Monday, August 13, 2007

US Housing Meltdown.

"But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums" - Alan Greenspan, 2005.

4-7 million Americans will lose their homes in the coming months.

Given the fervour we are seeing in our housing market, I think the American situation offers many lessons. It has taken me a long time and plenty of reading to get a handle what is going on in the US. It is a tragedy for many Americans and can potentially turn into something ugly for all of us if Bernanke is not skillful at handling this situation. It reminded me of my cousin and her husband who bought a $750,000 condo on a household income of $5000 in 1996 at the height of our own property bubble. They had to endure alot of pain when the construction sector where they were employed slowed they saw their incomes falling.......banks hike interest rates to a whopping 8% during the Asian crisis they struggled to keep their home. They pulled through and are in better financial shape today but buying that condo burned a hole in their pocket that took about a decade to overcome.

The best video I've seen on the current US housing meltdown is an interview with Pulitzer-prize winning business reporter Gretchen Morgenson. For those who want to understand the current situation and its implications, this video is highly recommended:


Anonymous said...

The housing bubble will come as no surprise if you've been following Paul Krugman's NYT columns. He has been talking about this since 2002. That's the same guy who saw the Asian financial crisis coming long before everybody else. Every few weeks, Krugman will discuss some aspects of the housing bubble, usually alongside some other topics, in his biweekly columns. Here's a small selection (there are many more):

These are only the earlier ones (before October 2005). The recent ones you'll need a TimeSelect password to read.

LuckySingaporean said...

I've seen Krugman's interview on this in Sep 2006. I know about the housing bubble from the onset.

Bubbles come and go. They are interesting always. But the US housing bubble is not just a bubble...the Singapore housing bubble in 1996 was even BIGGER....if you look at the price appreciation. The Japanese bubble in the 80s even bigger than ours.

I just find the new inventions like ARMs, Subprime loans, mortgage brokers, CDOs etc very interesting. They are nearly fraudulant - cheating the small guy. The story is not just a bubble but how 4 million americans will be homeless because they were 'cheated'.

Singapore had a bubble in 1996. People borrowed from banks...they were too eager to buy. Many speculators got burnt....when PM Lee (then heading MAS) step in and prick the bubble. There was no fraud, no cheating, no interesting stuff like ARM, CDOs, ...etc.

Anonymous said...

The bottom line of CDOs, explained lucidly in 740 words by the master of Economics exposition.

Just Say AAA
July 2, 2007

What do you get when you cross a Mafia don with a bond salesman? A dealer in collateralized debt obligations (C.D.O.'s) -- someone who makes you an offer you don't understand.

Seriously, it's starting to look as if C.D.O.'s were to this decade's housing bubble what Enron-style accounting was to the stock bubble of the 1990s. Both made investors think they were getting a much better deal than they really were. And the new scandal raises two obvious questions: Why were the bond-rating agencies taken in (again), and where were the regulators?

To understand the fuss over C.D.O.'s, you first have to realize that in the later stages of the great 2000-2005 housing boom, banks were making a lot of dubious loans. In particular, there was an explosion of subprime lending -- home loans offered to people who wouldn't normally have been considered qualified borrowers.

For a while, the risks of subprime loans were masked by the housing bubble itself: as long as prices kept going up, troubled borrowers could raise more cash by borrowing against their rising home equity. But once the bubble burst -- and the housing bust is turning out to be every bit as nasty as the pessimists predicted -- many of these loans were bound to go bad.

Yet the banks making the loans weren't stupid: they passed the buck to other people. Subprime mortgages and other risky loans were securitized -- that is, banks issued bonds backed by home loans, in effect handing off the risk to the bond buyers.

In principle, securitization should reduce risk: even if a particular loan goes bad, the loss is spread among many investors, none of whom takes a major hit. But with the collapse of the $800 billion market in bonds backed by subprime mortgages -- the price of a basket of these bonds has lost almost 40 percent of its value since January -- it's now clear that many investors who bought these securities didn't realize what they were getting into.

And it's also becoming clear that in addition to failing to appreciate the risks of subprime loans, many investors were fooled by fancy financial engineering -- those collateralized debt obligations -- into believing they had protected themselves against risk, when they had actually done no such thing.

The details of C.D.O.'s are complicated, but basically they're supposed to transfer most of the risk of bad loans to a small group of sophisticated investors, who are compensated for that risk with a high rate of return, while leaving other investors with a ''synthetic'' asset that is, well, safe as houses.

S.& P., Moody's and Fitch, the bond-rating agencies, have gone along with the premise, telling investors that the synthetic assets created by C.D.O.'s are equivalent to high-quality corporate bonds. And investors have, in the words of a recent Bloomberg story, ''snapped up'' these securities ''because they typically yield more than bonds with the same credit ratings.''

But the securities were never as safe as advertised, because the risk transfer wasn't anywhere near big enough to protect investors from the consequences of a burst housing bubble. It's not quite the metaphor I would have come up with, but here's what the legendary bond investor Bill Gross had to say about C.D.O.'s in Pimco's latest ''Investment Outlook'':

''AAA? You were wooed Mr. Moody's and Mr. Poor's by the makeup, those six-inch hooker heels, and a 'tramp stamp.' Many of these good-looking girls are not high-class assets worth 100 cents on the dollar.''

Now we're looking at huge losses to investors who thought they were playing it safe. Estimates of the likely losses on C.D.O.'s range from $125 billion to $250 billion, with some analysts warning that a wave of distress selling will deepen the housing slump even further.

Now, you might have thought that S.& P. and Moody's, which gave Thailand an investment-grade rating until five months after the start of the Asian financial crisis, and gave Enron an investment-grade rating until days before it went bankrupt, would by now have learned to be a bit suspicious. And you would think that the regulators, in particular the Federal Reserve, would have learned from the stock bubble and the wave of corporate malfeasance that went with it to keep a watchful eye on overheated markets.

But apparently not. And the housing bubble, like the stock bubble before it, is claiming a growing number of innocent victims.

Anonymous said...

Here's another one about the impending liquidity crisis.

Very Scary Things
August 10, 2007

In September 1998, the collapse of Long Term Capital Management, a giant hedge fund, led to a meltdown in the financial markets similar, in some ways, to what’s happening now. During the crisis in ’98, I attended a closed-door briefing given by a senior Federal Reserve official, who laid out the grim state of the markets. “What can we do about it?” asked one participant. “Pray,” replied the Fed official.

Our prayers were answered. The Fed coordinated a rescue for L.T.C.M., while Robert Rubin, the Treasury secretary at the time, and Alan Greenspan, who was the Fed chairman, assured investors that everything would be all right. And the panic subsided.

Yesterday, President Bush, showing off his M.B.A. vocabulary, similarly tried to reassure the markets. But Mr. Bush is, let’s say, a bit lacking in credibility. On the other hand, it’s not clear that anyone could do the trick: right now we’re suffering from a serious shortage of saviors. And that’s too bad, because we might need one.

What’s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in stuff that is normally traded all the time — in particular, financial instruments backed by home mortgages — have shut down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.

The origins of the current crunch lie in the financial follies of the last few years, which in retrospect were as irrational as the dot-com mania. The housing bubble was only part of it; across the board, people began acting as if risk had disappeared.

Everyone knows now about the explosion in subprime loans, which allowed people without the usual financial qualifications to buy houses, and the eagerness with which investors bought securities backed by these loans. But investors also snapped up high-yield corporate debt, a k a junk bonds, driving the spread between junk bond yields and U.S. Treasuries down to record lows.

Then reality hit — not all at once, but in a series of blows. First, the housing bubble popped. Then subprime melted down. Then there was a surge in investor nervousness about junk bonds: two months ago the yield on corporate bonds rated B was only 2.45 percent higher than that on government bonds; now the spread is well over 4 percent.

Investors were rattled recently when the subprime meltdown caused the collapse of two hedge funds operated by Bear Stearns, the investment bank. Since then, markets have been manic-depressive, with triple-digit gains or losses in the Dow Jones industrial average — the rule rather than the exception for the past two weeks.

But yesterday’s announcement by BNP Paribas, a large French bank, that it was suspending the operations of three of its own funds was, if anything, the most ominous news yet. The suspension was necessary, the bank said, because of “the complete evaporation of liquidity in certain market segments” — that is, there are no buyers.

When liquidity dries up, as I said, it can produce a chain reaction of defaults. Financial institution A can’t sell its mortgage-backed securities, so it can’t raise enough cash to make the payment it owes to institution B, which then doesn’t have the cash to pay institution C — and those who do have cash sit on it, because they don’t trust anyone else to repay a loan, which makes things even worse.

And here’s the truly scary thing about liquidity crises: it’s very hard for policy makers to do anything about them.

The Fed normally responds to economic problems by cutting interest rates — and as of yesterday morning the futures markets put the probability of a rate cut by the Fed before the end of next month at almost 100 percent. It can also lend money to banks that are short of cash: yesterday the European Central Bank, the Fed’s trans-Atlantic counterpart, lent banks $130 billion, saying that it would provide unlimited cash if necessary, and the Fed pumped in $24 billion.

But when liquidity dries up, the normal tools of policy lose much of their effectiveness. Reducing the cost of money doesn’t do much for borrowers if nobody is willing to make loans. Ensuring that banks have plenty of cash doesn’t do much if the cash stays in the banks’ vaults.

There are other, more exotic things the Fed and, more important, the executive branch of the U.S. government could do to contain the crisis if the standard policies don’t work. But for a variety of reasons, not least the current administration’s record of incompetence, we’d really rather not go there.

Let’s hope, then, that this crisis blows over as quickly as that of 1998. But I wouldn’t count on it.

Anonymous said...

You knew and you still bought last friday?


yokokiko said...

this is the time to buy. i bought some today.

LuckySingaporean said...


Thanks for scaring me. This one looks serious and complex. One can only take comfort in the magnitude of the mess being so big nobody can figure out and hence there is uncertainty.

When there is uncertainty, one can say, the outcome is unknown....and hence can be positive. I hope there is no misuse of the word uncertainty when applied the current turmoil. One can only be cautious, there is no immunity against misery when one takes risk.

I believe things can actually get worse, but I take my chances ...prepared to part with some money should things go wrong.

I note there may be just be a very thin silver lining:

1. Warren Buffett has started buying.

2. US stocks are the cheapest since 1991 (remember there was a crisis then).

Stocks don't become cheap when everything looks rosy. Stocks are sold cheap when people think they will get cheaper. While I believe this is indeed a serious crisis, the immense fear it generates can make investors part with their assets way below what they are worth in the long term. No one can guarantee that I've bought near the bottom, I only know I didn't buy at the peak and did buy when things were expensive.

Cheers...exercise caution but don't be paranoid.

LuckySingaporean said...


You know I had the most unusual luck of buying 1 day before 911 and I still survived....and the stocks I bought then took a big dip after 911 but went on to be big winners.

Today the fear was thick....the market clouded by immense pessimism. Many are sure we are heading towards recession...perhaps we are. As an investor I don't mind recessions because the price of stocks are the best during one. May be we are heading towards depression...even the the great Graham's finances & Keynes' ...didn't survive but don't worry if that happens we will all be poor together.

Today will be remember by many ..a day of slaughter that came after a day of hope (Tuesday). Volatility is evil indeed, it doesn't hesitate to torture the hopes of investors, play with their minds, and extingusih their optimism. I always think of the dangerous ahead, never ever spend a minute on hoping, if volatility cuts me, I'll find a way to walk away and then come back.

Anonymous said...

The stock market is the most risky form of investment after the money market and bonds. Therefore, investment in stocks should come from extra money, money that you do not need now or in the foreseeable future. Do not gamble your coffin money on stocks.

Spare cash at hand should be used to clear debts first. The stock may potentially give you a return of 10% or -10%. But your credit card debt or housing loan is a 100% guaranteed loss of 3% or 5%. So clear your debts first.

Anonymous said...

Looks ike today (and tomorrow) is just as bad.
Do let us know when it is time to walk away. Your fans could sure use your experience.


Passer-by said...

Wont it be good if investors sell all their stocks when the market starts to crash (I know it's hard to predict but you kind of can see it coming when bad news spread and market falls badly over the entire week)and buy it again when the market is slowly recovering. (maybe in near future?)If the stock didnt rise anymore.. Wont it be better when u sold all the stocks long ago when it is still relatively high, instead of having any hopes on it rebounding?

People can ask.. but what if the stocks rise again after tat week or so where i sold all of it.. Yet still, you are able to earn money when the stocks start to rise again.. You can either hop on the fast-growing stock and get a free ride up or invest on some stocks that have yet to rise.

In my opinion, cutting lost is the main point of investing and the stocks will continue to fall.. all the way until the SGX index reaches 1000+ over the next 2years. This is due to panic over all investors, now it is no longer the US housing meltdown that ruined the market, I believe it is more of the fear of everyone that will lead to a bear market.

PLEASE comment on my theory and my way of thinking. I really hope that you all can correct me if I am wrong and bring in some new points that i have miss out or failed to see.
Thank You in advance.

Anonymous said...

Paul Krugman's latest column.

Workouts, Not Bailouts
August 17, 2007

In April, Henry Paulson, the Treasury secretary, declared that all the signs he saw indicated that the housing market was “at or near the bottom.” Earlier this month he was still insisting that problems caused by the meltdown in the market for subprime mortgages were “largely contained.”

But the time for denial is past.

According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in free fall. And if historical relationships are any guide, home prices are still way too high. The housing slump will probably be with us for years, not months.

Meanwhile, it’s becoming clear that the mortgage problem is anything but contained. For one thing, it’s not confined to subprime mortgages, which are loans to people who don’t satisfy the standard financial criteria. There are also growing problems in so-called Alt-A mortgages (don’t ask), which are another 20 percent of the mortgage market. Problems are starting to appear in prime loans, too — all of which is what you would expect given the depth of the housing slump.

Many on Wall Street are clamoring for a bailout — for Fannie Mae or the Federal Reserve or someone to step in and buy mortgage-backed securities from troubled hedge funds. But that would be like having the taxpayers bail out Enron or WorldCom when they went bust — it would be saving bad actors from the consequences of their misdeeds.

For it is becoming increasingly clear that the real-estate bubble of recent years, like the stock bubble of the late 1990s, both caused and was fed by widespread malfeasance. Rating agencies like Moody’s Investors Service, which get paid a lot of money for rating mortgage-backed securities, seem to have played a similar role to that played by complaisant accountants in the corporate scandals of a few years ago. In the ’90s, accountants certified dubious earning statements; in this decade, rating agencies declared dubious mortgage-backed securities to be highest-quality, AAA assets.

Yet our desire to avoid letting bad actors off the hook shouldn’t prevent us from doing the right thing, both morally and in economic terms, for borrowers who were victims of the bubble.

Most of the proposals I’ve seen for dealing with the problems of subprime borrowers are of the locking-the-barn-door-after-the-horse-is-gone variety: they would curb abusive lending practices — which would have been very useful three years ago — but they wouldn’t help much now. What we need at this point is a policy to deal with the consequences of the housing bust.

Consider a borrower who can’t meet his or her mortgage payments and is facing foreclosure. In the past, as Gretchen Morgenson recently pointed out in The Times, the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.

Today, however, the mortgage broker who made the loan is usually, as Ms. Morgenson says, “the first link in a financial merry-go-round.” The mortgage was bundled with others and sold to investment banks, who in turn sliced and diced the claims to produce artificial assets that Moody’s or Standard & Poor’s were willing to classify as AAA. And the result is that there’s nobody to deal with.

This looks to me like a clear case for government intervention: there’s a serious market failure, and fixing that failure could greatly help thousands, maybe hundreds of thousands, of Americans. The federal government shouldn’t be providing bailouts, but it should be helping to arrange workouts.

And we’ve done this sort of thing before — for third-world countries, not for U.S. citizens. The Latin American debt crisis of the 1980s was brought to an end by so-called Brady deals, in which creditors were corralled into reducing the countries’ debt burdens to manageable levels. Both the debtors, who escaped the shadow of default, and the creditors, who got most of their money, benefited.

The mechanics of a domestic version would need a lot of work, from lawyers as well as financial experts. My guess is that it would involve federal agencies buying mortgages — not the securities conjured up from these mortgages, but the original loans — at a steep discount, then renegotiating the terms. But I’m happy to listen to better ideas.

The point, however, is that doing nothing isn’t the only alternative to letting the parties who got us into this mess off the hook. Say no to bailouts — but let’s help borrowers work things out.