Thursday, August 21, 2008
The Worst Is Yet To Come?
Stocks managed some gains in the last hour of trading Wednesday on strong earnings from Hewlett-Packard and despite a rise in crude prices. The Dow added 68.88 points to close the session at 11,417.42. The SPX tacked on 7.85 points to close at 1,274.54. We are in the green and looking ok.
Not much else to say really about yesterday.
Anyway I saw this article on msn today and thought you might find it interesting. It talks about the interelationship between the US and UK economies.
The worst is yet to come in the US
"The worst is yet to come in the US," said Kenneth Rogoff, former chief economist at the International Monetary Fund at a speech in Singapore this week.
Rogoff wasn't in the mood to mince his words. "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."
Apocalyptic stuff, but enough to hammer global stock markets all on their own? It seems so. Rogoff is taking the blame - and a fair amount of criticism in some quarters - after the slump in the Dow Jones and the FTSE 100 was pinned largely on his gloomy prognosis.
Rogoff really to blame?
But markets have been waiting to sell-off again - they just needed an excuse. Rogoff just reminded the financial world of what it already knew - that this downturn is far from over and there is plenty of pain to come before we're anywhere near the light at the end of the tunnel.
He just so happens to be one of the most high-profile figures so far to have nudged Wall Street and said: "Oh by the way, did you notice that the Emperor's got no clothes on?"
Old trends die hard. When you get to the end of a bull market, investors are still primed for an upturn. They just keep buying on the dips, not realising that said "dips" are just the latest pitstops on a gut-wrenching ride to the bottom.
The same happens when bear markets end. Investors just can't believe that prices will keep rising, so they sell as soon as they've locked in even the tiniest profits.
How bad could it get?
Rogoff thinks "the financial crisis is at the halfway point, perhaps". That could be right, or it could be a touch optimistic. So far about $500 billion has been written off in losses globally. That's about half the $1 trillion that many respectable commentators now reckon will have to be written off in total.
What this all hinges on is the US housing market. A quick recap - as most people know by now, the problems kicked off in the subprime market. Lenders got too careless and greedy for fees, and gave out loans to people who almost immediately defaulted on them.
As those loans, which had been parcelled up and sold to banks and investors around the world, went bad and the financial system froze up.
Liquid crunch
Back then, it was called a liquidity crisis. That was what brought Northern Rock down. Banks still clung to the hope that most of their assets were of perfectly high quality.
The short-term problem was simply that no one was willing to lend money to each other as they couldn't be sure of where the toxic subprime loans were.
This was hopelessly optimistic. It's important to understand that subprime wasn't the root cause of this crisis. Subprime was merely the last straw. Subprime was the logical end-point of a system that had grown bloated and careless on cheap money and a complete disregard for risk.
Think about it. By the end game, lenders were giving loans to people who couldn't even make their first mortgage payment, let alone 20 years' worth of payments. So what does that suggest about the quality of their other loans?
Regular mortgages at risk
As Nouriel Roubini, the famously downbeat New York University economics professor, puts it: "We have a subprime financial system, not a subprime mortgage market."
And as Rogoff says, it's only going to get worse. US house prices have already fallen by 15.8% in the year to May, according to the S&P Case Shiller index. Banks repossessed three times as many homes in July as the year before, while the number of homes at risk of repossession (or foreclosure, as the Americans call it) jumped by more than half, reported foreclosure data group RealtyTrac last week.
The extent of the carnage is mind-boggling. Already, about a third of homeowners who bought in the last five years owe more than their homes are worth, according to property valuation group Zillow.com. In four cities in California, more than 90% of homeowners are in negative equity.
And it could get far worse. A report in April from Credit Suisse suggested that a full one in 12 US homeowners look set to lose their properties in the next five years. It predicts that 63% of subprime borrowers will be in negative equity by 2009.
US crisis reaches beyond houses
This all has knock-on effects. People who are in negative equity, or who have lost their home, aren't going out there spending. If they're not spending, companies aren't making money. If companies aren't making money, they're laying people off and going to the wall.
Meanwhile, car loans, credit card loans and personal loans are all threatening to go bad as well. And there's no sign of the lending squeeze letting up - a quarterly Federal Reserve survey of banks found that banks intend to tighten their lending criteria even further in the three months ahead.
And no wonder. They're going to need the money. Meredith Whitney, the Oppenheimer analyst who was among the first to start talking about credit writedowns at banks, reckons that house prices in the US will fall 40% from peak to trough. Yet Daniel Alpert from Westwood Capital, quoted in The Telegraph, reckons that a fall of just 28% would see lenders forced to write down $1.25 trillion in total.
So Rogoff wasn't exaggerating. There have been fears about a major bank collapsing in the US since Bear Stearns was rescued by JP Morgan earlier this year.
The demise of IndyMac, the Californian lender, was bad enough. Another banking crash on the scale Rogoff suggests would certainly mean further falls in stock markets, and possible questions being raised about the ability of the Federal Deposit Insurance Corporation (the US equivalent of our own Financial Services Compensation Scheme) being able to cover all of the banks at risk. That could lead to runs on other banks as real panic spread through the system.
What does it mean for us?
Let me turn to fund manager Jeremy Grantham of GMO to give the UK perspective. Grantham is another well-known pessimist, he reckons that US house prices could fall a further 17% at least. But there's one place that's far worse off than the US, he reckons.
"The UK housing event is probably second only to the Japanese 1990 land bubble in the real estate bubble hall of fame. UK house prices could easily decline 50% from the peak and at that level they would still be higher than they were in 1997 as a multiple of income."
Grantham continues. "If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial."
So we should be keeping a close eye on the US. Because their problems could be appearing in a housing market near you, very very soon.
Until next time.
Not much else to say really about yesterday.
Anyway I saw this article on msn today and thought you might find it interesting. It talks about the interelationship between the US and UK economies.
The worst is yet to come in the US
"The worst is yet to come in the US," said Kenneth Rogoff, former chief economist at the International Monetary Fund at a speech in Singapore this week.
Rogoff wasn't in the mood to mince his words. "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."
Apocalyptic stuff, but enough to hammer global stock markets all on their own? It seems so. Rogoff is taking the blame - and a fair amount of criticism in some quarters - after the slump in the Dow Jones and the FTSE 100 was pinned largely on his gloomy prognosis.
Rogoff really to blame?
But markets have been waiting to sell-off again - they just needed an excuse. Rogoff just reminded the financial world of what it already knew - that this downturn is far from over and there is plenty of pain to come before we're anywhere near the light at the end of the tunnel.
He just so happens to be one of the most high-profile figures so far to have nudged Wall Street and said: "Oh by the way, did you notice that the Emperor's got no clothes on?"
Old trends die hard. When you get to the end of a bull market, investors are still primed for an upturn. They just keep buying on the dips, not realising that said "dips" are just the latest pitstops on a gut-wrenching ride to the bottom.
The same happens when bear markets end. Investors just can't believe that prices will keep rising, so they sell as soon as they've locked in even the tiniest profits.
How bad could it get?
Rogoff thinks "the financial crisis is at the halfway point, perhaps". That could be right, or it could be a touch optimistic. So far about $500 billion has been written off in losses globally. That's about half the $1 trillion that many respectable commentators now reckon will have to be written off in total.
What this all hinges on is the US housing market. A quick recap - as most people know by now, the problems kicked off in the subprime market. Lenders got too careless and greedy for fees, and gave out loans to people who almost immediately defaulted on them.
As those loans, which had been parcelled up and sold to banks and investors around the world, went bad and the financial system froze up.
Liquid crunch
Back then, it was called a liquidity crisis. That was what brought Northern Rock down. Banks still clung to the hope that most of their assets were of perfectly high quality.
The short-term problem was simply that no one was willing to lend money to each other as they couldn't be sure of where the toxic subprime loans were.
This was hopelessly optimistic. It's important to understand that subprime wasn't the root cause of this crisis. Subprime was merely the last straw. Subprime was the logical end-point of a system that had grown bloated and careless on cheap money and a complete disregard for risk.
Think about it. By the end game, lenders were giving loans to people who couldn't even make their first mortgage payment, let alone 20 years' worth of payments. So what does that suggest about the quality of their other loans?
Regular mortgages at risk
As Nouriel Roubini, the famously downbeat New York University economics professor, puts it: "We have a subprime financial system, not a subprime mortgage market."
And as Rogoff says, it's only going to get worse. US house prices have already fallen by 15.8% in the year to May, according to the S&P Case Shiller index. Banks repossessed three times as many homes in July as the year before, while the number of homes at risk of repossession (or foreclosure, as the Americans call it) jumped by more than half, reported foreclosure data group RealtyTrac last week.
The extent of the carnage is mind-boggling. Already, about a third of homeowners who bought in the last five years owe more than their homes are worth, according to property valuation group Zillow.com. In four cities in California, more than 90% of homeowners are in negative equity.
And it could get far worse. A report in April from Credit Suisse suggested that a full one in 12 US homeowners look set to lose their properties in the next five years. It predicts that 63% of subprime borrowers will be in negative equity by 2009.
US crisis reaches beyond houses
This all has knock-on effects. People who are in negative equity, or who have lost their home, aren't going out there spending. If they're not spending, companies aren't making money. If companies aren't making money, they're laying people off and going to the wall.
Meanwhile, car loans, credit card loans and personal loans are all threatening to go bad as well. And there's no sign of the lending squeeze letting up - a quarterly Federal Reserve survey of banks found that banks intend to tighten their lending criteria even further in the three months ahead.
And no wonder. They're going to need the money. Meredith Whitney, the Oppenheimer analyst who was among the first to start talking about credit writedowns at banks, reckons that house prices in the US will fall 40% from peak to trough. Yet Daniel Alpert from Westwood Capital, quoted in The Telegraph, reckons that a fall of just 28% would see lenders forced to write down $1.25 trillion in total.
So Rogoff wasn't exaggerating. There have been fears about a major bank collapsing in the US since Bear Stearns was rescued by JP Morgan earlier this year.
The demise of IndyMac, the Californian lender, was bad enough. Another banking crash on the scale Rogoff suggests would certainly mean further falls in stock markets, and possible questions being raised about the ability of the Federal Deposit Insurance Corporation (the US equivalent of our own Financial Services Compensation Scheme) being able to cover all of the banks at risk. That could lead to runs on other banks as real panic spread through the system.
What does it mean for us?
Let me turn to fund manager Jeremy Grantham of GMO to give the UK perspective. Grantham is another well-known pessimist, he reckons that US house prices could fall a further 17% at least. But there's one place that's far worse off than the US, he reckons.
"The UK housing event is probably second only to the Japanese 1990 land bubble in the real estate bubble hall of fame. UK house prices could easily decline 50% from the peak and at that level they would still be higher than they were in 1997 as a multiple of income."
Grantham continues. "If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial."
So we should be keeping a close eye on the US. Because their problems could be appearing in a housing market near you, very very soon.
Until next time.
# posted by Paul @ 5:54 AM 
