Too much froth in the housing market. Greenspan has said it. It was mention during the FOMC's May third meeting. Atlanta Fed Bank's Jack Guynn
Continuing the Pattern of Growth and Low Inflation Certified Professional Home Builder LuncheonAtlanta, Georgia May 25, 2005
has also said it. So, what is the problem. I think the question should be “what are the problems”?
There are two problems that a linked.
Problem number 1: the buying and selling of dwellings not yet built. This is a “futures” market. Also, one can throw in the buying and reselling of existing homes. As in any futures market, the future price is dependent on the value of the property, the value of the US currency and the expectations of the future buyer's that the property will not lose its value. In general, the housing market is not subject to violent price swings, but it can be if the underlying link is also in flux.
Problem number 2: Creative financing of homes. Again, this is not a problem on to itself. Creative financing dependents on the expectations that the home buyer does not run into financial trouble as he/she occupies the home. Again, no problem as long as the link is not in trouble.
The Link is the $7 trillion dollar derivatives market. Corporations that finance the housing market use the derivatives market to protect themselves against prepayments, defaults and interest rates movements. Unfortunately for these corporations, the derivative market is also home to other players that are in it for the short term gain due to some sort of a price mis-match or a counter bet. If these players get into trouble, the link is in trouble.
Can one deduce if there is a potential problem based on just one event? I'm going to say yes. One can point to the rumored problems of hedge funds that were short on GM and Ford's stock, but long on their bonds. The credit down grade supposedly caught them by surprise. One can key on the knowledge that their bonds were going to be downgraded. Why did they not pull out of the trade? Were they looking for some sort of information that they thought was going to be announced (or leaked) before the down grade? Were they looking for pricing level? This tells me that a lot of fund managers do not understand the “business” of business nor the mathematics of the instruments they use. One should expect more rumors of hedge funds in trouble as the months progress. This is due to the fact that the Fed is raising short term interest rates. The removal of the carry trade always causes trouble.
It will be really funny if California (the state) declares bankruptcy due to poor bond structure (Orange County, Cal.) and those who hold interest only mortgages to lose their property and then find out that China owns a large part of southern California because they hold the deeds.
My expectations for the future of the US economy. The third quarter is going to be below Wall Street's expectations. Activity in the first and second quarter is due to tax refunds being sent and spent. This stimulus will not be in play during during the third quarter. It will be vacations over shopping. The fourth quarter and the year's GDP will be made if four hurricanes hit the high population regions of the southern shoreline (it took four last year). One or more making landfall in the swamps, will be the starting gun for excuses and finger pointing on Wall Street and Washington DC.
There is no phantom job market. There will be the usual Equity to Liquidly being substituted for labor in GDP ($700 billion worth). Mortgage rates may be low, but the cost of closing the deal will increase because of the cost of the US currency will be higher (US dollar strength). The cost of risk management will also be higher due to a decrease in the number of willing buyers.
All bets are off if there are problems in the oil pits or if there is a major meltdown in the derivatives markets.
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