Monday, November 17, 2008

This Week's Theme: Trends That Will Stick
Even If Credit's Available, Who's Qualified to Take On More Debt?

This week's theme is "trends that will stick"--that is, trends which will not be reversing for quite some time. Why is this important? Simply put: investment and life decisions which are aligned with major trends are more likely to be successful than decisions and investments which run against the current of profound trends.

One cognitive error humanity is especially prone to is assuming a short-term trend can be extrapolated into the future. In the grip of a bubble mentality, we are easy converts to notions such as "real estate only goes up," even when the historical record has demonstrably proven such an extrapolation to be false.

In a similar fashion, low volatility and low interest rates were assumed to be permanent features of the "new" global financial world. Alas, it is now painfully visible that super-low interest rates and super-low volatility/risk were short-term artifacts, not semi-permanent trends.

So how can we tell the difference between a short-term trend and a long one? Start with the fundamentals: supply, demand, demographics, historical averages, etc.

Today's "trend that will stick": regardless of the amount of credit available, few are qualified to add to their existing debt burden. And of those who are qualified, many are allergic to debt; regardless of the blandishments offered to take on debt, they're not interested. Credit card balances, mortgages and auto loans--all are absolute anathema to this slice of citizenry.

It's ironic, isn't it: Credit's Available, But Who's Qualified to Take On More Debt? Only those who don't want to borrow.

Let's run a list of those who, if subjected to an old-fashioned (i.e. from 1999) prudent assessment of creditworthiness, would not qualify:

1. Most banks and lenders. Balance sheets loaded with toxic "assets," off-balance sheet toxic "assets" which if brought over to the balance sheet would immediately render the firm insolvent, "assets" which are still marked to fantasy rather than real-world realities--the list of reasons why banks themselves are poor credit risks is nearly endless.

2. Most consumers. The percentages of "debt owners" whose mortgages exceeds the value of their home is about 25% now, but this was as of September; one wonders what the number will be by next September:

From Lots of homes 'underwater' on mortgages in U.S.:

Over 7.5 million mortgages or 18% of all properties with a mortgage were in a negative equity position as of the end of September 2008. There are an additional 2.1 million mortgages that are approaching negative equity. These are defined as mortgages within 5% of being in a negative equity position. Negative-equity and near-negative equity mortgages combined account for over 23% of all properties with a mortgage."

Mark Zandi pegs the current number at 12 million and next year's total at 14.6 million: from Underwater mortgages inundate US:
About 12 million US homeowners owed more than their homes were worth, compared with 6.6 million at the end of last year and slightly more than 3 million at the close of 2006, Mark Zandi, the chief economist at Moody's, said this week.

With home prices now likely to decline on average by another 10 percent, Zandi said there would be 14.6 million homeowners under water by next September."

Even this astounding number sounds optimistic for a number of reasons. Job losses have yet to really kick in, and so the causal connection between forced sales and declining prices has yet to run its course. If 7 million people lose their jobs ( 5% of the total U.S. workforce) and about 65% own homes (the national average), then about 4.5 million may have to sell their house once their income drops and their savings (if any) are depleted.

Then there's the ugly mortgage re-set chart which suggests re-sets of interest-only and adjustable-rate mortgages will continue forcing sales for years to come:

And let's not forget this sobering chart of household liabilities, which have rcoketed to unprecedented levels of indebtedness:

Please go to to view the 5 charts.

Most households have few other assets to fall back on. As noted here many times before, the vast majority of productive assets in the U.S. are owned by the top 5% of the populace:

Can we trust the data? Why should we? Who defines who's mortgage is "underwater" or "distressed"? All sorts of shenanigans are being pulled to keep distressed/defaulting mortgages off the "overdue" ledgers. For instance, banks have magically decreased the number of distressed mortgages by raising the trigger from 90 days overdue to 120 days overdue. Is skepticism is order that the "underwater" numbers have been massaged wherever possible to minimize the number? Yes.

What evidence is there that housing is about to reverse and start appreciating in value? Basically, there is none. Basic supply and demand suggests additional steep declines lie ahead for at least the next 4-5 years.

HELOCs? Toast. Equity extraction via refinancing? Toast. How many homeowners still have equity in excess of 20%? How many will still have equity in excess of 20% next year, or in 2010 or 2011? Since the transaction costs of selling a house are about 7% of the sales price, then even 10% equity is in practical terms about 3% net equity after escrow closing, and 20% is really only 13%. Not much to hang your hat on in terms of assets you can borrow against.

And what lender is willing to bet your 30% equity today won't shrink to 20% by next year? That's a risky bet in anyone's book.

Here's the reality: Our economy is awash in debt: mortgages, credit cards, auto loans, home equity lines of credit, you name it. This chart says it all:

That is a trend which is not going to be reversed next month or next year. Simply put, this depicts an economy burdened with crushing debts that will either have to be written off as uncollectable (otherwise known as losses), severely depreciated (sold for 10 cents on the dollar, etc.) or paid down slowly out of earnings.

None are rapid processes which can magically be reversed. Holders of distressed assets will resist taking writedowns with every fiber of their beings, and consumers saddled with astounding debts will have to work through a painfully long bankruptcy process before being freed to borrow stupendous sums of money again.

The debt wagon lost a wheel, folks, and the mule ran off. You can try pulling the load yourself, but the slope gets mighty steep up ahead. Just look at the tremendous rise in the nation's total mortgage burden:

3. Corporations and commercial real estate. If you're wondering why the stock of once-mighty corporations like General Electric has been crushed recently, look no further than their debt load and/or exposure to rapidly depreciating debt of all flavors. Think anyone wants to lend big bucks to develop another empty mall or office tower? Here's a "big picture" snapshot of our economy's debt in relation to our GDP:

Adjectives such as "unprecedented" don't quite do this chart justice. Clearly, an enormous amount of this debt will have to be repudiated/written down or written off, and a large percentage of corporate and consumer income will be allotted to pay down debt for years to come.

4. Nations. By any prudent underwriting standards, entire nations are increasingly as risk of defaulting on their sovereign debt.

So go ahead and crank out trillions of dollars in new Treasury debt, Ben and Hank, and then pump hundreds of billions into the lending machine: by prudent underwriting standards, few who are willing to borrow are qualified to borrow. And many of those few who are qualified have zero interest (bad pun intended) in taking on debt.

That's a trend that will stick for years to come.

More comments on "Joshua Bell plays the subway." Readers found interesting things to say about A Ringing Bell: More Than Music at Play (The Politics of Experience) (November 15, 2008). (The original entry was Crowds Ignore World Renowned Violinist: What Does This Say? (November 13, 2008).

David W.
Let me tell you a story. About 8 or 9 years ago, when I lived in Manhattan's Upper East Side, I was waiting for the subway and there was a man playing the violin in the station. The music was BEAUTIFUL, especially with the acoustics of the subway station and tunnel, until the subway came, of course. It really made my morning. But, the Upper East Side stations being what they were, very hot and very crowded and uncomfortable, I didn't want to stay there one extra millisecond, so I got on the 1st train that arrived.

Now, the musician could have been a world class professional, or a student amateur for all I know, because I'm not a classical music connoisseur. If I had been in a more comfortable location during rush hour, I may or may not have stopped depending on whether I was running late for work or was anxious about getting to work, etc.

There was a time when I walked through Rockefeller Center on my way to work around the time the NBC Today show was showcasing their Friday morning summer musical groups. I usually didn't stop to listen because the music was annoying and there were 1000s of crazed tourists screaming for Katie Couric. Once they had the Monkeys playing. I know it's not classical and it's very pop, but there music brings back childhood memories, so I stopped and listened as did many non-tourists, which was unusual.

John K.
I enjoyed that post and the very good responses to the Bell experiment post, especially Eric’s response. I don’t like classical music either. It just doesn’t affect me in the way it “should”, I guess. I’d be more apt to stop and watch an alternative rock/pop band like Cake or Cracker or any band with a more upbeat sound. I don’t think it’s an elitist/non-elitist thing. However, I do doubt your premise that “the masses” back in the 1700s all liked what we now call “classical” music. I very much doubt it was ever popular in the way rock n’ roll is now, or perhaps some kind of folk was back then. Classical had the benefit that it was written down. Other music in the same era likely wasn’t written down, or if it was, wasn’t reproduced as effectively for whatever reasons. I’m certainly no historian, but I’m pretty sure that varieties of folk (Celtic, etc) were far more popular and more likely to draw a crowd away from their everyday worries and tedious jobs than was classical. Classical isn’t music geared to be listened to on one’s hectic commute. It takes a more pensive environment to appreciate. Not a subway.

Anyway, it’s a thought-provoking discussion.

An invigorating topic, the Bell experiment. My mind was "spirited away" by Eric's response and your re-response; both absolutely brilliant. You each played notes, chords, yes even a few measures of familiar music; as well as inspiring this composition.

My personal belief is that music, [as the air] is part of all that exists. Through various and sundry forms it elicits responses from deep within the soul. Some play music, some dance it, some write it, some sing it, some paint it, some cry it, others simply listen--and on and on. Everyone is a musician.

Every person was "part of the music" that day, at the train station. They heard the music. It effected them in some way. They just didn't all react in a way the 'experimenter' or the 'observer' anticipated. The results were not measurable.
Just my "tuppence."

Bill Murath
I went to the Denver Symphony last week on a school field trip. This was the 5th time, since my kids play the violin. This one just melted my mind. They featured Gustav Holst's the Planets. The movements were other worldly. It was actually the day you put up the piece about how blinded we are to beauty. I came away with such a postive outlook on the human race. It doesn't matter if we nuke most of ourselves to kingdom come. The finest achievements in all of mankind's history are the instruments created during the Middle Ages. Since these were built with hand tools I see hope eternal. To me the Violin and Piano are much greater accomplishments of man than a rocket, Ipod or cell phone. The only thing that comes close is a surfboard :-)

Chris S.
Eric A wrote: "I live in spaces designed by soulless theory and not visceral joy, and every day I interact with the frightened and shell-shocked, who have each chained up their childish joy in a hidden closet for their own protection—which is simply to say, I'm your average American."

I would have liked to see this expanded upon more. I worked in psychology, trauma, emotions, family systems, etc for 15 years *before* I deployed to Iraq and jumped head-first into the combat zone, so I always wonder about the very subjective perceptions and justifications of why each person in a "soulless space" gives up and gives in to their fears.

Why do 95% of people do this especially in my opinion when there is actually VERY little objective basis for their supposedly shell-shock inspired self-justification? Sorry to quote a past expert, but is this simply giving in to one of the seven deadly sins (Sloth) aka "Indifference"? Are people actually helpless in changing the soulless system they live in or really don't care to help change it? Do most even notice there's a problem in the first place with it? My "expert" and "experienced" position is that most do NOT even notice it.

Sadly, it has been my observation that not only do people chain up that "childish joy", but willingly lend a hand in the beating of anyone else who would seek to free it. Keep in mind that the captive person is often not the one actively setting himself "free", but is the subject of such actions by an outside free player who can be the focal point of the herd's attack --including by the captive subject himself. Most people really do like their chains especially when the invisible ones feel far more comfortable than the physical ones of the past did.

BTW, I like celtic music --nothing like the bagpipes to get the scots-irish going when there's a battle to be fought ;-)"

Additional reader commentaries on Joshua Bell plays the subway: Readers Respond to "Bell Plays the Subway".

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