[OPE-L] Quantifying the "credit crunch" on my pocket calculator... or why there is no need for panic

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."

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.


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