From: Jurriaan Bendien (adsl675281@TISCALI.NL)
Date: Fri Sep 21 2007 - 14:12:17 EDT
Here's my quick analysis of the "credit crunch" blah blah. Federal Reserve chairman Mr Bernanke's speech is rather short on comprehensive data, but he does mention usefully that: "About 320,000 foreclosures were initiated [in the US] in each of the first two quarters of this year (just more than half of them on subprime mortgages), up from an average of about 225,000 during the past six years. (...) Historically, about half of homeowners who get a foreclosure notice are ultimately displaced from their homes, but that ratio may turn out to be higher in coming quarters because the proportion of subprime borrowers, who have weaker financial conditions than prime borrowers, is higher. The rise could be tempered somewhat by loan workouts." http://www.federalreserve.gov/newsevents/testimony/bernanke20070920a.htm#fn1 This would imply just 95,000 US foreclosures in excess of the six-year average number for the first two quarters. Assume for the sake of argument, the annual total of foreclosures in 2007 will be twice the two-quarter total, then you have 640,000 foreclosures for the year. There were about 117,356,000 households (CES consumer units) in the US in 2005, of which 50,172,000 (42.7%) mortgagers, 28,900,000 (24.6%) freehold, and 38,284,000 (32.6%) renting. Thus, the possible 640,000 foreclosures would represent around 1.2% of the total number of mortgaged households, half a percent of total households. Assume let's say 70% rather than 50% of these foreclosures cause mortgage holders to lose their home, so they have to rent instead, that would be 448,000 "displacements" of home owners into tenancy for the year. Assume a US average home price of $220,000, then the total capital involved is about $98.6 billion. Assume an average 6.3% mortgage rate on the principal per year, then the actual annual income flow of mortgage repayments involved here is around $6.2 billion. If the foreclosures occur, the total capital involved is obviously not all lost - the ex-homeowner will retain some of his capitalised savings, while the home (perhaps devalued to some extent) changes owners. Some finance companies may go broke in the US and elsewhere, because they overplayed their hand..But that is about it. Assume an average US tenancy rent of $980 per month for a US home, that's $11,760 a year (about 23.5% of average household income, i.e. still less than a third!). Then the total "displaced" ex-home owners will be paying $5.3 billion in tenancy rent, instead of paying $6.2 billion in mortgage payments, a slight reduction in income for the propertied class. Whereas the foreclosures are obviously very painful for the aspiring home owner (young workingclass families are hit hardest), these kinds of magnitudes just don't seem very significant macroeconomically on their own to me. To put it bluntly, macro-economically it's chickenfeed. The worry in the US in this respect is more really a longterm "vise" of rising mortgage rates against falling home prices, with its effects on lending facilities, demand, employment and net output growth. However, as Greenspan notes, there is as yet little "spillover effect" noticeable from this housing crisis to total value added or capital formation or total employment. That figures. 95,000 extra US foreclosures don't make much of a dent. It is a human tragedy, but compared to the tragedies happening all around the world, it is just a teardrop. Assume the total value of the physical stock of residential structures in the US is about $16 trillion (working from Budget estimates). If this stock is "overvalued" by let's say 20%, this amounts to $3.2 trillion and that would obviously be macroeconomically very significant. But any stagnation or decline of property values does not occur all at once, it would be a very gradual process stretching through a decade, and within a decade, a lot can happen, including a new boost to property prices. Radical declines in prices are rare, in the property market. Usually property prices stagnate if anything, but do not decline radically, the reason being steady continuing demand. The hausse in property values is an enduring feature of modern capitalism, not simply a bubble that pops. To conclude, it takes a lazy mind or a stupid person to suggest that this credit beep is the mainspring or trigger of the next recession in the US or even the next world recession. Admittedly, US industrial profitability is now slightly lower than it was before, but profitability was already very high. For a recession, much more is necessary. The BBC made much of the fact that Bernanke said "the resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans." But the point is that although a few billions of dollars are not chickenfeed to an individual or a finance company, it is chickenfeed from the point of view of the world economy. The more pertinent remark by Bernanke was the one immediately following the "doomsayer" quote put about by the press: "These wider losses reflect, in part, a significant increase in investor uncertainty centered on the difficulty of evaluating the risks for a wide range of structured securities products, which can be opaque or have complex payoffs. Investors also may have become less willing to assume risk." There is a definite "spillover effect" (contagion) in this sense, and that can cost a whole lot of extra money. The general effect is that loans are more scrutinised, and that lenders become more conservative, tempering greedy moods with caution. The Federal Reserve cut interest rates to inject a bit of buoyancy, but what happens? A lot of money capital exits the USA, driving down the exchange rate of the US dollar, which has been hemorraghing downwards for a year or more. But that is a boon for US exporters as well, and helps correct trade deficits. The real cause of modern anxiety is that any catastrophic event causing any sudden, large drop in economic activity can touch off a financial panic with worldwide repercussions that are difficult to oversee, while it is difficult to predict where exactly the damaging blow to investor confidence could come from. This leads to a lot of theoretical speculations, but the reality is more humdrum. What you can predict is that if e.g. Sarkozy decides to slash public service jobs and pensions in France, that he is picking a fight. He thinks he can win that fight, but then again this may have "spillover effects" as well. Jurriaan
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