We have the specter of two CEOs, each heading a firm that is a leader in its businesses and a debt powerhouse, making close to polar opposite statements about the prospects for the credit markets.
Lloyd Blankfein, Goldman’s chief, said today that the credit crisis was half to two thirds through its course. While there may be more rocky episodes, he believes the worst is over.
Bill Gross, the co-head of Pimco, argued in the Financial Times that if Feds don’t start throwing money at the housing market immediately, we’ll have, um, a super bad contraction (as we discuss later, he goes to some length to avoid using the D word).
They’ve both oversold their case.
Now in fairness, while Blankfein was optimistic about the trajectory, he still sounded cautious notes. From Bloomberg:
Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein said the credit-market contraction that started with subprime mortgages is at least halfway over.
“We’re not in the ninth inning by any means, we’re maybe two-thirds through, a half to two-thirds,” Blankfein, 53, said today in an interview. “I think it will consume our attention for the rest of this year.”…
“It’s going to be difficult, there’s going to be stress and pain, not just for Wall Street but more importantly for citizens, but it is being worked through,” Blankfein said. “The signs of it are all the attention, the writedowns, the fact that assets are being disposed of” and sold to “more patient capital.”
Now of course, Goldman needs to be positive; it’s almost certain to join its peers and show signs of bond market stress in its first quarter earnings announcement March 18. Investment banks, almost without exception, have misread the severity of the crisis, each quarter taking writeoffs that were deemed to put the past behind them, until more rot turned up.
Now just as Blankfein has reason to sell an upbeat reading. so too does Gross have cause to try to get the powers that be to resort to emergency measures. And stylistically, Gross is prone to flights of hyperbole. But even for him, his latest offering is a bit much.
His piece in the Financial Times, “Urgent action is needed to stave off the rise of Bushville,” relies more on scaremongering and anecdote than analysis. While I agree with Gross that there is the possibility of a severe recession centered on housing, he fails to make his case.
Disingenuously, he says that while he does not expect to see a depression in his lifetime, he spends the rest of the article evoking that possibility:
The US is a going concern and will remain so. Still, there are developments that remind observers of the days of Hoovervilles – shantytown 1930s communities of homeless citizens nestled out of sight near the railroad tracks instead of on Main Street USA.
Most of the headlines focus on the housing market as indeed they should. While there are no visible Bushvilles as of yet, there were, according to reports from RealtyTrac, 153,000 initial foreclosure notices sent out during the month of January, which, when annualised, suggest that nearly 1½ per cent of America’s homeowners in 2008 may at some point be headed for the tracks or some other destination most of us don’t care to think about.
I have trouble with Gross’ assertions about the health of America and his figures on housing market. I’m not certain at all America is a going concern; we are dependent on kindly foreigners to feed our overconsumption habit. One of these days, they are going to decide that they’ve had enough of selling us goods and oil in return for depreciating IOUs.
Regarding the foreclosure numbers, while that may seem factual, the data is dubious.
First, there is no reliable information on foreclosures; it’s directional at best. As we commented in “Foreclosure Stats: Pick a Number, Any Number“:
A story in the LA Times, “Getting a Fix on Forclosure Data,” tells us how the two most widely cited sources of foreclosure information, RealtyTrac and DataQuick, are almost certainly incorrect. RealtyTrac counts every step in the foreclosure process as a foreclosure, and is also charged with not correcting its data for multiple liens on the same property, resulting in figures that are almost certainly too high. Experts charge that DataQuick’s results are too low. And the differences are large. For the state of California, RealtyTrac reported 142,149 foreclosure filings in a February news release; DataQuick’s figure was 12,672.
Stop a second. Did you get that? The difference between two sources, each considered reputable, was more than an order of magnitude.
OK, back to the post, now quoting the LA Times story:
[F]oreclosure is really a process, one that can stretch over a year and vary from state to state.
It officially begins when the lender files a notice of default. This signals to investors that there’s trouble with the mortgage, and the beleaguered homeowner is often courted for a private sale. There’s also the possibility the owner can restructure the mortgage with his or her finance company.
If the borrower can’t negotiate a sale or refinance within three months or so, the house is scheduled for a public auction. Many of these homes wind up as the property of the lender. They are labeled REOs, short for “real estate owned.”
Deciding which of these moments constitutes “foreclosure” has become a matter of interpretation and dispute.
“No one can agree,” said Ryan Slack, chief executive of Propertyshark.com, a website that reported 2,453 foreclosure auctions in Los Angeles County in the first quarter.
That doesn’t mean that 2,453 families were forced out on the street, Slack cautioned. He estimated that more than half of the auctions were postponed or canceled.
Due to the deterioration of the housing market, the cancellation rate may well have fallen, but the general point holds. Each step in the foreclosure process results in a filing; the process and number of filings varies by state.
Worse, some properties can teeter on the edge of foreclosure (as most of us think of it, meaning the loss of a home) resulting in repeat filings. Tanta has commented that when banks offer a repayment plan (they’ll usually do that before a mod, to see if the buyer has the commitment and wherewith all to get a bit more current), they’ll stop the foreclosure proceedings, but will move forward again if the restructuring plan fails. Of course, you can also have borrowers (I’ve seen this happen) who get current, pay for a bit, and then fall into arrears, so the bank has to go back to the start of the process.
Now the scary 153,000 number that Gross cites likely came from a New York Times article by Floyd Norris which said:
During January, it was reported this week by RealtyTrac, there were 153,745 initial foreclosure notices sent out in the United States
The article also uses a chart lifted from a RealtyTrac press release dated February 26, 2008 which summarizes foreclosure data in January.
However, nowhere in the press release or the table is there use of the term “initial foreclosure notices” nor is there any obvious way to reconcile the press release data with the 153,745 figure that the Times cites (click to enlarge).
The column headings are NOD (Notice of Default), NTS (Notice of Trustee Sale), NFS (Notice of Foreclosure Sale), LS (Lis Perdens) and REO (Real Estate Owned).
The combination that gets you closest to the Time’s figure is NOD+LS+REO, which equals 153,238. But REO is the last step; it’s when the bank winds up buying the property because the bids at the foreclosure auction haven’ been high enough. That does not constitute an “initial foreclosure notice.”
So the Times figure looks questionable on its face, even before allowing for the fact that processes vary by state, that properties can enter the foreclosure process more than once, that the only way to get at a number over 60,000 requires adding entries in multiple columns, which almost certainly entails double counting, and that some properties have more than one mortgage (multiple mortgages mean multiple filings).
Now Norris is not an expert; who knows how he (or a staffer) arrived at that figure. But Gross has real analytical horsepower; his minions ought to know full well that the RealtyTrac data yields inflated estimates, which was clearly the point of this exercise.
So back to the scaremongering:
Wherever they are and whoever was at fault in allowing them to buy a home in the first place, they are at the forefront of a recessionary saga that will cause considerable damage to many US citizens, communities and corporations alike.
Jefferson County, Alabama, for instance, announced last week that it may be unable to buy back nearly $1bn worth of floating rate debt owed to banks owing to the auction rate preferred (ARP) crisis. Standard & Poor’s swiftly cut its municipal bonds from A to junk status.
Even if default is avoided, repercussions in the ARP market apparently have led to last week’s unwinding of billions of dollars of high-quality municipal bonds encased within levered hedge fund structures, raising A and AA yields spreads to levels not seen since – well – since the Depression. Similarly, Ben Bernanke in his Congressional testimony last week spoke of the potential failure of a growing number of small banks; regulatory authorities are now preparing for the hard times by rehiring retired bank examiners who cut their teeth during America’s last banking crisis in the early 1990s.
Oh, Gross couldn’t contain himself, He did mention the D word.
The auction rate securities seize up has become a costly disaster for many hapless (dumb? greedy? snookered?) cities and public entities. I’ve heard stories of good programs being cut to fund unexpected interest charges. There’s no denying this is a very bad situation. Lynchings are in order.
But instead of marshaling data (again, if anyone can muster it up, it ought to be Pimco), Gross instead pulls out the poster child of the crisis, Jefferson County. It took a spectacular level of incompetence to create their financial mess. The perp is also the Typhoid Mary of municipal budgets. He’s now the mayor of Birmingham, the moving force behind a certain-to-be-a-white-elephant sport complex that has good odds of bankrupting the city.
So back to Gross, who cranks up his rhetoric for his call to action:
And so it appears we may have something to fear besides fear itself. The American economy, so dependent on asset inflation of one sort or another, is now experiencing price deflation in all three major categories – real estate, stocks, and yes, bonds.
Despite the rapid decline in Treasury yields, mortgage and corporate credit markets are not co-operating, producing aggregate price declines in total. Historically high levels of consumption as a percentage of gross domestic product are not being supported any more by leverageable assets that appreciate perpetually in price. The economy is faltering.
Policymakers may have noticed this asset deflation but it appears to have had little bearing on the haste of their salvage efforts….
Something needs to be done quickly – not to bail out PIMCO, we’re doing fine, thank you – but to halt a destructive asset deflation which, if allowed to proceed, will move our economy in the direction of those Bushville railroad tracks – although still a far distance from them.
Whatever the decision, be it a housing fix advocated by Alan Blinder or the one by Larry Summers or a massive expansion of Federal Housing Association lending authority, it has to be studied and acted on with urgency.
And if the Fed needs to become even more vigorous by expanding the size of its TAF or the collateral it will accept, it must do it now. Policymakers must move quickly to ensure that Bushville is just a figment of some op-ed writer’s imagination and that fearing fear itself as opposed to government inaction and asset deflation becomes the order of the day.
Please. Gross conflates the nasty housing contraction with a claimed stock and bond deflation. The stock market isn’t even in bear market territory, and bonds can hardly be called a deflating asset class.
The core of Gross’s argument is that the bubbles must be reflated at any cost to keep the leverage game going. But the fallacy is that for this to lead to economic expansion, the bubbles have to grow so the leverage can grow so that consumers can go further into debt to keep spending. That is a lousy prescription and will just lead to a bigger bust later.
Despite the calls of Blinder and Summers to take desperate measures, the US told emerging markets in 1997 to do the exact opposite: live within their means, accept bank failures, get their government budgets in balance. That led to nasty GDP contraction in some countries (my recollection is that it was 13% in Indonesia). But no, an empire, even a fading one, shouldn’t be subject to that indignity.
I’m not saying the cold turkey remedy is the best, but we have to go in the direction of taking our lumps. A strategy of trying to dampen the dislocation and social cost has merit, but the fantasy that we can keep the bubbles going (and are well served by taking that course) is delusional. Yet that idea is proving to be dangerously popular with people who should know better.