Is the recovery on?

Well, last night there was a great debate on most of the financial news networks about whether yesterday's lovely stock market gains constitute the start of the recovery. Some said yes. Some said no.

So is the recession over, and is the recovery on-going? I'll give you a short answer and a long answer. The short answer is: No, fuck no. The long answer? Let me tell you about it.

There are two fundamental forces driving this recession.
1. Housing prices
2. De-leveraging

First we have the structural economic problem that the housing in America is vastly overpriced and unaffordable. Go do a housing survey in any region. Go do an income survey in that same region. Just about everywhere in the country, you will find the same relationship. Housing is more than 4 times the total annual income level of the typical family or buyer. In afflicted regions such as Los Angeles, San Diego and San Francisco, it is much worse. A typical family home can be 6 or 7 times the annual income of the typical family.

So what? Old bankers will tell you that (historically) the safe formula for mortgages says write a mortgage for no more than 2.5x the house hold income and ensure that the total cost of housing does not exceed 28% of total income. Insurance, HOA, and Mortgage payment must be less than 28% of household income. We are vastly beyond this safety limit right now, and this is the absolute fundamental reason for this horrible banking calamity we are experiencing. People are defaulting on mortgages because they cannot afford them.

Certain politicians and real estate brokers are attempting to re-cast reality to say that this calamity was brought to us by a bunch of unethical loan sharks who wrote nasty loans. The implication is that housing prices don't need to go down, loan terms just need to be adjusted. What...? As if they could have written a good mortgage for these outrageous amounts? No way. Every mortgage looks predatory if you write it for a party that cannot afford the basic price of sale. The absolute problem is an over-bought, over-speculated, inflated housing market that is fundamentally unaffordable for the people. The variable that must be adjusted is base-price of sale. That figure needs to go way down. All the way down to 2.5x average household income.

This can be accomplished in two ways:
1. You can raise average household income, which is bloody unlikely
2. You can lower the base price of sale through a process of default, foreclosure, auction, and short sale. This process is absolutely in progress right now.

That process of price tatonement must run to completion before the recovery will begin. We are not near the equilibrium point just yet, so forget about recovery. I predict that the equilibrium point will occur when average housing prices = 2.5x average income by region. Once we hit that, recovery will be possible.

The second problem driving this recession is de-leveraging.

When the economy had it's stroke and heart attack on September 15th 2008, the wave of panic that shot through the media was totally unprecedented in my lifetime. The U.S. Presidential election cycle stopped cold for several days and was thrown on the back-burner by the news agencies. Barrak Obama and John McCane suspended their campaigns.

This scared the unholy shit out of the people. At our Thanksgiving Day table, we had not a single conversation about anything other than the economy, job loss, the Great Depression, banking collapse, retirement funds, being under-water, etc. We did not discuse McCane or Obama. Our family was pretty dang terrified. I bet you were too.

The natural response to this new threat was to pay off all debt, store up some savings, and prepare for unemployment, should it strike. Just about all businesses and individuals began throwing all new earnings at debt. Consumption fell off a cliff. Businesses starved for customers and demand. This is about as pro-cyclical a move as the American consumer could have possibly made, but we all made that move together. We did it individually and collectively. The result is a deep, agonizing, downward spiraling recession.

So now we have a problem to solve: When does de-leveraging stop? There are two possible answers:
1. De-leveraging stops when everybody is completely out of debt
2. De-leveraging stops when the American consumer gets tired of austerity and breaks out the credit cards again.

Here, I can sound a bit more optimistic. I have little faith in the fiscal discipline of my people. We Americans like to spend and consume. We don't like zero debt for this reason. I expect our good people to half-step here. They will move their debt loads down considerably, perhaps even to safe levels, and then they will begin consuming again.

But then on the other hand... We should also remember that America's favorite shopping tool is the credit card. Certain credit card firms, most importantly Amex and Chase, are in a lot of trouble with consumer credit. They are playing shutdown defense right now. There are more and more reports of Chase and Amex closing accounts, reducing credit limits, hammering long term customers with massive interest increases.

There are some reports of Citibank doing the same thing. I personally have two Citibank MasterCards and they have done no such thing to me... yet. Let's hope they don't. I like my gasoline cards.

Anyway, presuming that consumer credit largely stays intact. Americans might start spending again by Christmas of 2009.

So, whatever happened to my NEW HDTV?

I haven't bought it yet, that's what happened. Why? Essentially, my Dad is having financial trouble due to the close of his Restaurant. He wanted to back out of the deal. This suited me just fine, because--as it turns out--I was having a little financial problem of my own.

It turns out that HSBC turned me down for the Mitsubishi Diamond Credit program. They gave no specific reason for doing so. They simply stated that they had consulted Transunion before making their decision. I happen to subscribe to TrueCredit.com, a service provided by Transunion. Everything is fine there. I don't have a long and deep credit history including three car loans, and two mortgages, but what I do have is pretty good. My Transunion FICO is resting at 708 right now. That ain't bad. I am shocked that HSBC would turn down a 708 FICO for a TV loan... but then again I am not.

I just blogged recently about HSBC going into crisis. [Consult The Great Depression II.] I just want it to be understood that this is their fault, not mine. In an ordinary environment, they would have lent me the money. As we all know, this ain't no normal or ordinary banking environment.

There is a certain Korean car vendor I know [he also owns my apartment building and lives here] who was deeply dismayed when he heard my report on this matter. He claimed that no FICO above 700 ever drove away from his car lot without financing on a brand new car... At least prior to this mess. He has seen many cases like this lately. It is killing his business. He was hoping for news that the credit freeze was thawing. I brought news of continued winter weather.

Regardless, I am going to buy a new HDTV as soon as I can find a buyer for my current HDTV. I have more or less decided to buy a Mitsubishi DiamondScan WD-73835. This will give me an extra foot of screen, a 120Hz refresh rate, and 3d movies. I think this is the best value on the market. I would like more time to pay for it and lower interest, but I will do it anyway.

So why the hell are we in this financial crisis anyway?

The root of the present crisis is pretty simple: The price of housing has reached the preposterous point where every common middle-class home is totally unaffordable by every common middle-class buyer. Housing has been overbought, over-speculated, and overpriced for some time now.

Call me foolish. Call me irresponsible. Call me a dreamer, but I think you have a serious structural problem when every common home is unfordable by every common buyer. I remember when my Dad told me I had to jump in the housing market back in 2005. He insisted that housing had appreciated at the rate of 7% compound per year for the longest time. It was only going to get more expensive. I needed to jump in.

"Where is the growth in real wages to cover this 7% increase in housing prices?" I scoffed.

"Real wages, adjusted for inflation, have been increasing at pretty close to 0.0% for the past 20 years. It might even be negative, according to some reports. Prices cannot continue to increase like this. Houses are already unfordable. Who will buy this houses in a few years?"

My Dad didn't like that at all. He had just refinanced his house, through Country Wide, at something like $350,000. He harvested a ton of 'equity' to open a restaurant, which is now closed for business. The notion of being locked at debt level, or being underwater, did not appeal to him at all. He hated that notion. Still, he grimaced in pain, understanding that there was a problem.

The problem is that markets like to get even. The market is getting even right now. The real value of homes dropped more than 10% from historic highs by the month of September. This created systemic failure in the credit and finance industries. Speculators who were underwater, stopped paying their mortgages. Many abandoned investments, looking forward to foreclosure as a way to get out of a risky gamble. As the losses mounted Country Wide, Fannie Mae, and Freddie Mac all exploded. LIBOR shot through the roof. AIG was swimming in red ink due to "Mortgage Default Swaps", a type of insurance we don't call insurance.

How can the mortgage industry drag the entire system down like this? How can a single burst blood vessel in your brain kill you? How can a little blood clot in your heart give you a fatal heart attack? How can one crushed vertebrae in your back paralyze you? All it takes is one serious point of failure to bring the whole system down into a collective crisis.

But I digress... The real subject of this crisis is the outrageous price of housing. The credit crisis is a side effect not the cause of problem. The boss of BB&T bank, John Allison, says that all the chaos of September 2008 was created by a 10% drop in that price. The good news is that housing has to drop another 30% in order to reach a point of moderate affordability across much of our country. The bad news is that housing has to drop another 30% in order to reach a point of moderate affordability across much of our country.

If most of this chaos and crisis was fomented by a 10% drop, what will 30% more look like? There have to be a lot of losers over a significant period of time for the average price of a home to decline another 30%. A lot of ordinary home owners will have to take losses when selling. A lot of real estate investors and developers will have to take losses. A lot of banks will have to take losses. A number of insurance companies have to take losses.

This is going to be a long, tough, grinding deflation.