Compression, Distance and Gas Prices

Transportation and distance can be translated in economics in several different forms. The most common is to draw iso-time and iso-cost lines so that all points on the line are equally costly or equally time consuming to traverse from that point to a common central point. Decreasing costs or increasing velocity allows for regions that were previously marginally unattractive for certain economic activity to now become attractive and feasible for a given economic activity.


For instance, reliable overnight air transport has made the proliferation of high end seafood restaurants in Pittsburgh, St. Louis and Chicago feasible as fresh supplies can cheaply be brought in while fifty years ago, the radius of fresh delivery off the docks was limited to a half day worth of driving, or maybe three hundred miles. Anything else had to be frozen and then shipped. Now the fresh off the docks time is still half a day, but that means that all metro areas served by large airports are now within the economically feasible radius.


Menzie Chinn at Econbrowser is looking at the increasing price of transportation and is advancing the idea that international trade flows will slow down or potentially decrease as the iso-cost lines are shrinking.

Several implications flow from these musings. First, more goods will now be "nontraded". This would lend more "home bias" to US consumption (and more home bias to each other countries' consumption, as well). Second, one might think that as transport costs rise, foreign and domestic goods would become less substitutable, holding all else constant...

To the extent that the development of cross border supply chains relied upon low trade costs and rapid transport, higher oil prices should be expected to retard this process.

I think we can expand this analysis to intra-national, regional analysis. The most common distance as cost trade-off people make is where they live within a metropolitan area. Shorter commutes tend to lead to location premiums/higher property prices, while living on the periphery leads to lower property prices, but higher commuting costs (both on a cash and implicit time basis). The dominant trend in the United States over the past fifty years has been to sprawl towards cheaper lands on the periphery and accepting the higher commute times and costs, partially mitigated by a trend decrease in automobile usage costs. That trade-off may be breaking down.

CNN Money is running a series of vignettes on the middle class squeeze, and the first one features a couple from my hometown of Lowell, Massachusetts. Lowell is an old cotton mill town whose mills left in the 1960s, and it has become a combination of high tech manufacturing, high tech software support, skilled craftsmen, comparatively cheap housing for people leaving the inner Boston suburbs but want to stay within the Boston city region, and a massive immigrant community with great food. It is an interesting place, and it is still comparatively 'cheap' compared to any place ten miles closer to Boston.

I work in Belmont, MA, which is in the Cambridge area. I am in LOVE with what I do....'

Sadly, my husband and I were priced out of this community when we decided to buy our first home almost two years ago. We decided to move to Lowell, about 10 minutes shy of the New Hampshire border....

I will most likely need to leave my wonderful job as program coordinator due to the rising cost of gas. It costs me about $250 a month to commute to work,

As transportation within regions gets more expensive, less movement will occur. The trade-offs are becoming more pronounced, and the value of savings on property versus the direct and indirect commuting costs may have been worth it when annual commuting costs for this individual was only $1,500/year but the trade-off reverses itself when cash commuting costs come out at $3,000/year. Depending on one's assumptions, the increase in gas costs has led to a devaluation of the Lowell property to this family of $20,000 (interest rate and amortization schedule sensisitive of course).

If we continue to see higher gas prices, which I think is likely, the peripheral and outer ring suburbs (which Lowell is one within the Boston economic region) will see a further acceleration of home price declines as people will try to move closer to their jobs and closer to the center of their economic regions (assuming job density is higher towards the center). Shorter trips and better substitution of trip modes will occur as the alternatives to driving increase in higher density places.

Lowered Expectations

Great News --- the housing bust has bottomed

Psyche!

CNN.Com is reporting some good news in housing, or at least that is how it is being perceived --- housing starts came in above expecations.

Privately owned housing starts fell to a seasonally adjusted 1,065,000 annual rate in Feburary, according to the Census Bureau. The rate was down 0.6% from January and off 36% year-over-year.

Economists surveyed by Briefing.com expected 995,000 new starts.

Permits for new building declined 7.8% to 971,000, well below the 1.02 million Briefing.com consensus forecast.

So being down 36% Year over Year, and running at a level we have not seen in 16 years, and this is good news... wow it is amazing what lowering one's expectation is. Next week's paycheck will be grand as I am expecting that I will only be earning minimum wage, so I'll enjoy the shock to the upside...[/snark]

Captain, the containment field, it's failing

Ahh, a year ago the concept of a credit crunch was a farcical fantasty of fevered bloggers and professional doomsdayers. There were a few minor credit problems in the subprime mortgage market, but these problems were contained to just the small subprime market and there would be absolutely no spillover effects. Well, the containment field expanded over the summer to include mortgage backed securities, some Alt-A loans and some A/prime loans. Now it has expanded to include the monoline insurers, credit default swaps, auction rate securities and who knows what else, but it is contained.

Yesterday I noted that the some of the same structural problems that permeated the mortgage market have spread to other consumer credit markets; namely car loans were being stretched to seven years. This step will marginally bring down monthly payments. Throw in the heavily advertised negative equity loan offers being offered by local dealers, and the same toxic mixture of loose credit with no standards is being is in the auto market as it was in the housing market. I was beginning to wonder when there would be significant problems in the servicing of those debts.

Thankfully USA Today read my mind and printed this story concerning rising repossessions:

Car and truck repossessions this year are headed for the highest level in at least a decade, thanks to easy credit and a faltering economy, says an economist for one of the largest wholesale auto auction services.
So many vehicles are being snatched from owners who stop making payments that some repo operators and auto auctioneers say lots are overflowing.

This year's predicted 10% rise in vehicle repos to 1.6 million would be a third higher than 10 years ago, says Thomas Webb, chief economist for a unit of Atlanta-based Manheim, which sells cars to dealers worldwide. The increase comes atop a 10% rise in repos last year....

An executive at another big auto auctioneer says that easy subprime car loans in recent years are a big reason for the flood of repossessed cars...

"Our business has skyrocketed," says Patrick Altes, president of Falcon International in Daytona Beach, Fla. In recent times, his service saw a first wave of defaults that involved picking up boats and recreational vehicles.

Now, it's cars and trucks, often in affluent neighborhoods.

"A lot of the vehicles we're getting are high-dollar pickups" whose owners got caught in the construction downturn, Altes says.

Speculative purchases based on ever increasing values of cash being accessible through either HELOCS or annual refinancing is where the cash came for these cars and trucks. Now that the home ATM is shut off and HELOCS are being squeezed by higher credit standards, there is no cash to pay the monthly payment.

I don't know how much more containment we can take.

I'll hold my breath until you're sorry!

Conservative leaning groups are forming a nice little circular firing squad. This time a decent size sector trade and lobbying group, the National Association of Home Builders, is threatening to withhold its political donations because the federal government has not handed them enough goodies in the past couple of years. Besides ensuring the only long bonds available were mortgages, keeping the regulatory barn door open after the horses were hitched, trotted out of the gate, ridden hard, rubbed down, put away, fed and taken out again the next morning, and getting the IRS residual value interest deduction that they lobbied for, they got absolutely nothing in the past couple of years.

The National Association of Home Builders said Tuesday its political action committee has decided to stop making contributions to candidates for Congress "until further notice."

Since 1990, the trade group has given nearly $20 million to federal candidates, with 35 percent going to Democrats and 65 percent to Republicans, according to the Center for Responsive Politics.

As a progressive I love this action. It marginally weakens Republican fundraising, although I have to ask how much disposable cash the NAHB has due to their entire market segment's current implosion. Even the money that the NAHB gave to Democrats went to conservative suburban/exurban expansion Democrats. This was money that is against my interests within the Democratic Party. A little less corporate suburban expansion cash marginally weakens the Mark Penns and Rahm Emmanuals of the party who argue that the Democrats must blur as many policy distinctions as possible in order to have any chance of running any decently funded candidates against slightly to signifcantly worse Republicans. Cutting the cash flow of the DLC/Bush Dog Democrats improves progressive interests and power in Congress by a marginal amount.

Please let their be a corporate donor strike this cycle; it would be great for my interests

Bubbles, cheap money and long terms

USA Today 2/13/08:

Toyota Motor Credit brought the loans to light when it acknowledged at a meeting last week it is making 84-month loans — seven years — to cut buyers' payments and boost sales. It's been making them since August.

GMAC, some credit unions and others also offer 84 months, and a sliver of auto loans, 0.1%, are even longer: 96 to nearly 102 months, says Power Information Network, a unit of consultant J.D. Power and Associates. About 82% are 60 to 77.9 months.

"Definitely bad," says Kevin Tynan, auto analyst at Argus Research. Easing buying with long loans "is bubble-inducing, and the bubble's bursting."

British government 2005:

Britain's first sale of 50-year inflation-protected government bonds was warmly received yesterday as pension funds and insurance companies lapped up the world's longest inflation-linked bonds.

A major Japanese grocery chain 2006:

Aeon, the biggest supermarket chain in Japan, will become thecountry's first company to sell 50-year debt, as it looks to refinance its short- term borrowings.

The company joins the governments of Britain and France in issuing 50-year debt. The longest sovereign debt Japan currently offers is for a 30-year term.

Aeon will issue ¥26.5 billion, or $226 million, of debt

Alex at Marginal Revolutions 2/13/08

The conventional wisdom is that there was a housing bubble which has now popped. The data, however, tell a different story....

The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). ...

Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you? If we don't see the massive drop back to "normal" levels then the run up in prices should be described as a shift to a new equilibrium - much as happened during World War II - see the chart. (It's an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.

Interesting, and wrong I think. Basically we had multi-generational low interest rates in the middle part of this decade that everyone was taking advantage of in the quest of cheap and easy money. This drove some economically rational price increases as the price of a bond increases as its interest rate decreases, and then massive and crazy speculation.

We are still operating in an environment of extraordinarily loose credit. Car loans are starting to stretch out to seven or more years, there were some forty and fifty year mortgages bandied about a couple of years ago and interest rates have been at multi-generation lows. With Helicopter Ben being Wall Street's bitch, this will continue in the short term, but home prices are still coming down despite all of the macro-support.

There was no housing bubble only if you are projecting 1% to 2% short term interest rates for several generations as well as a continued proliferation of stupid and amazingly prone to fraud loans within a business model that has absolutely no one being paid to say no to dumb loans.

Quirky non-inflation

The BLS Consumer Price Index does not measure the cost of housing/shelter directly by looking at the prices of mortgages, taxes, insurance etc. The cost of shelter is derived by a proxy measurement of looking at Owner Rent Equivilant. Basically the idea is that rents are less sticky and more frequently reported than home sales and we are interested in the cost of housing today and not ten years ago when a home and mortgage was locked in. There is an additional assumption that ownership costs closely correlate with the net present value of rental income streams. Reality bites and this correlation holds true over the long term, but not in the intermediate and short terms.

Rents have been slowly increasing over the past decade while home prices have skyrocketed in absolute, proportional and real terms. Since rents have been increasing at near trend levels, there has not been any significant reported increases of inflation due to shelter while anyone who has bought a home in the past five years would severely disagree with the statement that housing inflation has not occurred. On the flipside, as home prices have fallen in the past eighteen months or so, OER has been relatively stable.

Calculated Risk is passing along what will be an interesting statistical quirk on how housing price inflation will be reported as increasing despite the reality of dropping values:

California Apartment Assn., the state's largest organization of rental property owners, estimates that as much as a quarter of all foreclosed single-family residences are occupied by renters. The number of renters ensnared in the foreclosure fiasco is even larger when duplexes and other multi-unit buildings are factored in.

And the evictions show no sign of abating. Total foreclosures of single-family homes statewide rose more than 400% to a record 31,676 in the fourth quarter from a year earlier, according to DataQuick Information Systems.

Foreclosed homes and rental units are removed from the market for some length of time as banks and MBS trusts don't want to be landlords. That is a skillset past their area of minimal competence and profitability. Units are left empty. Combine renters being evicted due to failure of their landlords to pay the mortgage, individuals who are walking away from their homes, and individuals who are renting today who three years ago would have qualified and taken a NINJA loan to buy a house, the demand for rental units has greatly increased while supply is constrained. Rental prices will increase, and due to how BLS measures housing inflation, OER will increase.

This is not a conspiracy, it is not a cover-up, it is a deliberately chosen statistical quirk that will smooth itself out over the next three or four years, as it is correcting for the underreporting of housing inflation during the bubble years as the rental demand was artificially low, leading to lower prices than a correctly clearing market would have dictated.

2nd Order Impacts of Housing

Pittsburgh has escaped the worst of the first order effects of the bursting of the housing bubble as the city and region never really experienced the bubble. Good homes in decent school districts were and still are available for less than twice the area median household income. Pittsburgh is not alone in escaping the burst, as other Rust Belt cities never saw the boom:

Median sales prices for single-family homes in Pittsburgh increased 6.1 percent from a year ago, while some cities in Florida and California posted double-digit declines in sale prices during the same period, suggesting that home prices have fallen most dramatically in areas where the speculative frenzy was hottest.

"Pittsburgh doesn't have a hangover because it wasn't at the party," said Dr. Marc Louargand, president of the American Real Estate Society and a principal with Saltash Partners LLC in Hartford, Conn.

However the second order effects of the bubble burst are being felt in Pittsburgh even if this region never got too frothy. The Post-Gazette reports today of the real estate industry job losses:

The U.S. mortgage meltdown is roiling Pittsburgh's western suburbs in unexpected ways. Jobs, not homes, are being lost.

Pittsburgh-area companies eliminated 1,590 mortgage-lending and consumer finance positions between the end of 2005 and the end of 2007 -- the 10th highest drop among any metro area in the country, according to Moody's Economy.com.

Many of those layoffs occurred along the Parkway West, in towns such as Moon and Robinson, Coraopolis and Green Tree, where companies have aggregated to provide appraisals, title insurance, closing and deed preparation services for mortgage lenders nationwide.

These are decent to well paying jobs; I interviewed for a couple of them in 2003 and 2004 and they were paying above median wages for people straight out of college. Pittsburgh is doing better than other Rust Belt cities but job growth has been slowing down in the region faster than the national slow down.

Ahh, the joys of integrated national economies so even when a region did not go crazy, the second order effects impact the region anyways.

Schools Out!

By Cernig

Here's one that's off my usual track, but I just found fascinatingly scandalous. Schools out for one set of Florida kids - because their school was built on an old bombing range!

This weekend the Army detonated more than 400 pounds of World War II-era bombs and munitions found on the grounds of a Central Florida middle school.

Forty-nine bombs, each about 23 pounds, as well as several rockets, a rocket booster and a cannon had been found buried near Odyssey Middle School since recovery efforts began Dec. 27.

Also found in one underground pit: an entire U.S. Army tank.

Army workers detonated the explosives in pits over the weekend in controlled explosions.

"This shows how urgent this is," said Orlando City Commissioner Phil Diamond. "I don't know if everyone has grasped the magnitude of this."

The Orlando Sentinel has a whole page of detail, including a short vid clip and graphics. It appears the Army Corps of Engineers have known about the possibility of problems for years - perhaps since '48 but certainly since 1994 - and that tons of earth from the site, containing who knows what, were also used as landfill on local roads and housing developments. In 2002, after a tractor exploded a bomb, private engineers categorised the area as of "critical hazard". the School and surrounding district had been built more than a year before after the Corps said there was no risk despite it's own 1994 report that munitions still existed on the site.

Sens. Bill Nelson and Mel Martinez and U.S. Rep. Ric Keller have written to the Corps demanding that they should immediately put up more fences around the property, post more warning signs and start cleaning up all of the neighborhoods in and around the 12,483-acre former Pinecastle Jeep Range.

You have to think the Corps slipped up badly here. Especially since plans for the old range currently include a medical research center, a Veterans Affairs hospital and a medical school.


(Hat Tip - Comments From Left field.)

Recessions, Exports and Employment

Paul Krugman earlier this week has posited that exports may lead the US into avoiding a full blown recession:

I pointed out that up through the third quarter of 2007 rising exports had roughly offset the impact of the housing bust.....
So did the U.S. economy dodge a bullet?

Yes, it did — which is why I haven’t been as sure about a looming recession as, say, Larry Summers or Marty Feldstein, let alone Nouriel Roubini. (No, I’m not always a doom and gloom guy — only when the situation warrants, which has been pretty often lately.)

While we dodged a bullet, however, there are between one and three more bullets headed our way.....

I am wondering if he is positing a point of hope that has little practical reality as I am musing that an export led recession buster would still feel like a significant recession on the employment and wage front even if GDP growth never goes negative for a quarter or the official recession line of two quarters. Exports are still overwhelmingly goods as the US service economy is a local economy. The goods that are produced are either manufactured goods, raw materials or agricultural products, and here we have a real divergence in productivity. And this is why I think a 'mild' recession won't feel like one to anyone who works for a living.

The Bureau of Economic Analysis has the composition of US exports here, and as you can see over the past twenty years, there is a mild downslope of goods to total US exports, however this is a matter of two points; real, especially when viewed within the context of a larger export share of the US economy, but mild.



Over the last couple of years once we got back to trend performance instead of the job-loss and jobless recovery, a significant chunk of the employment gains came through the housing and construction booms; either directly by increased employment in the building trades, assessors, appraisers, mortgage processors etc, or indirectly through the multiplier effect jobs and localized services fueled by people buying new appliances, new rugs, and new cars through the wealth effect of seeing their home values increase. A good chunk of these people will need to find new jobs as this sector of the economy has and will continue to be punched in the groin for a while longer.

Some of the economic activity transfer has occurred already as Dr. Krugman noted, US exports are up and have taken a good chunk of the GDP slack. However on a short to intermediate employment term, this is bad news for most workers as the primary export sector (good production) is way more productive than the general US economy; via the Bureau of Labor Statistics is the index of output per hour, with 1992=100 for manufacturing and business in general:



Since manufacturing productivity has grown faster than business productivty over the past twenty years, the shift of a dollar of GDP from business expenditures to manufacturing expenditures means we are getting far less employment for the buck than we would have gotten twenty years ago. The productivity gap is fairly significant between the sectors, and the growth rates are still divergent in favor of manufacturing.

So even if we are able to dodge a technical recession on the basis of increased exports, and assuming that goods still constitute roughly 70% of US goods and services exports, then we can still see a fairly significant jobs, wages and waiting time for employment recession type environment.

The Tax Revolt of 2010

I am fairly confident that a Democrat will win the White House and Democratic majorities in the Senate and the House will be maintained and most likely expanded in both. However as Stirling Newberry noted a few days ago, the Democratic Party is running as competent technocrats without seeking to diametrically upset the dominant paradigm:

all three top Democrats are proposing health plans which are to the right of what Mitt Romney signed into law as the Republican governor of Massachusetts, and to the right of what Richard Nixon proposed almost 40 years ago as a Republican President, then it is clear that change is what you have in your pocket, and it isn't worth much.

As a short term strategy, this probably will work as a 'Not Republican' is a decent qualification for public office, but as long as we stay within a mindset of zero-sum gamesmanship, reactionary and exclusionary politics is a much stronger hand to play as it is easier to assemble a narrow coalition to protect fixed slices of the pie. And as an intermediate term strategy this is a good way to reap a tax revolt within the next couple of years as the politics of pain will be too strong and the pallative of short term relief will be tempting; thus the symptoms of the underlying problems of short term pervese incentives, decreasing cutting edge productivity, loose credit and perpetual debt will be addresse without actually changing the actual structure of these trends.

I wrote in November that the local politics of housing and taxes will get increasingly nasty as there is a significant concentration of pain.

if you live in Pittsburgh like I do, the crushed speculator demographic is minuscule and politically irrelevant. However if you live on the East Coast, in California or on the Florida coasts, this demographic is going to be fairly large, and fairly loud because they are in significant pain

This concentrated dynamic of pain will produce people seeking anything that can shift some of their costs to someone else even if the long term trade-offs are remarkably poor as long as the short term breathing space is created in which a bet for improvement can be made:

People who are stuck with mortgages and houses that they can not sell, refinance or service will be looking for help. They will be looking for refinancing deals, special breaks, holds on foreclosures, delays on credit reporting, and most significantly at the local level, assistance on minimizing the quasi-fixed costs.... and most importantly, constant and downwardly revising re-assessments without concurrent increases in millage rates......

Mish at Global Economic Analysis has flagged an interesting Yahoo article that is describing the start of the tax revolts as highly likely voters are seeking relief on their property taxes.

Falling home values and rising property taxes in many parts of the country are generating the loudest complaints about property levies since the 1970s, forcing state and local officials to address the outcry even as the housing-market slump eats into many sources of their revenue.

Indiana residents held public protests this summer against a surge in property taxes and acted on their frustration by ousting the mayor of Indianapolis. Florida voters will decide next month whether to adopt massive property-tax cuts, in a debate that has pitted part-time residents against full-time Floridians....

In Florida, where the falling housing market has gouged the state's economy, residents are debating massive property-tax cuts that will be voted on Jan. 29. Implementing the proposed changes would require amending the state's constitution. The plan, which strongly favors longtime homeowners over new buyers and part-time residents, has sparked opposition......

Across the U.S., concerns about property taxes have reached levels not seen since the passage of California's Proposition 13 in 1978. That landmark law capped property taxes at 1% of assessed value and said the base assessment on a home couldn't increase more than 2% a year until it is sold. A companion initiative, Proposition 8, allows homeowners to get assessments temporarily reduced during a weak housing market, until home prices recover.

The long established and previously protected are core voters and it is their power and interests that politicians cater too. Ian Welsh on the French elections noted that Sarzoky was elected by the death bet crowd --- the costs of their choices would be paid by others after they die:

the old folks telling the young folks that the protections the oldsters enjoyed their entire lives; the easy jobs they enjoyed their entire lives; are being taken away. It's real easy to vote for tough medicine for someone else, and that's what just happened in France.

Homes are the primary asset for most people, and right now homes are under systemic threat as a symptom of a greater problem. People want to make that pain go away without the costs of fixing the greater problems, and engaging in a local government financial death spiral and micro-local education arbitage seems like a decent short term fix, so we'll see a full scale tax revolt in 2010 or no later than 2012 as the last round of housing bubble junk Option ARM mortgage resets will be hitting in 2010/2011 --- what we are seeing now is just the tip of the iceberg....

Housing as a non-protected industry??

Our frequent correspondent Kat passed along an interesting article from Wired Magazine that is attempting to explain the increase demand for new housing versus old housing. Basically the proliferation of electronics and the increased power supply needs has made older houses a whole lot harder to retrofit.

wireless remotes that control lights and the thermostat, rooms wired with everything from coaxial to Cat-5, security setups worthy of Dr. No....That charming 1920s three-bedroom craftsman wasn't built to accommodate all these new devices, much less modernized subsystems like updated electrical, solar power, or flexible plastic plumbing. Which is one reason Americans have come to prefer new homes to pre-owned ones. Check out these numbers: In 1993, just 48 percent said they hoped their next house would be newly built. By 2004, that number had grown to 74 percent.

There is definitely some truth to that, newer houses are easier to renovate and retrofit a new wiring job. I have spent at least twelve hours fighting my home's layout to get a junction built off of old knob and tube wiring and then up threw some narrow wall jams to reinstall a broken outdoor light. A new build house the drops would have been straight down and I could have completed the job in two or three hours tops. However the most interesting segment of the article is on the nature of home building:

At MIT, architecture professor Kent Larson is working on designs in which the bones of a house — a skeleton of studs, beams, and trusses — are like the chassis of a car or a PC, and linked components like sensors and A/V equipment slot into integrated receptacles. The builder community is famously hidebound, but if it could be convinced to change its practices, Larson's scheme would mean faster, cheaper assembly (and disassembly and reassembly). "You'd move away from conventional construction, and builders would become assemblers," Larson says. [my emphasis]

Assembly is much lower skilled worker than construction. This means significantly lower wages for the home construction field as there will be less need for the highly skilled craftsmen such as plumbers, masons, carpenters and electricians. They will still be needed but for fewer hours per house. Furthermore assembly implies off-site fabrication which then leads to a much larger exposure of the middle of the construction chain to international competition. If significant modules of a residential unit can be built off site, then it matters far less whether off-site is twenty miles away, or seven thousand miles away.

The big winners of the Bush economy have been the people who have been able to work in either extraction fields such as the oil industry, or in protected segments of the American economy that are not exposed to significant international competition at this time. Real estate, until recently, construction, healthcare and security companies had done well under the Bush economy. The NASCAR decaled pick-up truck driver was and still is a core Bush voter because the Bush economy has treated this group of people reasonably well.

If residential construction faces more competition at the intermediate stage on the value chain versus the long standing raw material input stage, this element of the Bush base will very quickly become another Democratic leaning segment... interesting

More on Pittsburgh Municipal Bonds

I'm following up last week's post on the potential problem for the city of Pittsburgh and its mounds of debt. The city has a mediocre prime credit raiting and routinely uses bond insurance to improve its net interest rate and lower the total cost of borrowing money. In the last post I implied that FGIC is the primary insurer of a significant portion of the city's debt. However Chris Briem at Null Space actually hosts the city's bond agreements and offerings, and MBIA insured a massive 2005 bond issue.

As stated in that post, MBIA looks to be in trouble, and the bond insurance sector as a whole looks to be in significant trouble. Calculated Risk is posting this Bloomberg article on a potentially significant ratings downgrader for a major bond insurer:

Security Capital Assurance Ltd. may lose its AAA credit rating at Fitch Ratings, the first top-ranked bond insurer put on notice since the industry came under scrutiny last month because of rising defaults on subprime mortgages that back securities they guaranteed....Security Capital is among seven AAA rated bond insurers that being reviewed by Moody's Investors Service, Standard & Poor's and Fitch for the past month after declines in the credit quality of the securities they guarantee. A loss of its top ranking would wipe out XL's main business of using its AAA rating to guarantee $154.2 billion of debt....
MBIA this week raised $1 billion in a sale of stock to Warburg Pincus LLC to help avert a downgrade

Security Capital is not, as far as I know, an insurer of Pittsburgh debt, but its problems of insuring asset and collatoral backed debt obligations that were rated as AAA but are now either in junk status or worthless is a common problem throughout the entire bond insurance universe. This could be a significant problem for Pittsburgh especially as the 2005 bond issue has significant balloon payments due in the next three years that will require the city to issue roll-over debt at probably higher interest rates.

Another budget bust on Pittsburgh's horizon?

Pittsburgh is functionally bankrupt. Right now there are two state appointed boards that have final (and occassionally non-cooperative) say on all of Pittsburgh's budgetary decisions. The biggest problem for the city is a debt servicing problem. The city due to its previously higher population has a very large pension and other retirement obligations relative to both state aid (which is tied to the current number of municipal employees)and the current tax base and population base. Throwing in expensive to maintain aging infrastructure and the diversion of local and county tax revenues such as RAD to fund signature but negative net value projects, and Pittsburgh is in a pickle.

Everything that I have read strongly suggests that the overwhelming majority of Pittsburgh's debt is insured by one of the major bond insurers. This makes the municipal debt look decent despite the city having a credit rating that is not in the toilet but is "hovering over the toilet like a soused fraternity jock after a hard St. Patrick's Day, crying that, as God as it's witness, it will never drink like that again..."

Officially Pittsburgh is out of the intensive fiscal care unit, but re-admission looks probable as a series of short term fixes and freezes have not fixed the underlying structural problems in the budget. Some of these fixes such as the 50% parking tax are state mandated to decline despite what seems to be fairly inelastic demand for parking.

There could be another, wider problem coming in soon, and that is related to the general credit market crunch and more importantly the absolute crap that was reassembled, rematched, and released as AAA bonds that were insured for a song. Mish at Global Economic Analysis caught an ugly piece of news from Bloomberg on two of the dominant insurers:

MBIA Inc. had the biggest drop in more than 20 years in New York Stock Exchange trading after Moody's Investors Service said the biggest bond insurer is "somewhat likely" to face a shortage of capital that threatens its AAA credit rating.

"The guarantor is at greater risk of exhibiting a capital shortfall than previously communicated," New York-based Moody's said. "We now consider this somewhat likely."...

MBIA is among at least eight bond insurers seeking to ward off potential credit-rating downgrades by Moody's, Fitch Ratings and Standard & Poor's. The insurers guarantee $2.4 trillion of debt and downgrades could cause losses of $200 billion, according to Bloomberg data.

MBIA's problems are not isolated to their business model. There is a systemic problem in the bond insurance industry, and if there is a run on insurance due to collapses in bond values so that the perception of the value of the guarantee significantly decreases, Pittsburgh will be facing significantly higher debt service costs. These costs will occur either due to new bonds being priced at Pittsburgh's real credit rating of Moody's AA3 or priced at AAA with very expensive insurance premiums.

The city budget is heavily committed to debt service already, and a 50 or 100 basis point increase in interest rates is between a long term, recurring $5 to $10 million dollar hole in the budget.

Economic explanation of a joke

"What do lesbians call a third date ---- Moving Day"

An old, hoary joke built on stereotypes, but it was floating in the back of my head when I wrote my post concerning rethinking marriage's tax advantages yesterday morning due to this passage and some thinking about incentives:

The quasi fixed costs of living increased far slower than household size so we effectively had higher disposable or at least not immediately accounted for cash flow as a co-habitating and now married couple than we would have had as single individuals.

The gender wage gap means that on average women earn 77% of men in 2006, and any change this year is likely to be small in either direction. This gap starts early as I noted earlier this summer, and it occurs even when controlling for education and career field.

So a woman in a given field is likely to be making less than a man and two women couple are likely to make less than a similiar male-female couple, holding everything else equal.

Is this a partial explanation of the joke --- pooling resources and living together is a way of stretching out incomes that may tend to be smaller than similiar heterosexual couples in the same fields with the same basic qualifications?

Are there no workhouses....

Belle Waring at Crooked Timber is calling out a mortgage workthrough specialist for being an absolute Scrooge (via the New York Times) as the specialist shows how divorced she is from reality.

“The risk is that you could be modifying loans for people who don’t need it,” said Sharon Greenberg, director of mortgage strategy at Barclay’s. “There’s only so much you can do without talking to the borrower. You’re spending $60 a month on cable TV; can you get by with less? You’re spending $200 a month on food for two people, but food costs in your area show that you should be able to get by with $100 a month. These are the kinds of conversations that loan-servicing companies have to have with borrowers.” (my emphasis)

Let's just take a look at the food costs. Let us assume that a month is 30 days to make the math easier, and that each person eats three meals and only three meals per day which means no snacks, or desert or anything else. So @$200 per household, that is $100/person, or roughly $3.33 per day. So $1.11 per person per meal on an excessive lifestyle. The specialist contends that it is possible to eat on half of that level, or being generous 56 cents per person per meal and presumably maintain decent health over the long run.

Well Gov. Kulongski (D-OR) led an interesting public demonstration of food budgetting priorities earlier this year and shows the absurdity of trying to live on 56 cents per meal.

Governor Ted Kulongoski has challenged all Oregonians to join him and his wife, Mary Oberst, during “Hunger Awareness Week” from April 23rd-29th, and live off of an average food stamp budget of $21 per person for the week - or an average of $3 per day, per person.

“I challenge all Oregonians to experience first-hand what thousands of Oregon families go through everyday,” said Governor Kulongoski. “Budgeting just $1 a meal each day for food, and trying to make that food nutritious, is a difficult task that sadly is a reality for too many Oregonians and their families.”

I believe food stamps are already insufficient to provide a sustainably healthy diet with any degree of variety [oatmeal and veggie chili twice a day for months on end is not sustainable], and they provide a base for a food budget that will be greater than than $3.33 per person per day. Get real, and figure out that a big chunk of the problem with the loans that are in trouble is on your absolutely shitty business model and screwed up incentive structure that rewarded very short term thinking and rational risk ignorance over making reasonable loans that people could actually afford.

Ugly Picture and worse news....

Barry Ritzholtz grabbed this great graph from the Wall Street Journal first, and it shows the supply of houses available for sale based on the number of months at current rates would it take to sell every single house on the market. The rule of thumb is that normal supply is about 6 months, bubble supply is anything less than 4.5 to 5 months, and tough markets have about 8 months. Remember the trend is your friend when making short term predictions.


This is based on the absymal October home sales data and for anyone who wants to call a bottom, Calculated Risk is doing some depressing data crunching by making the assumption that the trend and long term historical norms still have some relevance in predicting the intermediate term future and that the New Paradigm in housing is really nothing new...

the annual variability in the turnover of existing homes, with a median of 6% of owner occupied units selling per year.

Currently 6% of owner occupied units would be about 4.6 million existing home sales per year. This indicates that the turnover of existing homes - October sales were at a 4.97 million Seasonally Adjusted Annual Rate (SAAR) - is still above the historical median.

There is still a good way down for the US to start returning to trend in the housing market which means construction employment is going to take a significant hit, especially as non-residential investment is now slowing down as a near substitute of skills, which means the basic activity multiplier effect of construction jobs will take out a bunch of other jobs, which will feed into both worsening credit capacity and credit maitenance which means more foreclosures and more pressure on housing, all in an environment where very few people have easily tappable, liquid and reliable reserves.

Housing and the politics of pain

Betting that the American consumer is tapped out and unable to spend any more is a good way to lose money. I have been convinced that the American consumer has been tapped out for a couple of years now and any time now PCE should be slowing down or going negative. Each time I have thought/wrote that sentiment, I've been wrong as we collectively go into more debt. Ian Welsh is making the same declaration at the Agonist based on the Black Friday sales numbers --- aggregate sales up, sales per person down ---

Looks like the American consumer is finally tapping out. Expect a really abysmal Christmas, followed by a year where consumer demand drops.

Consumer spending has been entirely driven by home price asset inflation, which has been withdrawn in the form of loans, along with other forms of consumer borrowing. The US consumer actually has a net negative savings rate. That's not sustainable, and now that housing prices are beginning to drop, and ARM (adjustable rate mortgages) are going down, it's not going to be sustained.

During the summer of 2006, I was and still am curious as to how the housing bubble bursting will affect politics. Most of my questioning at the time was related to local politics and stuck flippers, but I think these questions can be expanded to a much larger group of people and geographical scope:

However, what happens when speculators are forced to stay in properties that they were trying to flip because they are effectively upside down at current market prices. They have three basic choices; the first is sell now to minimize guaranteed losses due to carrying costs and find outside assets to make your mortgage holder whole, the second is a variation of the first, and that is to default and walk away with damaged credit. The final option is to hunker down, piss money down the hole while minimizing carrying costs and wait for the market to turn around at some indeterminate point in the future.

If this third scenario is the basic course of action adapted by a speculator, then the incentive to get involved in local politic goes up massively. Now if you live in Pittsburgh like I do, the crushed speculator demographic is minuscule and politically irrelevant. However if you live on the East Coast, in California or on the Florida coasts, this demographic is going to be fairly large, and fairly loud because they are in significant pain. So how will they respond in local politics? [emphasis added]

People who are stuck with mortgages and houses that they can not sell, refinance or service will be looking for help. They will be looking for refinancing deals, special breaks, holds on foreclosures, delays on credit reporting, and most significantly at the local level, assistance on minimizing the quasi-fixed costs. That means support for more heating and energy assistance, lobbying for lower insurance limits for flooding and hurricanes in disaster prone areas with the hope of either dodging the bullets, or shifting those costs to someone, somewhere else, and most importantly, constant and downwardly revising re-assessments without concurrent increases in millage rates. Ian sees something different...

Aided by the bankruptcy bill passed by Congress, the leg-breakers will be out after Americans. But they're going to find that no matter how much Uncle Sam is willing to bust kneecaps to help you get your 20% plus penalties, you can't get blood from a stone.

I expect, as entire communities are devastated, that those who try to repossess cars, homes and other assets will, by 2009, be facing actual threats and violence.

I don't expect a lot of this to happen; instead I expect a combination of localized political actions to become much more favorable to debtors, as the US has a long history of these types of actions, starting with the pre-cursors of the Shays Rebellion. Even more likely, I think in severely impacted domains state and local officials will make it known to debt collectors to not expect timely help if they run into troubles enforcing debts.

On a national scale, I think Digby is right in that tough times will create openings for new groups to be blamed; right now immigrants are bearing the brunt of these accusations, but this could expand if more scapegoats are needed:

The election feels eerily reminiscent of 1992, when so-called reasonable centrists stoked the crazy man Ross Perot's campaign by backing his obsessive concern for "the deficit" which was nothing more than a weird abstraction into which misinformed discontented voters could pour their economic fears.

People are going to be looking for others to blame instead of looking for tough, systemic explanations, so there will be openings for demagogic populists out there and an even nastier zero-sum politics.

ThatcherBush-enomics

By Cernig

In honor of Peggy Noonan and just to repeat what I've been saying for three years, here's a video from the illustrious Spitting Image team and the band Madness which has more than a little relevance to current affairs in the U.S.

Gnossis Politics

Chris Bowers at Open Left is riffing off of something that has been floating in the back of mine, the particularly sharp edges of being at an intellectual/political edge and the temptation to engage in gnostic politics.

Yes, there is a certain eschatological feel about some of the writing coming from the Draft Gore movement, which one can also find at times from peak oil junkies. For both groups, the end of the world / second coming is always near, and the unfaithful are often mocked for their ignorance.....

I think I gave $10.00 to Graft Gore in the summer of 2006 and I have been following the ideas behind Peak Oil since soon after I started to blog.

The other two areas of edge thinking that I have routinely engaged in has been 4th Generation warfare, or at least non-traditional kinectic defense thinking, and the initial argument that the housing market was massively out of whack with reality and it was propped up by massive amounts of easy credit. When I first came across these ideas, opinions, theories, and storylines, they were fringe opinions with highly estoric knowledge required to understand them.

Who the hell outside of a small group of strange intellectuals heard of Lind? Who thought of decision making as OODA? What the hell is Hubbert Linearization? Secondary bubbles --- what are they and do they form only with glycerin? The terminology was different, the initial operating assumptions were in stark contrast to prevalant majority group assumptions, and the predicted end results are significantly different than consensus forecasts. And right now the Housing Bubble folks, and the 4th GW/alt. defense strategy thinking are being heavily validated by reality conforming much closer to their expectations nnd predictions than predictions made three to five years ago by the consensus groups. Peak Oil is still in the undecided category, although the evidence is starting to come in that there is at least a global plateau if not a peak in conventional crude production.

Alternative theories have done a better job of describing the behavior of the economy's primary growth sector, the critical production bottleneck of expansion, and the (in)ability of the state to impose its will through force than traditional theories this decade. And here I am worried; both that the consesnus explanations are so consistently wrong ---- 30,000 troops in Iraq by Christmas 2003, New Housing Paradigm, and the Alberta Oil Sands will save us ---- and the fact that the initial creaters and early adapters of non-traditional explanations operate at the margin and submargin of debate.

The initial steps of understanding that debate is a revelation and a rejection of the commonplace, and here exists the danger of gnossis, a dismissal of the everyday world. There is a temptation of contempt, and distancing of oneself from the common debate. Election revealed through the knowledge of an alternative explanation is a strong current in American releigous-political history, and the quasi-secret but open source knowledge that is available for anyone to stumble across invites an inward turn....

Housing Problems contained to...

First the housing credit problems were contained to a few bad subprime companies, but the safeguards and credit protections as well as tougher underwriting standards protected Alt-A, jumbo, and prime markets. Next we found out this summer that credit problems were taking down the Alt-A and jumbo markets, but we were assured that the combination of a Bernacke Put, a Super SIV, improved credit risk assessment and underwriting would protect the prime markets from seizing up. And now the Wall Street Journal via Calculated Risk is the least prime of the prime market is starting to show some serious problems:

Some loans classified as prime when they were originated are now going bad at a rapid pace.

These ... option ARMs ... typically have low introductory rates and allow minimal payments in the early years of the mortgage. Multiple payment choices include a minimum payment that covers none of the principal and only part of the interest normally due. If borrowers choose that minimum payment, their loan balances grow....

An analysis prepared for The Wall Street Journal by UBS AG shows that 3.55% of option ARMs originated by Countrywide in 2006 and packaged into securities sold to investors are at least 60 days past due. That compares with an average option-ARM delinquency rate of 2.56% for the industry as a whole....

It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS.

I am not a mortgage guy, although the ones that I talk to say that the market is frozen for anything that they prepare that does not have W-2/1099 income verification, reasonable DTI, multiple months of bank statements as well as significant cash reserves. The mortgage brokers that I know can still qualify people who would have qualified as prime borrowers ten years ago, twenty years ago and forty years ago. They can not qualify anyone else at any interest rate and conditions that are economically and cash flow reasonable right now. This is ancedotal information, so take it with a grain of sea salt.

What seems to be happening is the end result of a massive case of credit worthiness inflation, similiar to grade inflation. People at the bottom end of the credit ladder were getting bumped up one or two levels of creditworthiness and being offered loans that in normal underwriting circumstances they should have never been considered for, and this had a cumulative impact of bumping up slightly better credit risks that should have been seriously subprime to 'good subprime', and so on and so forth down the line.

Throw in a speculative frenzy, minimal real wage growth, generationally low interest rates, a bevy of teasers rates and hooks that make the first couple of years affordable and the evaporation of personal financial reserves to deal with any set back, any shock to the pre-exisiting system makes the entire system unstable. And that is what is happening now as the supply of greater fools ran out in late 2005/early 2006 and the reserves are not there to cope with personal losses.