As reported exhaustively, GM, in its present state, has only weeks left to live. So does California. The state, successfully terminated by the Terminator (though it'd be unfair to blame it all on his incompetent head), has brainstormed its way into two new bound-to-fail solutions for all its different, but still the same, conundrums.
This is Ilargi's intro over at The Automatic Earth.
First, Arnold wants TARP funds. He may get some, but that’s not what those funds are for, and California is not the only squeezed state by any means.
Second, the pièce de résistance of 2009 politics to date, the state of California plans to forcibly confiscate property tax revenues from lower levels of government in order to cover its own holes. Never mind that counties and municipalities themselves see their revenues fall off a cliff steep enough to scare a bodybuilding Austrian mountain goat.
I read that this morning, and couldn't believe it. I guess we can now wait for Washington to impose taxes on Californians that will further empty Sacramento coffers. Do unto others as you.... How do you measure despair?
Florida's biggest mortgage lender, BankUnited, doesn't have weeks to live; it has days, if that. For many hundreds of car dealerships and their employees, tomorrow will be the last day of business. Given the average size of a dealership, that means a lot of square feet of empty commercial real estate, and a lot of additional downward pressure on prices and on the local banks that hold the loans for the properties.
Citigroup and AIG have a bit more time, they may last a few months longer. Not because they are healthier, you might argue the opposite is the case. They live on for a while just because they are bigger. And they are "connected". Still, they are also connected to their past business and that makes their situation hopeless. Citi sits on mammoth piles of bad loans, securities and derivatives. Former personnel at Ameriquest, America's largest subprime mortgage lender, which Citi acquired in 2007, claims 90% of their loans are set to default. Its derivatives involvement makes AIG such a giant black hole that one can imagine all too well the fear on Wall Street that it may drag off all of Lower Manhattan down the waters of the Hudson into a parallel universe, never to be heard from again.
But I'm getting carried away; I intended to talk about something else: homes. As you may know, I have for a long time said that home prices, in the US and many other places, will fall 80% or more from their peaks. All I have to do now is sit back and wait for that prediction to come true. Which it will, there are no other options available, it just takes time for people to understand why. Very few homes would sell these days stateside without Fannie Mae and Freddie Mac, which are nothing but government vehicles to buy your neighbor a home with your money.
So far, Fannie and Freddie have received some $70 billion in bail-out checks. Today, the US Office of Management and Budget reports that they will need at least $92.2 billion next year. But those are just the losses that cannot be hidden, there are hundreds of billions more that should be written down, but are not. Alt-A and OptionARM resets are bound to raise the loss numbers manifold. How about half a trillion this time next year? And then there will come a day when the government will not be able to buy all mortgages, which means no more homes will be sold to people who can't pay cash. And the few that still can may think twice.
Mike White, a mortgage broker in Chicago, explains in Our American Homes. They All Fall Down - Much Further that a simple math extrapolation of the Case/Shiller index indicates that US home prices will fall 45% more from their current prices, and 62% in total peak to trough. A broker who advises people to rent, maybe there's still hope.
What Mike ignores in his simple model is that even Robert Shiller himself, as I often have, has predicted that because of the huge and rapid movement in prices, they are bound to violently swing way below the bottom the index seems to point to. That is what I’ve always maintained, and it confirms my prediction of an 80%+ loss. In the past few years, there have been quite a few graphs like the one of the Case/Shiller index, with data based on historical price ranges, and it always seemed very simple to me that prices would have to come back to the trendline. And then break it downward, as least as much as it had broken it on the upside. I’m not saying that to pound my chest, but because there are still millions walking wide open eyed into a debt servitude trap, whereas this has been obvious for a long time. The graph below from the ContraryInvestor is 3 years old. Once you've seen this, how hard is it to see the rest?
(see graphs at TAE)
And there's more. You can look at these graphs and not see more than a 50-60% drop in home prices, if you take the high road and the sunny scenario. But what you miss, then, is that it is that 50-60% drop that will of necessity lead to an additional 20-30% drop, because it will tear apart the entire economic system. The vast majority of mortgage holders owe more than 20% on their loans, so the vast majority will be underwater. Equity will virtually disappear, and what will remain is debt; lots of it. At the end of 2009, there will probably be about 20 million Americans without a job, which makes it impossible to pay off any debts. There will be tens of millions more who do have work, but still can't afford to pay back what they owe. Clusterstock's Henry Blodget this morning assembled some good stats in The Problem With Debt , which I think may open some eyes to what is going on, and what will inevitably come next. Here's Blodget:
A couple of years back, the value of US residential real estate was about $25 trillion. Mortgage debt constituted about 45% of that ($11 trillion) and owner equity 55% ($13 trillion). (Very rough numbers) Now, the value of the US housing market is down almost 30% and headed to, arguably, down 40%. In other words, if the peak value was $25 trillion, the current value is about $18 trillion, and the trough value will be about $15 trillion. So what will happen to homeowner equity? It will drop by 70%.
Ouch. And by the way, that percentage holds regardless of what the actual peak value of the housing market was, as long as you start with 45% debt-to-value. Also, most of that equity is owned by folks who own their houses outright. And what happens if you have a more typical debt-to-value ratio--say, 80% debt? Then, unfortunately, your equity IS going to zero. In fact, it will only take a 20% fall in the house price for that to happen. That's why so many households are now underwater.
That's also why lot of consumer households will get wiped out. (By the way, this is what killed all those Wall Street banks. Unlike consumers, they didn't have 45% debt-to-value ratios or even 80% debt-to-value ratios. They had 97%-debt-to-equity ratios. So it didn't take much of a decline in equity to blow them to smithereens.)
The reason I think this is an interesting example is that it not only shows how much equity can get lost, but also how easy it is to slip into negative equity. And of course, as you can see, Henry’s examples are based on very conservative (40% instead of my 80%) loss estimates. Not only compared to mine, but also to Mike White and Robert Shiller's figures. And that means, look at the graphs and look at the numbers, that tens of millions of Americans will soon not just be underwater, but underwater to the tune of hundreds of thousands of dollars. On top of that, millions will lose their homes because of it, and are likely to lose their jobs as well.
That entire situation will drive down real estate prices further, rinse and repeat, until you wind up with a society that simply cannot function properly any longer. Schwarzenegger's threat looks like an act of war, or at least them's fighting words. And that's not all right. Arnie today should focus on getting people out of tent cities with dignity, not on flexing his muscles. If we all choose to go there, we'll be using each other for stuffing come Thanksgiving.