at 4.90, gold I bought at 325, some farm land I bought last year, and 3 homes which are a small part of my net. I’ve been selling into strength on stocks and my largest current holding is in money market funds waiting to go short. I mostly trade the gold, oil and drug stocks.

I have some long term money in the two Hussman funds and the two Prudent bear funds. Hussman seems to be pretty smart and I have done well with his funds. Prudent bear is for the fat tail event and capital preservation in the case of a Oh Sh-t! event.
Hussman Funds - Weekly Market Comment: April 9, 2007 - Investors Need Not Be Bearish to Hedge Risk

Kevin,

Our differences are mostly our time frames it seems.

It's funny. When I bought gold and silver in 2004 I told a friend that I'd hold it for 30 years if need be.

2 years later he asked me why I sold. I told him that once the chart turned parabolic, I was done. That was nearly 10 years worth of inflation hedging. Thanks! Now I'll hedge the government approved way through TIPS for any remainder.

I'm also more conservative than most. In 1999, I retired off of investing (at the age of 35). In hindsight, that wasn't exactly the best timing, lol. Fortunately, I did not have dotcom stocks during that "Oh Sh-t! event". I was 80% in the market though and it did hurt. By 2004, my investments actually turned a decent profit and I quietly exited (did almost as good as my 6.5% CD over that period, hahaha).

These days, I'm simply trying to keep the majority of what I have. I live modestly. I have no great desire to be even better off. I suspect that during the next market downturn people may also become more risk averse, maybe even surprisingly so. I plan to be a buyer at that time, should it happen. I'm patient. Part of me hopes it never comes. We just muddle right up until the point I need a cemetery. I could live with that (or is it die with that?).

Fool me once, shame on you. Fool me twice, shame on me.

I think the next "Oh Sh-t! event" is going to see some serious flights to safety. The masses are eventually going to put two and two together and come up with three. Three sounds like a pretty fair price to pay. Sign me up.

dr strangemoney,

Even the Fed chairmen, Greenspan and Bernanke and Volcker, never deny that they look at the price of gold. I was in Congress when Volcker was chairman, and I had a breakfast meeting with him. I had gotten there early, and when Volcker came in, he didn't say good morning, he went right to his staffer and said, "What is the price of gold?" That was the most important thing on his mind because people buying gold were voting no confidence in the dollar, and his job was to protect the dollar.

I would not doubt this for a second. I also think that the Fed might have taken interest rates to 5.25% simply because they didn't want "Record High Gold Price" in the headlines.

In January of 2006, George Soros felt interest rates would peak at 4.75% and we'd be seeing a recession in 2007.

"Almost inevitably, they have got to overshoot because they can't stop (raising interest rates) until the economy shows signs of a slowdown," Soros said. "By the time it shows those signs it may be a little too late. I happen to be on the pessimistic side."

They overshot Soros. Let's see if the rest of his prediction is accurate though. He's certainly had some good ones in the past.

Maybe the music has stopped but people are still dancing. - Soros, 2000

here a heatmap from the wsj

WSJ.com

I can't see how there can be any orderly movement from the dollar to any other currency or a basket of currencies -- even though fifteen years or more ago I personally was arguing to people that that would happen. About three years ago I concluded that the situation had evolved to the point where that was no longer a conceivable outcome, as the major foreign holders of dollar reserves had created a tiger from which they simply could not dismount.

To whom would the Asians sell their vast holdings of dollars? And what would be the side effects if they did?

The reason the Asian governments have bought all those dollars* is that no one else would have bought them at any exchange rate that would have made their exports profitable. The dollar reserves are a measure of their cumulative past subsidies to their export manufacturers, and their current account surpluses are a measure of the ongoing run rates of their subsidies.

If they were ever to abandon these subsidies, their export manufacturers would experience a Wyle E. Coyote moment. Another Wyle E. Coyote moment would follow soon for their business and political elites.

Though someday foreign dollar reserves (and their counterpart, the cumulative US current account deficit) will reach a level such that this lunacy can no longer continue, it is impossible to predict by rational calculation of national economic interest when that will occur, because the people making the decisions are interested not in their nations' economic interests but in their own, and their interests lie in continuing the subsidies as long as possible. No sense in letting that Wyle E. Coyote moment happen any sooner than it absolutely has to, eh? (The "eh" is appropriate here because the Chinese elite will probably move en masse to Vancouver when it happens.)

*Or, in the case of Japan, reduced their interest rates to zero so as to get the same result indirectly by inducing/forcing carry trades on the yen-dollar yield spread.

I can't see how there can be any orderly movement from the dollar to any other currency or a basket of currencies

Who says it has to be orderly?

The only reason the Asians defacto peg to the dollar is that all the others defacto peg to the dollar. It isn't that they want to keep their currency low against the dollar per se... rather they want their currency low against the OTHER Asian currencies, that is their real competiton - NOT US manufacturers... and the yardstick or benchmark they use is the ratio of their currency against the USD vs. the ratio of their competitions currency against the UDS.

This worked great when we were the only game in town but we aren't anymore.

China is shipping almost as much crap into the EU now as NAFTA Zone... And EU shipments are growing faster than US shipments.

Plus Asians are trading more among themselves - components & materials used in the products the then ship out of the region (to NAFTA Zone & eurozone) if nothing else.

Pegging to the dollar alone isn't as useful given those new realities. However nothing will change until the EU starts fighting back - trying to intervene to stop euro appreciation. When that happens the Asian merchantilists will have to aggressively manipulate the euro as much as the dollar.

And man does it get messy then.