After my many, many warnings about Donald Trump and his administration (I'll list those a little later)... It's official, Fitch has actually warned that the Trump administration is detrimental to sovereign ratings around the world. Keep in mind that we are in this world.

Fitch says Trump bad credit risk

Published in BoomBustBlog

Many have asked me if I believe in austerity measures or the Keynsian approach of spending out of recession. I have stated, time and again, that the question is loaded - hence the answer can never be sufficient. When you are trying to go from your home to the market across town in a crowded urban environment, you cannot make the trip successfully by deciding ahead of time that you are just going to make left turns (austerity? Austrian?) or right turns (stimulus? Keynsian?). You come to an intersection and you make the turn that's necessary to get you where you want to go. It might sound overly simplistic and common, but I'll be damned if common sense is one of the most uncommon things I've come across over the last 7 years or so!

On that note, there does appear to be a misunderstanding on how government finances work as compared to finances in the private sector. The government is not a for profit player that competes directly with those in the private sector, but is instead a universal support network that benefits from the success of the private sector. Hence, the government must work in the best interests of the private sector in order to thrive. This sometimes entails taking the other side of the trade to ensure that a trade can take place. One pundit who has done a good job of explaining this through pretty charts that explain the peculiar situation that we are now in (a balance sheet recession), is Dr. Richard Koo of Nomura Securities. See the FT.com article abstract:

In 2008, Barack Obama told the US people the nation’s economic crisis would take a long time to overcome. In 2012, many of those voters are losing patience, because they have not been told why this recession has lasted so long or why his policies were the correct response. Here is the missing explanation – based on not only the US experience, but also that of Japan and Europe. 

when-the-government-tries-premature-fiscal-consolidation-things-get-much-worse-and-debt-goes-higher

Today, the US private sector is saving a staggering 8 per cent of gross domestic product – at zero interest rates, when households and businesses would ordinarily be borrowing and spending money. But the US is not alone: in Ireland and Japan, the private sector is saving 9 per cent of GDP; in Spain it is saving 7 per cent of GDP; and in the UK, 5 per cent. Interest rates are at record lows in all these countries.

For those who may not get the gravity of this statement, it makes no sense to save money with a negative risk/reward proposition, unless of course the saver does not see it that way. One must save if savings are in deficit, and the risk to invest funds is considered greater than the benefit of having said funds in the first place. We are still attempting to wade through the bursting of a massive bubble, and we are playing defensive - not offensive.  In other words, are Americans seeking return OF capital over return on said capital? We are over-leveraged, and to effectively delever you cannot borrow more money or take the risk of aggressive investments. This is so even if investment capital is being offered at zero interest rates. Mr. Koo illustrates the consequences of such behavior eloquently...

However, if someone is saving money or paying down debt, someone else must be borrowing and spending that money to keep the economy going. In a normal world, it is the role of interest rates to ensure all saved funds are borrowed and spent, with interest rates rising when there are too many borrowers and falling when there are too few. 

But when the private sector as a whole is saving money or paying down debt at zero interest rates, the banks cannot lend the repaid debt or newly deposited savings because interest rates cannot go any lower. This means that, if left unattended, the economy will continuously lose aggregate demand equivalent to the unborrowed savings. In other words, even though repairing balance sheets is the right and responsible thing to do, if everyone tries to do it at the same time a deflationary spiral will result. It was such a deflationary spiral that cost the US 46 per cent of its GDP from 1929 to 1933. 

Those with a debt overhang will not increase their borrowing at any interest rate; nor will there be many lenders, when the lenders themselves have financial problems. This shift from maximising profit to minimising debt explains why near-zero interest rates in the US and EU since 2008 and in Japan since 1995 have failed to produce the expected recoveries in these economies. 

For some reason, the Fed doesn't seem to get what Mr. Koo and BoomBustBloggers do!

With monetary policy largely ineffective and the private sector forced to repair its balance sheet, the only way to avoid a deflationary spiral is for the government to borrow and spend the unborrowed savings in the private sector.

Wait a minute! The EU states are definitely borrowing, but they are not redploying the capital back into the private sector, they are simply bailing out banks! In addition, the banks are not deploying the capital into the private sector, they are simply sitting on it, just as Mr. Koo stated they would in the article excerpt above! So, after trillions of borrowing, there's no surprise why there's just relatively pennies making it into the private sector. What Mr. Koo and many who follow Keynsian economic theories seem to forget to include, is that upon borrowing the money to plunge into the private sector, you have to have a plan for paying said monies back. When you borrow said monies and simply waste them (ex. perpetual dead bank bailouts) you create a truly structural problem. Simply ask Greece, or see How Greece Killed Its Own Banks! and then move on to...

As The Year Comes An End The Ability Of Greece To Kick The Can Mirrors The Chances Of A Man With No Feet

Despite extensive, self-defeating, harsh and punitive austerity measures that have combined with a lack of true economic stimulus, Greece has (to date) failed to achieve Primary Balance. For the non-economists in the audience, primary balance is the elimination of a primary deficit, yet the absence of a primary surplus, ex. the midpoint between deficit and surplus before taking into consideration interest payments.

Greece_Primary_balanceGreece_Primary_balanceGreece_Primary_balance

The primary balance looks at the structural issues a country may have.

Government expenditures have outstripped revenues ever since 2007 and have gotten worse nearly every year since, despite 3 bailouts a restructuring, austerity and a default!

Greece_Primary_deficit_copy

On to Mr. Koo's diatribe... 

Recovery from this type of recession takes time because the flow of current savings must be used to reduce the stock of debt overhang, necessarily a long process when everyone is doing it at the same time. Since one person’s debt is another person’s asset, there is no quick fix: shifting the problem from one part of society to another will solve nothing.

The challenge now is to maintain fiscal stimuli until private sector deleveraging is completed. Any premature attempt to withdraw that stimulus will result in a deflationary implosion – as in the US in 1937, Japan in 1997, and Spain and the UK most recently.

Japan’s attempt in 1997 to reduce its deficit by 3 per cent of GDP – the same size as the “fiscal cliff” now facing the US – led to a horrendous 3 per cent drop in GDP and a 68 per cent increase in the deficit. At that time, Japan’s private sector was saving 6 per cent of GDP at near zero interest rates, just like the US private sector today. It took Japan 10 years to climb out of the hole.

when-the-government-tries-premature-fiscal-consolidation-things-get-much-worse-and-debt-goes-higher

Average citizens find it hard to understand why the government should not balance its budget when households and businesses must all do so. It is risky for politicians to explain but, until they make it clear that the economy will implode if everybody is saving and nobody is borrowing, public support for the necessary fiscal stimulus is likely to weaken, as seen during the past four years of the Obama administration.

The US economy is already losing forward momentum as the 2009 fiscal stimulus is allowed to expire. There is no time to waste: the government must take up the private sector’s unborrowed savings, to keep the economy from imploding and to provide income for businesses and households so they can repair their balance sheets. Fiscal consolidation should come only once the private sector has repaired its finances and returned to profit-maximising mode.

I have ventured along these lines several times in the past. Here is the subscription research that I feel is best poised to take advantage of the guaranteed mistakes to be made ahead, simply click your industry/sector for the most recent research (note, non-subscribers will only be able to view free reports, you may click here to subscribe)...

As for whether Mr. Koo is correct in the application of severe austerity when one should be trying to prime the pump....

Greece Is To Pathogen As Cyprus Is To Contagion As Spain Is To Infected...

CNBC reports Greece Austerity Strike Will Hurt GDP Further even as Cyprus Expects Bailout as S&P Cuts Ratings to Junk:

Cyprus said on Wednesday it expected talks to start with lenders on badly needed aid next week, as ratings agency Standard & Poor's pushed it deeper into junk territory, implying domestic political expediency lay behind a delay in clinching a deal. One of the smallest nations in the euro zone, Cyprus sought European Union (EU) and International Monetary Fund (IMF) aid in June after its two largest banks suffered huge losses due to a write-down of Greek debt.

Well, our Contagion Model showed clear paths of the knock on effects of Greek infection, and we haven't even gotten started with the economic pathogen party yet!

 

Although it seems as if Tyler is being a smart ass, he couldn't be farther from the truth. Reference my piece Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! concerning the accuracy of the IMF's baseline scenarios...

image005.pngimage005.png

And back to the ZH post:

....Breakdown of IMF deleveraging forecasts for the three scenarios, of which the realistic one is highlighted:

  • Under weak policies, the withdrawal of foreign investors accelerates to twice the pace seen since 2009. Periphery spreads widen by about one standard deviation above the baseline.

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Published in BoomBustBlog

 

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_01BoomBustBlogger and Director of Research at Paisley Financial, Mario Ricchio, writes on the abject futility of QE during a balance sheet recession. That is where I, and he, believe the US and Japan are right now. See my video take on this from a real estate perspective here. You can download Mr. Ricchio's report via this link, but in the mean time I would like to highlight some of the not so common sense remarks that I came across in such.   

The report relies heavily on the conceptual framework of a U.S economy in a balance sheet recession. Our main thesis rests on the belief that until U.S households repair their balance sheets and generate real income growth, they are in no position to drive a self-sustaining economic recovery. Monetary policy (including quantitative easing (QE)) produces limited results in generating real economic growth--- since the demand for credit and the lack of qualified borrowers remain the issue not the supply of funds. Instead, expansive fiscal policy, through increased government budget deficits, exists as the primary lever to raise economic activity, transfer real financial assets to the private sector, and ease the pain of the deleveraging cycle.

When the U.S housing bubble burst, the effects reached far beyond the decline in home prices and in construction-related employment. The nature of the economic landscape changed. As home values began their descent in 2006 against a backdrop of record mortgage debt, household net worth plunged primarily through a loss of home equity (see exhibit 1). Consumer attitudes shifted from conspicuous consumption to frugality. After several decades of leveraging up the balance sheet and living beyond their means, households started the process of deleveraging characterized by: debt minimization and reduction, increased personal savings, and lower consumption (see exhibit 2). The balance sheet recession commenced and how we look at the economic cycle must change.

THE PRECURSOR TO A BALANCE SHEET RECESSION

A debt-financed asset bubble precedes a balance sheet recession. Consequently, we begin by paraphrasing the thoughts of legendary hedge fund manager, Ray Dalio, on the cycle leading up to the collapse. A healthy economic expansion starts with a private sector (corporate or household) agent holding minimal debt. The private sector begins to see income rise at the pace of GDP. At this stage of the economic expansion, the majority of aggregate demand comes from cash-based income.
For example, let’s assume the private sector spends $1,000 of cash income (which contributes to the economy); now someone else has $1,000 of income. As the economy expands, the private sector feels more optimistic and decides to leverage up the balance sheet by going to the bank and borrowing $100 per year against $1,000 of income....

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_03

FEATURES OF A BALANCE SHEET RECESSION

DEBT MINIMIZATION

Since asset prices decline (eg. house prices) well below the value of corresponding liabilities (eg. mortgages), balance sheets become impaired (eg. negative equity or negative net worth). In order to repair balance sheets, the private sector moves away from profit maximization to debt minimization2. The deleveraging cycle ends up reducing funding needs. Unfortunately, with no borrowers, the economy loses aggregate demand equivalent to the sum of un-borrowed savings and debt repayment3 . Even in a zero interest rate environment, the private sector refrains from taking on added liabilities (see exhibit 3). This outcome renders monetary policy ineffective by creating a liquidity trap.

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_05

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_07

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_08

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_09

Paisley-Financial-Macroeconomic-Outlook-The-Winds-of-Change-August-2011_Page_15

 

On this very salient point, I must chime in with my own analysis and opinion...

The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression! The MSM is Just Catching Up

September 1st, 2007: The very first post on BoomBustBlog tells the whole story for the next 6 years!

Thoughts on the US Publicly Traded Homebuilders - BoomBustBlog

I noticed that many pundits are focusing on single family residential market, most likely because it is in the news so often. It is bad, very bad. I am an ex-residential real estate investor who sold off in 2005 due to fundamentals that were totally out of whack. It appears that many do not see how precarious the commercial sector has become, with many deals being done at 2-5% cap rates (net profit yields) in Manhattan and many major metro areas, which is absolutely ridiculous considering the risk and illiquidity of these deals. The compensation for these deals are coming no where near justifying the risk. I am sure the excessive liquidity coupled with significant demand caused the cap rate compression, but the buyers fell for it assuming liquidity and demand would continue for some time. Well, corporate liquidity has just dried up, and many are stuck holding the bag with buildings that are yielding as low as half that of treasuries, yet easily quadrupling the risk. Some are even selling at lower cap rates in successful flips (reference the Blackstone purchase of Sam Zell's portfolio, which was totally overpriced, yet Blackstone managed to flip much of the portfolio over to speculators, some of which actually flipped it over to someone else at a profit – ALL in a period of a few months). This has now become nigh in impossible, but in an attempt to raise the cap rates, commercial rents have skyrocketed to all time highs in the major metro areas, causing significant pressure on corporate profits (I have inside knowledge of this affecting MAJOR public and private firms who are looking to expand and are getting squeezed).
And now, on to small residential (single family and 1-4 family residential)…

For those who really have a life and do not have the time to read building company annual reports, here is a bullet list of tidbits that all will find interesting, particularly in light of today's mortgage environment (pardon if their is info that you are already privy to, this is a comprehensive summary, but I am sure everybody is to find something that is of illuminating):...

_________________________________________________

Reggie's grassroots analysis:

The S&P index severely understates the glut in housing and the downward pressure on pricing. It uses the repeat sales methodology which only includes houses have that have been sold at least twice, which excludes all new construction. So the homebuilder’s product which is being slashed in price with butcher knives and cleavers don’t even show up in the index, and these homes must be slashed enough to sell in a slow market that no longer has cheap credit, has much competition in excess supply, and no longer has the phantom appraisal pricing which helped sustain the bubble in the first place (more on this later).

The index also fails to include anything but single family detached and semi-detached housing, so coops and condos aren’t included in the mix. This means that areas like Manhattan and Brooklyn, South Miami and Las Vegas, DC and Cally are severely under counted. The mere act of excluding condos (the worst victim of boom time speculation) instantaneously makes things look a lot better than they are.

Also excluded are properties who experienced larger than median jumps in pricing, which where considered to be investor properties (benefiting from significant renovation in anticipation of resale). Investor properties constitute a very significant amount of the current prime and sub-prime defaults now.

Mentioned earlier was the push from appraisers eager to win new business. In the residential investment game, you (as in bank, mortgage banker, mortgage broker, real estate broker, investor, seller, and everyone in between) push the appraiser to come in with the highest value possible to allow you to a.) get the biggest loan possible, b.) obtain the most preferential pricing/terms (lower LTV) possible, c.) get as much from the sale as possible, or d.) all of the above. In the comparable valuation game, you pick comparables and adjust them for particulars to come up with a valuation. Once that inflated value is actually recorded in the city register, it's inflated value is used to further hyper-inflate other deals, and the upward spiral continues. The appraiser, in the boom times, picked the highest prices (which were inflated) to get a highest price (which itself was inflated) that is added into the records to make (guess what???) higher prices. Throw the petrochemical fuel of very cheap money and easy credit NINJA loans and it is easy to see how this housing boom was more than a boom, it was a speculative explosion in real asset prices that usually average 1%-3% a year in appreciation doing about 12%-100% in many places.

The caveat is, this works both ways. When the appraisers get busted for being too aggressive (and threatened with litigation and discipline - if you read the articles, they have been passing the buck saying they were pressured into inflating numbers) they start getting overly conservative and do the opposite. The banks also stop looking the other way since they may actually have to use their own money to fund/keep these loans instead of the OPM method of MBS/CDO fame. So now, the guys are looking for the lowest average prices in an attempt to be conservative, and the process reverses itself.

Now, we haven't even gotten to the commercial sector yet, where the real money is thrown around. Speculation and credit underwriting lite is coming home to roost in a sector near you.

October 2007

Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt IThursday, October 11th, 2007

December 2007

Do you remember when I said Commercial Real Estate was sure to fall?Thursday, December 20th, 2007 by Reggie Middleton

My first post on my blog in September warned about the coming drop in real estate prices. I revisited the topic a couple of weeks ago, as I prepared the research of a short position in the sector. Well, we are almost done with the research and the position and I will release a summary of the research and the performance (expected and actual) of the position after Christmas.

Check this out from January 2008

The Commercial Real Estate Crash Cometh, and I know ... - BoomBustBlog

A couple of weeks ago I informed BoomBustBlog.com readers that I was working on a big project concerning commercial real estate short candidates. I stated last year that I was sure CRE was headed down, hard. Well, I am now ready to start releasing the results of my research over the next week or so. Unfortunately, the market has moved against the subject of my research fiercely as I was completing it, but it appears to be far from over. Who is the subject of that research, you ask? General Growth Properties (GGP).  I have actually seen this company pop up in the media and a few discussion groups from time to time, but they have no idea what the management of this company has been up to. First, a little background on how I got here. Those who are not versed in commercial real estate valuation are urged to read my quick and dirty primer on CRE valuation .

I told members of my analytical team to screen the commercial real estate trust, service, and development sector for the usual suspects, starting with the the guys that purchased Sam Zell’s flipped properties from Blackstone. I made some of the companies available via blog post and download: icon Commercial Real Estate Cos. (43 kB)icon Forest City Enterprise Peer Comparison (198.98 kB)icon Vonardo Realty Trust (146.49 kB). After and exhaustive screen and resultant short list, we chose GGP. I then instructed the team to canvass local and national brokers (4), databases (5) and data aggregators (several) to get the most precise localized rental and expenses figures possible. This data, as well as purchase dates, prices, management actions, capital improvements, etc. were used to plug into models such as this 33 page illustrative example, icon GGPs Woodlands Village (612.34 kB), to ascertain the true value of GGP’s portfolio. We also measured and valued their development operations, joint ventures, CMBS financing, off balance sheet vehicles and master planned communities. Sum total, I now have roughly 2 gigabytes of “REAL” valuation data on my servers covering 260 properties owned or partly owned by GGP. A this point, I may know more about their operations than they do.

What is more telling is the window of understanding this opens into the commercial real estate space in the US. It is my opinion that most are extremely over-optimistic regarding the prospects for this space.

And here we are Now, in 2011...

The “American Realist” Says: Past as Prologue – Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!! Wednesday, May 18th, 2011

In the post that followed said appearance, Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate, I ran down what I perceived to be the major risks of real estate in the states today, and that is a departure from the fundamentals and bleak macro outlook. During the Q&A at Roubini's crib, where I was actually guilty of accusing Nouriel of being too optimistic (I know, that's probably a first - but if anyone were to do such it would probably end up being me), participants were suggesting in a rather optimistic fashion that if a hard landing or recessionary environment were to come it would presage a time to buy assets at value prices. Of course, that is assuming those assets that you got very cheap didn't then proceed to get much cheaper. Nouriel replied exactly as I would have (and have in the past, particularly during my Keynote at the ING Valuation Conference in Amsterdam), and that was that it simply cannot taken as a given that assets prices will cyclically snap back in a year or even two. Now, I do have an investment strategy that I plan to pursue in regards to real estate, but it is quite different from what I see being bandied about today and over the last 8 years or so. To wit (as excerpted from the link directly above):

... It is the reporting company’s responsibility to report, not to obfuscate. The big problem with this “hide the market marks” thing is that markets tend to revert to mean. Unless said market values fundamentally catch up with said market prices, you will get a snapback. That is what is happening in residential real estate now. That is what happened in Japan over the last 21 years!!! That’s right, it wasn’t a lost decade in Japan, it was a lost 2.1 decades!

This has been the first balance sheet recession that the US has ever had, but there is precedence to follow. Japan had a balance sheet recession following their gigantic real asset bust. They made a slew of fiscal and policy errors, which essentially prolonged their real asset recession (now officially a depression) for T-W-E-N-T-Y  O-N-E long years! For those that may have  a problem reading that, it is 21 long years.What did the Japanese do wrong?
  • They refused to mark assets to market
  • They attempted to prop up zombie banks
  • They failed to promptly clean up NPAs in the banking system
    • They looked the other way in regards to real estate value shenanigans

 

Published in BoomBustBlog