Tuesday, March 9, 2010

Recesionary Thoughts

In response to my friend Aretae, who ponders the cause of the current "recession."

The main cause of the real estate bubble was "easy money" from the Fed. The long term cost of money was essentially free, and we all know what the demand for a free service tends toward.

While it is true that the roots of "community lending" started in the Carter Administration the plain fact of the matter is that is does not really matter where it started, the issue was that any loan that qualified for Freddy or Fanny protection was deemed to be "Risk Free".

In other words, all risk was assumed by the government, not the lending institution, so the lender didn't really care how risky the loan was; if the borrower could scrounge up 3% (or zero in some cases) the loan was good.

As a result, a lot of money was chasing low inventory. This caused inflation in the real estate sector. (note I specifically say inflation, not value gain) Due to rapidly rising prices, some folks started panicking and buying houses "while they still could" while others took advantage of rising "values" and cheap 4% loans to cash out equity.

New vehicle sales were running over 16 minion units during the real estate boom. That's not sustainable long term. The US normally absorbs about 13-14 million units a year. The extra 2-3 million came from people refinancing to buy new cars. (not speculation, it's the only source of free money available on such a scale)

The big auto makers expanded production to meet the new demand, which means they now are capable of building 20% more cars than the nation normally buys, and 40% more than when the crash finally came.

The extra capacity in the system is equivalent to one of the bigger auto makers, either everyone has to take a 20% hit or Chrysler has to go away. No amount of government bailout can change the fundamental calculus that there is simply too much capacity in the system.

The above is uncontestable.

Personally I think the best thing would have been to let Chrysler die an ignominious death. (and sell the Jeep brand name off to Ford)

Mark's theory on why things are still screwed up: (which is obviously contestable)

Currently the drag on the overall economy is the fact that real estate is in neutral, popped the clutch, high centered, or insert your favorite automotive metaphor here.

80% of the market is short sales. Short sales take on average 3-4 months to get an answer back on an offer. Very few people are willing to wait 4 months to hear yes/no/maybe. As a result the handful of foreclosures and traditional sales get multiple competing offers on the first day of listing. Unless listed for vastly more than it's real value, a listing will be bid up over it's asking price. (the current average in AZ is 2-3% above asking)

A friend of mine who is planing on moving to Ohio in several months foolishly listed his house for sale last week, at what I thought was too high of a price. (about $120/sq-ft) he got three offers on the first day, including a full price offer. Guess you are going to move twice Marc.

The best thing for the market would be for the fed to allow the banks to foreclose and clean off the inventory. But that's not happening. In fact, the federal government is exacerbating the problem with programs to prevent the banks from foreclosing.

Now I don't really care if real estate values go up, down, or stagnant. There are good societal reasons to want real estate to generally go up at the rate of inflation and no faster. Rising real sestate values means that your teachers, fire fighters, police etc can't afford to live in your community. That has it's own implications for another post.

Once again, Reagan was right. "In this present crisis, Government is not the solution to our problems. Government IS the problem."

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