Don't think yourself stupid! :)

My brother and I walked over to my sister's place.

"Let's get something from that sweet store across from her flat" he said.

After a detour to that store, we walked in with keera vadai, vegetable cutlets, and chumchum.  Sister made tea (black for me, of course!) and we talked about stuff.

Somehow the chat turned to the topic of real estate prices in the city.  The figures are simply astounding.  So, naturally, I asked, "how do people afford such prices?"

The response was that professionals earn quite a salary these days.

"But, what about people like the domestic help?  I mean, where do they live?  How do they survive?  After the cyclone rains the domestic help didn't come over because of the water-logging."

Turns out that Earl has sane advice for idiots like me:

I laugh now, but I know I will keep asking these questions forever.  After all, that is why I ditched engineering!

China surging at 8.5%

When Fareed Zakaria writes or says anything in a public forum, he does not give me anything to disagree with.  Maybe because we are both from India?  Ha ha.  His latest piece, on China, makes sense:

China entered the crisis in an entirely different position. It was running a budget surplus and had been raising interest rates to tamp down excessive growth. Its banks had been reining in consumer spending and excessive credit. So when the crisis hit, the Chinese government could adopt textbook policies to jump-start growth. It could lower interest rates, raise government spending, ease up on credit, and encourage consumers to start spending. Having been disciplined during the fat years, Beijing could now ease up during the lean ones.

And look at the nature of China's stimulus. Most of U.S. government spending is directed at consumption—in the form of subsidies, wages, health benefits, etc. The bulk of China's stimulus is going toward investment for future growth: infrastructure and new technologies. Having built 21st-century infrastructure for its first-tier cities in the last decade, Beijing will now build similar facilities for the second tier.

This to me is not a big deal.  After all, the Chinese economy has a lot to catch up with the US.  But, the following ought to make American politicians think twice about what they are up to, particularly the likes of those who want to yell "you lie!":

China is also well aware of its dependence on imported oil and is acting in surprisingly farsighted ways. It now spends more on solar, wind, and battery technology than the United States does. Research by the investment bank Lazard Freres shows that of the top 10 companies (by market capitalization) in these three fields, four are Chinese. (Only three are American.)

The only thing to watch out for, says this FT blog post:

Worries that China is in the grip of a real estate bubble intensified after a five-bedroom apartment in Hong Kong was sold for $56.6m this week. Andy Xie, a Shanghai based economist, argues that China is probably the most bubble-prone economy in modern times - and may be just ten years away from its final day of reckoning.

Geography matters. In unemployment, and otherwise.

A colleague emailed me a link to this piece by Harvard's Ed Glaesar .... and the following resulted ...

To begin with, issues such as rocketing home price was not country-wide at all. I don't think speculators were "flipping" homes in North Dakota as they were even in Bakersfield. Which also means that foreclosures are not a country-wide problem at all. To a large extent, the physical aspect of the housing crisis is highly geographic in nature. That is the physical, real, stock.
Similarly, the real, tangible, manufacturing was also geographically concentrated. If I remember correctly, the relative importance of manufacturing in Oregon--in terms of percentage of jobs--was higher in our state than in the Northeast.

Money on the other hand was flowing in from everywhere, including the unfortunate and greedy investors from Iceland.

Economists almost always aggregate all these issues, and space does not matter to them. Thus, if at all, Glaesar is a tad late to the game. Richard Florida provided an interesting analysis in the March issue of the Atlantic, with a provocative title: How the crash will reshape America. in that piece, Florida noted that:
Financial positions account for only about 8 percent of the New York area’s jobs, not too far off the national average of 5.5 percent. By contrast, they make up 28 percent of all jobs in Bloomington-Normal, Illinois; 18 percent in Des Moines; 13 percent in Hartford; 10 percent in both Sioux Falls, South Dakota, and Charlotte, North Carolina.

Anyway, I agree with Glaesar's thoughts there. California is in a mess, and will get worse before it can remotely get better. This crisis, I think, is worse than the impacts of the aerospace/defense contraction of the 1990s. Because, that one helped the skilled folks apply their talents to other fields, including IT. Now, there is nothing to be gained from empty and sprawling McMansions.
The politics and the government there is not helping either. If it were not for immigrants, California would have tanked a long time ago--almost half the new tech firms were founded or co-founded by immigrants!
CA, AZ, NV are in the same housing crisis .... Again, from Florida's essay:
To an uncommon degree, the economic boom in these cities was propelled by housing appreciation: as prices rose, more people moved in, seeking inexpensive lifestyles and the opportunity to get in on the real-estate market where it was rising, but still affordable. Local homeowners pumped more and more capital out of their houses as well, taking out home-equity loans and injecting money into the local economy in the form of home improvements and demand for retail goods and low-level services. Cities grew, tax coffers filled, spending continued, more people arrived. Yet the boom itself neither followed nor resulted in the development of sustainable, scalable, highly productive industries or services. It was fueled and funded by housing, and housing was its primary product. Whole cities and metro regions became giant Ponzi schemes.

I simply resonate with his description that the entire economy essentially became one massive ponzi scheme. Sickeningly true. This is a HUGE difference between the post-IT boom and now--then, we were at least left with miles and miles of fiber optics, for instance, which then helped as the economy recovered. I don;t see anything productive out of the mansions that are now sitting empty, and turning into slums.

Oregon is in deep shit as well--perhaps not as bad as California is. Earlier today I was speculating at a semi-serious conversation that our unemployment might top out at 14 or 14.5 percent before things begin to improve. This is going to be brutal. I don't see an emerging economic activity that can suddenly provide an upward momentum .... Kulongoski seems to be betting on electric cars. I am not sure if that is a winning bet. It is still a car with a lipstick, to paraphrase the election-season nastiness about lipstick on a pig -)

Unfortunately, to a large extent, Americans are not as geographically mobile as we think we are. I.e., not many unemployed Oregonians are going to move to New Hampshire where the probability of employment is higher. One of the main reasons as it turns out--housing. Owning a home drastically makes us immobile! It is easier for a renter to pack up and move. So, while economists assume that the probability of jobs might be a huge incentive for migration, apparently we have firmly established disincentives that discourage the move. To quote from that same essay by Florida,
“If you no longer can sell your property, how can you move elsewhere?” said Robin Boyle, an urban-planning professor at Wayne State University, in a December Associated Press article. But then he answered his own question: “Some people just switch out the lights and leave—property values have gone so low, walking away is no longer such a difficult option.”

The next forecast by the state economist will be on May 15th. We will all be yelling "mayday, mayday, mayday" then :-(

More Starbucks = more financial crisis. Really?

I am no fan of Starbucks. The last time I went on my own to buy a cup of coffee--whatever they call them sizes--was .... I don't remember when! I blogged earlier about the many, many takes on Starbucks. Frankly, I don't care a damn about Starbucks--it is like the adult stores by the freeways. Hey, I don't care for them, and if there are those who want to get stuff there, well, more power to them as long as nobody hassles me.

But, I do like intelligent and innovative takes on Starbucks. Which is why I liked this piece where the idea is simple: "The higher the concentration of expensive, nautically themed, faux-Italian-branded Frappuccino joints in a country's financial capital, the more likely the country is to have suffered catastrophic financial losses."
Pretty simple the idea, eh! I wish I had taken the trouble to correlate the location of Starbucks outlets with the real estate data and banks .... Some of these commentators are smart--unlike the motor mouths on talk radio and TV who spin the same ideological crap over and over and over .... Anyway, the theory is:

Having a significant Starbucks presence is a pretty significant indicator of the degree of connectedness to the form of highly caffeinated, free-spending capitalism that got us into this mess. It's also a sign of a culture's willingness to abandon traditional norms and ways of doing business (virtually all the countries in which Starbucks has established beachheads have their own venerable coffee-house traditions) in favor of fast-moving American ones. The fact that the company or its local licensee felt there was room for dozens of outlets where consumers would pony up lots of euros, liras, and rials for expensive drinks is also a pretty good indicator that excessive financial
optimism had entered the bloodstream.

Report from Nouriel Roubini: OMG, we are in deep shit!

The email (you too can sign up at his blog) says that this will be the worst ever since the Great Depression. Read for yourself:
This is by far the worst financial crisis since the Great Depression

Hundreds of small banks with massive exposure to real estate (the average small bank has 67% of its assets in real estate) will go bust

Dozens of large regional/national banks (a’ la IndyMac) are also bankrupt given their extreme exposure to real estate and will also go bust

Some major money center banks are also semi-insolvent and while they are deemed too big to fail their rescue with FDIC money will be extremely costly.

In a few years time there will be no major independent broker dealers as their business model (securitization, slice & dice and transfer of toxic credit risk and piling fees upon fees rather than earning income from holding credit risk) is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure (i.e. the four remaining U.S. big brokers dealers will either go bust or will have to be merged with traditional commercial banks). Firms that borrow liquid and short, highly leverage themselves and lend in longer term and illiquid ways (i.e. most of the shadow banking system) cannot survive without formal deposit insurance and formal permanent lender of last resort support from the central bank.

The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient to cover the hole from the biggest banking crisis since the Great Depression

Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

This financial crisis will imply credit losses of at least $1 trillion and more likely $2 trillion.

This is not just a subprime mortgage crisis; this is the crisis of an entire subprime financial system: losses are spreading from subprime to near prime and prime mortgages; to commercial real estate; to unsecured consumer credit (credit cards, student loans, auto loans); to leveraged loans that financed reckless debt-laden LBOs; to muni bonds that will go bust as hundred of municipalities will go bust; to industrial and commercial loans; to corporate bonds whose default rate will jump from close to 0% to over 10%; to CDSs where $62 trillion of nominal protection sits on top an outstanding stock of only $6 trillion of bonds and where counterparty risk – and the collapse of many counterparties – will lead to a systemic collapse of this market.

This will be the most severe U.S. recession in decades with the U.S. consumer being on the ropes and faltering big time as soon as the temporary effect of the tax rebates will fade out by mid-summer (July). This U.S. consumer is shopped out, saving less, debt burdened and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation and rising oil and energy prices. This will be a long, ugly and nasty U-shaped recession lasting 12 to 18 months, not the mild 6 month V-shaped recession that the delusional consensus expects.

Equity prices in the US and abroad will go much deeper in bear territory. In a typical US recession equity prices fall by an average of 28% relative to the peak. But this is not a typical US recession; it is rather a severe one associated with a severe financial crisis. Thus, equity prices will fall by about 40% relative to their peak. So, we are only barely mid-way in the meltdown of stock markets.

The rest of the world will not decouple from the US recession and from the US financial meltdown; it will re-couple big time. Already 12 major economies are on the way to a recessionary hard landing; while the rest of the world will experience a severe growth slowdown only one step removed from a global recession. Given this sharp global economic slowdown oil, energy and commodity prices will fall 20 to 30% from their recent bubbly peaks.

The current U.S recession and sharp global economic slowdown is combining the worst of the oil shocks of the 1970s with the worst of the asset/credit bust shocks (and ensuing credit crunch and investment busts) of 1990-91 and 2001: like in 1973 and 1979 we are facing a stagflationary shock to oil, energy and other commodity prices that by itself may tip many oil importing countries into a sharp slowdown or an outright recession. Also, like 1990-91 and 2001 we are now facing another asset bubble and credit bubble gone bust big time: the housing and overall household credit boom of the last seven years has now gone bust in the same way as the 1980s housing bubble and 1990s tech bubble went bust in 1990 and in 2000 triggering recessions. And a similar housing/asset/credit bubble is going bust in other countries – U.K., Spain, Ireland, Italy, Portugal, etc. – leading to a risk of a hard landing in these economies.

But over time inflation will be the last problem that the Fed will have to face as a severe US recession and global slowdown will lead to a sharp reduction in inflationary pressures in the U.S.: slack in goods markets with demand falling below supply will reduce pricing power of firms; slack in labor markets with unemployment rising will reduce wage pressures and labor costs pressures; a fall in commodity prices of the order of 20-30% will further reduce inflationary pressure. The Fed will have to cut the Fed Funds rate much more – as severe downside risks to growth and to financial stability will dominate any short-term upward inflationary pressures. Leaving aside the risk of a collapse of the US dollar given this easier monetary policy the Fed Funds rate may end up being closer to 0% than 1% by the end of this financial disaster and severe recession cycle.

The Bretton Woods 2 regime of fixed exchange rates to the US dollar and/or heavily managed exchange will unravel – as the first Bretton Woods regimes did in the early 1970s – as US twin deficits, recession, financial crisis and rising commodity and goods inflation in emerging market economies will destroy the basis for it existence.

Thus, the scenario of 12 steps to a financial disaster that I outlined in my February 2008 paper is unfolding as predicted. If anything financial conditions are now much worse than they were at the previous peak of this financial crisis, i.e. in mid-march of 2008

The real estate downward spiral

We lived in Bakersfield, CA, before moving to Oregon.  We sold our home just before the real estate mania set in.  Bigger and bigger homes were being built, and speculators (flippers) were buying from all over.  McAlister Ranch was one such mega project, which is one of the reasons that Lehman Brothers is now in a mess (watch the following YouTube clip)

Meanwhile, here is a news item from a different part of the US--Muskegon, MI:
A man, allegedly upset over a real estate transaction, shot a realtor in the head at the realtor's office Tuesday morning.



Robert Johnson, 73, walked into Nexes Realty at 880 Broadway in Muskegon and asked for the realtor, Troy VanderStelt, by name. He went into a conference room and waited.

"It appears this was essentially an execution-style murder in the conference room," Muskegon County Prosecutor Tony Tague said. "He went over there with a handgun, asked specifically for this real estate agent, went into a conference room and within minutes fired a shot at point blank range into the side of the victim's head."