New Geography

Tag: Financial Crisis

  • How Houston Will Weather The Recession

    In the past year or so, traveling the various geographies of this country has become increasingly depressing. From the baked Sun Belt suburbs to the green Valhallas of Oregon and the once luxurious precincts of Manhattan, it is hard to find much cheer–at least from entrepreneurs–about the prospects for the economy.

    Until recently Texas, and particularly Houston, has been one of the last bastions of that great traditional American optimism–and for good reason. Over the past few years, Houston has outperformed every major metropolitan area on virtually every key economic indicator.

    Last year, the region was rated among the major metropolitan areas as the best place for everything from earning a living to college grads to manufacturing, according to such publications as Forbes, Business Week and Kiplinger’s.

    But the city that could may soon not. Like a couple of bad storms, the recession is barreling in from east and west, shutting off credit to even the most successful businesses. Just last month, Hanley Wood’s Builder ranked Houston the “healthiest” housing market in the nation. But when you get on the ground, things appear far less sanguine.

    Particularly hard hit has been the once-vibrant inner city condominium market, which has been attracting a whole new generation of young professionals to urban living. Now some condominiums, suggests developer Tim Cisneros, are being abandoned by younger workers who have become the prime victims of a contracting economy. As seen in other regions, others are turning to rentals as potential buyers fail to qualify even at Houston’s reasonable prices.

    However, the biggest problem facing Houston today revolves around the energy industry, which represents to this region of well over 5 million what finance does to New York. Already lower energy prices, along with the global slowdown, have taken a dent in job growth. Just last week, the Texas Workforce commission reported a 0.7% employment increase for the area in 2008, compared with a robust 3.5% the year before.

    Bill Gilmer, a veteran economist who covers energy for the Dallas branch of the Federal Reserve, reports that proposed new taxes and regulations plus falling prices have started to decimate the domestic oil and gas industry. Over the past year, he reports the number of rigs in operation across the country dropped from 2,000 to some 1,300.

    The impact of this on Houston’s energy economy, Gilmer suggests, will be severe, and it will drag the region and much of Texas down with it. “We are talking about a Texas recession now without question,” he says. “I lived through the Jimmy Carter era before, and now it’s déjà vu.”

    Of course, some high-end jobs in energy will remain, particularly for those who work on massive new projects overseas, like in Saudi Arabia. Instead, the biggest hits will affect the production sector, which until recently was a prodigious creator of high-wage blue-collar jobs. Over the coming years, the production downturn could devastate places like western Texas, the Dakotas, Louisiana, California’s Kern County and anywhere else that produces American crude and gas.

    Indeed, it may turn out to be one of the great ironies that the Obama administration, which campaigned earnestly against our “dependence on foreign oil,” will in the end make us more so. Barring an unexpected shift toward nuclear power, it is hard to see how the country–given the administration’s stance–will produce enough energy to meet its need in the near or even mid-term without turning increasingly to the Saudis and others overseas.

    Of course, the Houston-centered domestic energy industry may not go quietly into the night. The D.C. correspondent for the Energy Compass, Bill Murray, expects a “battle royal” in Congress over climate change legislation this fall.

    Houston Mayor Bill White, who is running for the Senate in 2010, also seems ready to fight the anti-oil and gas prejudices of key administration insiders. Natural gas, he suggests, “has to be a big part of the future if [we] have any chance at all to have electric power that is affordable and cleaner.”

    It is critical to point out that White is not some Neanderthal GOP “ditto head” but a former assistant energy secretary under Bill Clinton, a one-time chairman of the Texas Democratic Party and a widely popular figure in majority non-white Houston. He has a long record championing energy conservation and alternative fuels, but he says he cannot embrace an inquisitional approach to his city’s signature industry.

    “There’s a difference,” he said, with obvious reference to the Democrats in Washington, “between mandating one kind of technology and reality.”

    Yet even if the green Torquemadas have their way, White thinks Houstonians will find a way to keep their city ahead of the country’s other urban sad sacks. Throughout the expansion of recent years, when other cities went on insane spending sprees, Houston has kept the cost of services low and focused on basic infrastructure. Critically, Houston is also among the few big cities that has streamlined its pensions for public employees.

    Houston may also benefit from its historical experience dealing with near-depression conditions. When energy prices collapsed after 1983, the region went through a decade-long recession. The city went from being one of the country’s busiest construction sites to being filled with empty “see-through” office buildings and expanses of foreclosed homes.

    Under another Democratic mayor, the revered Bob Lanier, Houston gamely recovered, without much help from Washington. Lanier and other Houston leaders drove to diversify the economy–particularly in medical services, international trade and manufacturing–by investing in basic infrastructure and keeping costs low.

    “We’ve already lived through one depression,” says local real estate investor David Wolff, who also serves as chairman of the region’s transit agency, Metro. “We have already learned humility, and we have learned how to prepare for the world when everything shifts under our feet.”

    So despite all the problems surrounding energy and the encroaching recession, Houstonians continue to be cautiously optimistic about their future.

    They still excel at all the hallmarks of a progressive economy, such as improving both road and rail transport, reforming the school system and working to expand new industries, such as medical services, that have not yet been targeted by the Obamamians.

    To be sure, Houston, which missed the Bush recession, is beginning to feel the pain during the new administration’s watch. But Houstonians long have displayed remarkable grit and creativity in the face of tough times. Having survived catastrophic energy price declines, several huge hurricanes and endless humid summers, Houston is still among the best bets to survive these tough times and come out, in the end, a strong winner.

    This article originally appeared at Forbes.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • Fantasy Default Scenarios

    Imagine the following scenario. John, Paul, Ringo and George are the only members of a society and each has amassed a pile of currency over his lifetime. John and Paul each have 100 utils, Ringo has 300 utils and George has 500 utils. All told, the size of the entire system is 1000 utils.

    John and Paul decide to enter into a private contract. Under the terms of their agreement and in exchange for an apartment on the ultra-hip Upper West Side, John will pay Paul 40 utils up-front, 1 util a month for 5 years, and 1,000 utils in a lump sum at year 5. While the insanity of such a contract is undisputed, there are two approaches for a government to take once the impossibility of its satisfaction becomes clear.

    The first, simpler and more sane approach allows the two parties to work out an eventual default between themselves. In fact, most economic systems, like ours, anticipate these types of failures and have time-honored methodologies for dealing with them once they occur.

    Approach two — the one that seems to be favored by our government at every turn — turns on the printing press, prints enough additional money and hands it to Paul (the non-defaulting party) in satisfaction of John’s (the defaulting party) obligation. While the second approach appears charitable and seems noble enough, it has ramifications throughout the entire society. John and Paul might both be satisfied that their contract can be completed. Ringo and George, however, will each have their share of the society’s resources seriously diluted by the government’s action.

    By virtue of the government’s actions in our little story, George’s ownership of the society’s resources falls by half from 500 of 1000 utilts at the beginning of our story to 500 of 2000 utils at the end — all by virtue of the bad behavior of other societal actors and the government’s choice of response.

    I bet that, upon reflection, George might favor of the first approach!

  • Many Investors Have More to Gain by Letting Your Mortgage or Company Fail

    I hate to say “I told you so” but… I told you so. The holders of the credit default swaps (CDS) have more to gain from the failure of the borrower than from accepting payments.

    Bloomberg is reporting a strategy at Citigroup, Inc. to do just that. In one example, they can buy up Six Flags bonds at 20.5 cents on the dollar, pay a small premium to get the CDS and then collect the full face value of the bonds when Six Flags files for bankruptcy – which the CDS holder can be sure happens.

    Normally, before a company goes into bankruptcy, they would meet with the debt holders to try to re-negotiate their debt. Debt holders will usually do this because they have more to gain from the company remaining in operation than otherwise. Sometimes, the company may even get them to exchange their debt for equity, provided there is a good business model that has the potential for future earnings.

    Now, as I’ve described repeatedly, the CDS holders have more to gain from the bankruptcy because they will get their entire investment paid back, with interest, not from the company that issued the debt but from another company that issued the CDS – some company like, for example, AIG!

    Speaking of AIG, there was very little coverage of the Senate Committee hearing Thursday (3/5/2009): “American International Group: Examining what went wrong, government intervention, and implications for future regulation.” It was a stunner! Bottom line? Senator Jim Bunning (R-KY) told the panelists that if they asked for another dime for AIG, “You will get the biggest ‘no’” ever heard. The entire committee was incredulous that Federal Reserve Vice Chairman Donald Kohn point-blank refused to tell them 1) who is benefiting from the AIG payouts on CDS and 2) how much more is it going to cost to bailout AIG.

    Stand by, because home foreclosures are on the same course as Six Flags: homeowners attempting to re-negotiate their debt will find that somewhere in the background, a CDS holder has more to gain from the foreclosure because they will get their entire investment paid back, with interest, not from the homeowners but from some company that issue CDS – some company like, for example, AIG!

  • One Fundamental Problem: Too Many People Own Homes

    Ben Bernanke made the following statement as he attempted to justify bailing out bad borrowers:

    “…from a policy point of view, the large amount of foreclosures are detrimental not just to the borrower and lender but to the broader system. In many of these situations we have to trade off the moral hazard issue against the greater good.” – Ben Bernanke, February 25, 2009

    I think he is wrong on this, and the moral hazard issue is only a small part of my objections.

    One of the fundamental problems we have right now is that too many people own homes. It sounds harsh, but please bear with me a few sentences. I think we can agree that 100 percent home ownership is not possible, or even desirable. Most of us can remember a time when our income and our jobs were such that home ownership was a bad idea. Home ownership is a commitment that requires a significant amount of stability and discipline. Not everyone is so stable or has the discipline to keep up with the payments.

    What is an appropriate national homeownership rate? Theory gives us no answer. We look to the data for a clue. Here’s a chart of home ownership rates since 1968:

    It seems pretty clear that a homeownership rate between 63 percent and 65 percent works pretty well. When we get above that range, problems seem to crop up. This was true in 1980 – the worst recession of the past 30 years – and it is true now.

    In light of these data, let’s think about what Bernanke is saying. He’s arguing that to execute the foreclosures required to move the rate back to that 63 percent to 65 percent range are bad for the economy. So bad in fact, that we’re better off not going there.

    The problem with that argument lies in a lack of historic understanding of the proper levels of homeownership. Financial and real estate markets can’t stabilize until we get closer to that equilibrium. Until we lower the home ownership rate, financial institutions will have a cloud around them, and residential real estate markets will be lifeless. It may not be politically popular, but those are the realities.

    This is a critical issue. For years, economists have believed that the failure of banks to recognize and remove bad assets contributed to Japan’s long period of economic malaise. I agree. Forbearance on bad real estate loans here in the states constitutes much the same thing. Our financial institutions are holding a bunch of bad assets; these are homes that are owned by people who can not afford them – never did, and likely never will. Until the financial institutions recognize those bad assets and get them off their books, our financial institutions won’t have the resources to fund, stabilize and then drive a broader economic recovery.

    What we need is not more mindless beneficence to everyone from Wall Street to Detroit and Main Street. The more we bailout failed financial institutions, automobile manufactures, or any business, the longer we postpone our recovery.

    Recessions are periods when assets are reallocated from less productive to more productive uses. That requires processes like repossession, foreclosure, mergers, and bankruptcy. These processes have been developed over centuries. They are the most efficient methods to restore an economy.

    Why are we suddenly abandoning these processes that have proved themselves in many business cycles? I suppose part of it is the desire to eliminate the business cycle. This is the same thinking that had many – including conservatives – arguing that stocks could not fall during the dot.com bubble or that housing prices would also move up.

    In reality the business cycle can not be eliminated. It can’t be done and it is pure hubris to try. One of the fundamental insights to come out of Real Business Cycle research is that recessions constitute the most efficient response to a negative shock.

    We need to stop wasting resources trying to stem the tide. Instead, let us allow the recession to work for us. In the meantime we can provide a backstop through unemployment benefits and some reasonable fiscal stimulus. But we have to experience some pain and let our processes and institutions work for us. The sooner we get these foreclosures, repossessions, mergers, and bankruptcies behind us, the sooner we will see a return to the only sure cure for a sick economy: real economic growth.

    Bill Watkins, Ph.D. is the Executive Director of the Economic Forecast Project at the University of California, Santa Barbara. He is also a former economist at the Board of Governors of the Federal Reserve System in Washington D.C. in the Monetary Affairs Division.

  • Want to Foreclose? Show Me the Paper!

    Since October 2008 I’ve been writing here about problems in mortgage backed securities (MBS). There is more evidence surfacing in bankruptcy courts that the paperwork for the underlying mortgages wasn’t provided correctly for the new bond holders, leading to delayed or denied foreclosure proceedings.

    New York Times’ Gretchen Morgenson is reporting new successes in cases from Florida and California. A judgment on a home in Miami-Dade County (FL) was set aside on February 11 when the new mortgage holder could not produce evidence that the original mortgage lien had been assigned. In one of the California cases, the lender tried for foreclose on a mortgage that had previously been transferred to Freddie Mac!

    The earliest decision I’ve seen is from Judge Christopher A. Boyko in Cleveland. Plaintiff Deutsche Bank’s attorney argued, “Judge, you just don’t understand how things work.” In his October 31, 2007 decision to dismiss a foreclosure complaint, Boyko responded that this “argument reveals a condescending mindset and quasi-monopolistic system” established by financial institutions to the disadvantage of homeowners. The Masters of the Universe were anxious to pump out mortgages into MBS so they could continue to earn fees – making money at any cost.

    One element of the newest Homeowner Bailout program is to allow bankruptcy court judges to modify mortgage loans. If the types of cases decided in OH, FL and CA continue to spread, that may not be necessary. The first question in any foreclosure procedure will become: can you prove a lien?

    This raises further questions about those “toxic assets” that Geithner and Bernanke are so anxious to buy up at taxpayer expense. According to the Morgenson article, some MBS holders are trying to force the mortgage originator to take back the paper. However, many of the worst offenders are already defunct.

  • Bernanke: Junkmeister Hides the Truth

    Federal Reserve Chairman Ben Bernanke testified before the Senate Budget Committee on Tuesday (March 3, 2009), the day after it was announced that AIG would be back at the federal teat for another $30 billion. The generally subdued Senate was nonetheless forceful in getting Bernanke to admit several things:

    • The Fed and Treasury are using the same three rating agencies to help them select triple-A collateral for bailout lending as were used to get triple-A credit ratings for junk mortgage bonds;
    • Neither the Fed nor the Treasury will tell us all the companies that are getting bailout money;
    • There is no “outer limit” to how much money the US government can print;
    • No one knows the “outer limit” of how much money the US government can borrow;
    • The “too big to fail” policy is a bigger problem than anyone thought it could be;
    • No one was in charge of AIG – not bank regulators, insurance regulators or capital market regulators.

    When asked about AIG several times, Bernanke replied that it’s “uncomfortable for me, too.” Through some hole in the regulations, the insurance regulators had no authority to monitor the financial products activities of AIG. Explained simply and bluntly, the world’s largest insurance company sold credit default swaps (CDS, insurance against default) on the junk bonds issued from mortgages and consumer purchases. Many of those mortgages and consumer purchases were made foolishly – when the borrowers failed to repay the loans the bonds also failed. The people and companies that bought CDS on those bonds did not look too closely at AIG to see what would happen if the bonds failed. As it turns out, they didn’t have to worry about AIG failing – AIG was deemed too big to fail.

    When the bonds defaulted and the buyers of CDS protection (“counterparties”) turned to AIG for payment, AIG turned to the federal government for help. The AIG bailout has cost $180 billion so far for which the US government owns 80 percent of a company that lost $61.7 billion in three months (for a total of $99.29 billion in 2008, an amount equal to all of their profits back to about 1990).

    Here’s a tough question: Why won’t the Fed disclose who is benefitting from the CDS payoffs? Bernanke made a comparison between your grandmother and AIG: like the owners of life insurance policies, the purchasers of financial insurance “made legal legitimate financial transactions. They have a right to privacy about their financial condition.” In other words, no one should know how much life insurance your grandmother has. That’s why the Fed won’t tell us who bought the CDS insurance on junk bonds! Senator Ron Wyden (D-OR) asked him to “come clean.” Senator Bernard Sanders (I-VT) asked point blank: tell us who got the $2.2 trillion loaned by the Fed. He got a one word response for his troubles: “no.”

    Bernanke said, “AIG made me angry…This was a hedge fund attached to an insurance company. We had to step in, we really had no choice. It’s a terrible situation, but we aren’t doing this to bailout AIG, we’re doing it to protect the broader economy.”

    Here’s how you connect the dots from AIG to main street: AIG is an insurance company and insurance companies are among the “safe” investments that money market mutual funds are allowed to invest their cash in – in fact most funds are required to keep some portion of their assets in these supposedly risk-free investments.

    Basically, this requirement is there to make sure that cash will be available to meet the withdrawal requests from investors. Now, money market mutual funds and mutual funds are a favorite investment for retirement money, including the 401k plans that many people have through their employers. But also, your employer’s retirement plan money is likely also invested in these funds. Pensions can hold stocks and bond directly, but as the size of these plans gets bigger and bigger, it becomes increasingly difficult for one or a few investment managers to handle everything. The California State Teachers Retirement System and the California Public Employees Retirement System (Cal STRS and Cal PRS, for short), the largest pension funds in the world, have $160 billion and $180 billion in assets to invest. So, propping up AIG means that the investments made in the stocks, commercial paper, policies, etc. issued by AIG will not collapse and take with them the retirement assets of many millions of Americans.

    In the final round of questions, Senators Warner (D-VA) and Wyden (D-OR) were especially clear on the point of finding out who is benefitting from the bailout of AIG. AIG was a good insurance company, Warner said, but their London-based financial products division started selling CDS into Europe. Now, American taxpayers are being asked to pick up the tab. Why does AIG continue to make the payouts when they require federal money to continue to exist? The Senators suggested that, at a minimum, Americans deserve to know who is benefitting from the CDS payouts. “It’s time for some sunlight.”

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Democrats Could Face an Internal Civil War as Gentry and Populist Factions Square Off

    This is the Democratic Party’s moment, its power now greater than any time since the mid-1960s. But do not expect smooth sailing. The party is a fractious group divided by competing interests, factions and constituencies that could explode into a civil war, especially when it comes to energy and the environment.

    Broadly speaking, there is a long-standing conflict inside the Democratic Party between gentry liberals and populists. This division is not the same as in the 1960s, when the major conflicts revolved around culture and race as well as on foreign policy. Today the emerging fault-lines follow mostly regional, geographical and, most importantly, class differences.

    Gentry liberals cluster largely in cities, wealthy suburbs and college towns. They include disproportionately those with graduate educations and people living on the coasts. Populists tend to be located more in middle- and working-class suburbs, the Great Plains and industrial Midwest. They include a wider spectrum of Americans, including many whose political views are somewhat changeable and less subject to ideological rigor.

    In the post-World War II era, the gentry’s model candidate was a man such as Adlai Stevenson, the Democratic presidential nominee who lost twice to Dwight D. Eisenhower. Stevenson was a svelte intellectual who, like Barack Obama, was backed by the brute power of the Chicago machine. After Stevenson, the gentry supported candidates such as John Kennedy – who did appeal to Catholic working class voters – but also men with limited appeal outside the gentry class, including Eugene McCarthy, George McGovern, Gary Hart, Bill Bradley, Paul Tsongas and John Kerry.

    Hubert Humphrey, a populist heir to the lunch-pail liberalism of Harry Truman (and who was despised by gentry intellectuals) missed the presidency by a hair in 1968. But populists in the party later backed lackluster candidates such as Walter Mondale and Dick Gephardt.

    Bill Clinton revived the lunch-pail Democratic tradition; and the final stages of last year’s presidential primaries represented yet another classic gentry versus populist conflict. Hillary Clinton could not match Barack Obama’s appeal to the gentry. Driven to desperation, she ended up running a spirited populist campaign.

    Although peace now reigns between the Clintons and the new president, the broader gentry-populist split seems certain to fester at both the congressional and local levels – and President Obama will be hard-pressed to negotiate this divide. Gentry liberals are very “progressive” when it comes to issues such as affirmative action, gay rights, the environment and energy policy, but are not generally well disposed to protectionism or auto-industry bailouts, which appeal to populists. Populists, meanwhile, hated the initial bailout of Wall Street – despite its endorsement by Mr. Obama and the congressional leadership.

    Geography is clearly a determining factor here. Standout antifinancial bailout senators included Sens. Byron Dorgan of North Dakota, Tim Johnson of South Dakota, and Jon Tester of Montana. On the House side, the antibailout faction came largely from places like the Great Plains and Appalachia, as well as from the suburbs and exurbs, including places like Arizona and interior California.

    Gentry liberals, despite occasional tut-tutting, fell lockstep for the bailout. Not one Northeastern or California Democratic senator opposed it. In the House, “progressives” such as Nancy Pelosi and Barney Frank who supported the financial bailout represent districts with a large concentration of affluent liberals, venture capitalists and other financial interests for whom the bailout was very much a matter of preserving accumulated (and often inherited) wealth.

    Energy and the environment are potentially even more explosive issues. Gentry politicians tend to favor developing only alternative fuels and oppose expanding coal, oil or nuclear energy. Populists represent areas, such as the Great Lakes region, where manufacturing still plays a critical role and remains heavily dependent on coal-based electricity. They also tend to have ties to economies, such as in the Great Plains, Appalachia and the Intermountain West, where smacking down all new fossil-fuel production threatens lots of jobs – and where a single-minded focus on alternative fuels may drive up total energy costs on the farm, make life miserable again for truckers, and put American industrial firms at even greater disadvantage against foreign competitors.

    In the coming years, Mr. Obama’s “green agenda” may be a key fault line. Unlike his notably mainstream appointments in foreign policy and economics, he’s tilted fairly far afield on the environment with individuals such as John Holdren, a longtime acolyte of the discredited neo-Malthusian Paul Ehrlich, and Carol Browner, who was Bill Clinton’s hard-line EPA administrator.

    These appointments could presage an environmental jihad throughout the regulatory apparat. Early examples could mean such things as strict restrictions on greenhouse gases, including bans on new drilling and higher prices through carbon taxes or a cap-and-trade regime.

    Another critical front, not well understood by the public, could develop on land use – with the adoption of policies that favor dense cities over suburbs and small towns. This trend can be observed most obviously in California, but also in states such as Oregon where suburban growth has long been frowned upon. Emboldened greens in government could use their new power to drive infrastructure spending away from badly needed projects such as new roads, bridges and port facilities, and toward projects such as light rail lines. These lines are sometimes useful, but largely impractical outside a few heavily traveled urban corridors. Essentially it means a transfer of subsidies from those who must drive cars to the relative handful for whom mass transit remains a viable alternative.

    Priorities such as these may win plaudits in urban enclaves in New York, Boston and San Francisco – bastions of the gentry class and of under-35, childless professionals – but they might not be so widely appreciated in the car- and truck-driving Great Plains and the vast suburban archipelago, where half the nation’s population lives.

    If he wishes to enhance his power and keep the Democrats together, Mr. Obama will have to figure out how to placate both his gentry base and those Democrats who still see their party’s mission in terms that Harry Truman would have understood.

    This article originally appeared at Wall Street Journal.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • Why Homeownership Is Falling – Despite Lower Prices: Look to the Job Market

    By Susanne Trimbath and Juan Montoya

    There’s something about “Housing Affordability” that makes it very popular: Presidents past and present set goals around it. The popularity of this perennial policy goal rests on the feel-good idea that everyone would live in a home that they own if only they could afford it. Owning your own home is declared near and far to be the American Dream.

    Recently, however, it seems that Americans’ aren’t all having the same dream. Despite improving conditions of affordability, home sales continue to decline. Affordability is balanced on a tripod of prices, incomes and interest rates. As incomes become unstable because of mounting job losses, housing falls further out of balance – no change in price or mortgage interest rates will be enough to rebalance the tripod within the next twelve to eighteen months,

    In a new study on Homeownership Affordability we identify two anomalies in the data: home sales are falling as housing affordability is rising; and the rate of homeownership since 2004 has fallen despite the apparent “boom” in housing.

    Rising Affordability with Falling Sales

    In the last three years, the average mortgage interest rate was 6.14%. Such historically low rates should improve affordability compared to, say, the time of the 1990s credit crunch when mortgage rates averaged 9.3%. Leading up to 2007, median income in the US rose by 0.6% and median home prices fell by 3.1% – also a positive indicator for affordability. The mortgage payment to income ratio at the median has fallen to about 23%. Compared to 32% in 2002 and even 40% in 1988, just before the 1990s credit crunch, this should be a very positive indicator for homeowner affordability. Yet, new home sales have plummeted from a rate of about 1.4 million per year in the summer of 2005 to less than 500,000 by the end of 2008.

    In 2007, for every 1% improvement in affordability, home prices fell by 2%. There clearly has been a breakdown in the fundamental relationship between supply and demand. Why? It appears potential buyers are concerned that homes are over-priced and, worse yet, that home price declines will increase in the future. There are indications that some households think that homes are over-priced regardless of affordability and, furthermore, not everyone who can afford a home is interested in buying one. Some communities, some jobs and some lifestyles are better suited to renting.

    Ownership Policies with Falling Ownership

    All this has occurred in the face of conscious federal policy. Expanding homeownership opportunities, especially for minorities, was a fundamental aim of the Bush Administration’s housing policy – one strongly supported by Democrats in Congress. In June 2002, HUD announced a new goal to increase minority homeownership by 5.5 million by the end 2010. Hispanics were the only minorities to have clear gains in homeownership through 2008: a 4.1 percentage point increase compared to the end of the last decade. The gains in homeownership for black Americans was about the same as for the nation as a whole. Yet the ownership rate for the nation as a whole declined by almost 1 percent during the more recent “housing bust” years.

    Some regions saw bigger losses in homeownership than others, especially those outside the urban areas and particularly in the Midwest.

    Where do we go from here?

    We believe the analytical focus needs to shift to employment when analyzing housing for individual states, regions or cities. The accompanying table shows where, at the state level, the workforce is shrinking as unemployment is rising. These are the areas, much like Southern California at the end of the Cold War or Houston after the 1980s bust in oil prices, that will suffer potentially devastating drops in home prices as a result of forced sales by departing labor.

    Supply, demand and pricing, the cost of financing, household income and home prices – all are critical factors in the equation of homeownership. But more than anything we believe that mounting job losses, in addition to a declining stock market, will now play the critical role. Over time, the current credit crisis will not only make funds more scarce – which must eventually drive up the price of credit – but also drive up the risk premium demanded by lenders. Growing job uncertainty will increase the price of credit even further.

    These factors alone will negatively impact affordability in the future. Keeping mortgage rates artificially low (for example, as the Federal Reserve buys up mortgage-backed securities as proposed in Congress) will create upward pressure on prices, which in turn will hurt affordability. Additionally, we see continued imbalances in the supply-demand equation as foreclosures add inventory to the market.

    In the coming 12 to 18 months, we believe that interest rates will rise and incomes will, at best, remain flat in the face of the global recession. More importantly, as job losses mount, “affordability” will be less important and “maintainability” – the ability of homeowners to keep their homes in the face of unemployment – will emerge as a major factor. In the meantime, housing affordability will hang precariously out of balance due to falling incomes and decreasing jobs as well as surging real interest rates.

    State Change in Total Workforce and Unemployed
    State
    %change in number of workforce
    %change in number of unemployed
    Unemployment rate as of Dec. 2008
    Michigan -1.9% 39.7% 10.6%
    Rhode Island -1.8% 88.1% 10.0%
    Alabama -1.8% 75.3% 6.7%
    Illinois -1.5% 40.3% 7.6%
    West Virginia -1.3% 4.6% 4.9%
    Mississippi -1.1% 25.6% 8.0%
    Missouri -0.8% 37.6% 7.3%
    Tennessee -0.4% 59.4% 7.9%
    Ohio -0.3% 33.8% 7.8%
    Arkansas -0.1% 12.7% 6.2%
    New Hampshire -0.1% 33.6% 4.6%
    Utah -0.1% 51.8% 4.3%
    Delaware 0.0% 75.3% 6.2%
    Wisconsin 0.1% 27.8% 6.2%
    Maryland 0.1% 63.4% 5.8%
    Kentucky 0.3% 48.4% 7.8%
    Iowa 0.3% 20.7% 4.6%
    Massachusetts 0.4% 61.1% 6.9%
    Idaho 0.4% 142.6% 6.4%
    Colorado 0.4% 53.8% 6.1%
    Georgia 0.5% 78.3% 8.1%
    Montana 0.5% 68.9% 5.4%
    Maine 0.6% 44.5% 7.0%
    Minnesota 0.6% 47.6% 6.9%
    South Dakota 0.6% 35.4% 3.9%
    North Carolina 0.7% 87.4% 8.7%
    Indiana 0.7% 86.0% 8.2%
    Connecticut 0.7% 48.0% 7.1%
    Florida 0.8% 80.9% 8.1%
    New York 1.0% 51.9% 7.0%
    North Dakota 1.0% 8.5% 3.5%
    Vermont 1.1% 66.9% 6.4%
    Nebraska 1.2% 46.0% 4.0%
    Wyoming 1.3% 12.4% 3.4%
    New York City 1.4% 47.2% 7.4%
    Kansas 1.5% 27.4% 5.2%
    South Carolina 1.6% 55.3% 9.5%
    California 1.8% 60.4% 9.3%
    Virginia 1.8% 69.2% 5.4%
    New Jersey 1.9% 72.8% 7.1%
    Hawaii 2.0% 82.9% 5.5%
    Oklahoma 2.1% 21.7% 4.9%
    Louisiana 2.2% 52.6% 5.9%
    New Mexico 2.2% 56.2% 4.9%
    Alaska 2.4% 22.4% 7.5%
    Pennsylvania 2.4% 55.7% 6.7%
    Washington 2.6% 60.0% 7.1%
    Texas 2.6% 45.9% 6.0%
    Oregon 2.8% 70.4% 9.0%
    Arizona 3.4% 72.0% 6.9%
    Nevada 4.9% 84.6% 9.1%
    Average 0.8% 53.2% 6.7%
    Median 0.7% 52.6% 6.9%

    Dr. Trimbath is a former manager of depository trust and clearing corporations in San Francisco and New York. She is co-author of Beyond Junk Bonds: Expanding High Yield Markets (Oxford University Press, 2003), a review of the post-Drexel world of non-investment grade bond markets. Dr. Trimbath is also co-editor of and a contributor to The Savings and Loan Crisis: Lessons from a Regulatory Failure (Kluwer Academic Press, 2004)

    Mr. Montoya obtained his MBA from Babson College (Wellesley, MA) and is a former research analyst at the Milken Institute (Santa Monica, CA) where he coauthored Housing Affordability in Three Dimensions with Dr. Trimbath. He currently works in the foodservice industry.

  • Oh, Canada? A Safe-Haven for Banking Investments

    Looking for a safe haven for your banking investments? The Royal Bank of Canada is about three times the size of Citigroup, Royal Bank of Scotland or Deutsche Bank – and they haven’t cut their dividend in more than 70 years. Although Canadian banking profits declined double-digits last year, they actually had profits. Pretty much the rest of the world’s banks are reporting massive losses.

    It seems the folks above the 49th parallel have been fiscally responsible. According to a story on Bloomberg.com “not one government penny” has been needed to support any Canadian bank “from British Columbia to Quebec” since the financial meltdown began in 2007. Not that the Canadian government left them out in the cold, either. A $C218 billion fund was set up last October – ostensibly to be sure Canadian banks could compete in international markets with all the government-backed banks in the rest of the world – but none of the banks took any of it.

    According to Bloomberg, European governments “committed more than 1.2 trillion Euros ($1.5 trillion) to save their banking systems from collapse.” As close as I can tell, between the Federal Reserve and Treasury, the US has poured over $3 trillion down the drain of financial institutions.

    (To understand the complications in calculating an exact U.S. amount, see my earlier articles for more information on how the Federal Reserve Bank of New York, under now-Secretary of the Treasury Tim Geithner, funneled money through Delaware limited liability companies to non-bank entities.)

    Only 7 banks in the world have triple-A credit ratings – 2 of them are Canadian. While the rest of the developed, industrial nations are pouring hundreds of billions each down the black hole that is their financial systems, our Neighbors to the North were engaging in “solid funding and conservative consumer lending.”

    Canada is the only member of the G-7 to have balanced their budget 11 years in a row. Immigrating to Canada is looking like a better idea all the time.

  • Not Everyone is Playing the TARP Game

    Banks in Connecticut, once interested in accepting funds from the Trouble Asset Relief Program, are now “questioning whether it’s worth participating in the program.”

    Concerns over the undefined terms and changing conditions imposed on those accessing TARP money has made the banks uneasy about such long-term commitments.

    President and CEO of Connecticut River Community Bank, William Attridge, said that the fundamental problem with the program is its open-endedness and the reliance on total-compliance from the banks regardless of any future changes.

    President Obama and members of Congress “are under public pressure to toughen conditions on the TARP money in order to improve the poor public image.”

    The TARP program was originally created with the intent to “revive bank lending” according to Treasury officials. However, with the obscure terms and conditions currently associated with the program, some argue we’ve lost sight of TARP’s original purpose.

    With approximately $293.7 billion in TARP funds distributed as of Jan. 23, undefined regulation doesn’t have all banks protesting.

    Some smaller bank feel that increased capital will help the banks “continue to steal market shares from larger banks and help offset inevitable weaknesses among borrowers due to the recession.”

    It remains to be seen whether or not the Connecticut bankers will take TARP money, but too many unknowns and perceived risks will certainly be factors in its approval.