Happy Macro

[peterbirks]

Where does spare time go? I'm sure that I had some when I got up. But since then I've been, well, doing things, and none of it seemed to leave any spare time. These days, you just keep running and running in order to stand still.

So, welcome to Pete's Saturday "we are all doomed" mode. First we can take the view of Morgan Stanley's chief economist Stephen Roach, perfectly summarised by the excellent columnist Stephen Schurr in today's FT. Mr Roach is saying, in blunt terms, that the US can't go on like this. Alan Greenspan and Warren Buffett and Bill Gates say the same. The only real difference between any of them is that Greenspan thinks the situation can be managed down, while Roach thinks we will reach a "tipping point". Whatever, it still seems like no-one in politics or in the public household is listening. Do you know what the personal savings rate was in the US in July (and I will admit that this number shocked even the normally unshockable me when it comes to observing the fiscal irresponsibility of Joe US PUblic)? It was minus 0.6%. Man, they must have good advertisers and marketers out there (or very stupid consumers). I'm not sure what the savings rate is in Germany and Japan is at the moment, but I can tell you for sure that it isn't negative (probably somewhere between 10% and 15% would be my guess).

The current account deficit in the US will climb above 7% as money is spent rebuilding New Orleans (wherever it is rebuilt) as expensive condos and "San Franciso on the Gulf", but no-one realizes that this also means that there should be a concomitant cut in personal consumption. All these numbers aren't just mad -- they are irredeemably nuts. The US overspend is funding about three-quarters of the rest of the world's current account surpluses. If and when the US stops being able to borrow against its future, there will be either a massive economic upheaval or a massive political upheaval, or both.

However, another obscure number slipped through this week which did not get the same kind of attention as is rightly being paid to the "spend on the never-never" economy which is keeping the rest of the world's economy moving. That number was the spread that investors in fixed income bonds were prepared to accept compared to T-Bills. In July it shrank to 44bps. Now, I can see why that might not make the headlines, especially since it only shrank something like .01bp from the month before. But let's put this in terms of simple numbers.

It basically means that investors are prepared to invest in a company that might go bust, rather than in US bonds, for just an extra 0.44% return. People in the market euphemize this as "an increased appetite for risk". We in the land of common sense prefer the slightly less technical term "insane beyond belief". If you ignore the tulip economics argument (that being, "yes, I know this bond is mispriced, but someone will pay more for it next week") then you are, as far as I am concerned, in a land where real risk has walked miles away from the price of risk. And you know what I blame? Yes, my old favourite, collateralised debt obligations. I think that, because investors tell themselves that they are investing in mathematically sophisticated relatively non-correlated "baskets" of 125 companies, they can afford a greater appetite for risk. But, it seems to me, this is Alice in Wonderland mathematics. If you get 125 companies all investing in CDOs consisting of 125-company baskets, no risk has disappeared. All that happens is that 125 companies suffer a bit of damage rather than all the damage lumping onto a single investor. In a sense this is like insurance -- everyone suffers a bit rather than one investor suffering a lot — but it doesn't eliminate the total amount of pain felt. The big worry is where the non-correlated turns out not to be non-correlated at all. The other worry is that if all the investors suffer "a bit", that means they will all shift in the same direction when there is a bad hit (say, for example, Ford and General Motors going broke). This could lead to a tipping point where the liquidity that Greenspan believes will keep us out of the shit will just vanish in a puff of smoke.

Of course, as this prophesier of doom, I desperately hope Greenspan is right and I am wrong, because the implication for the global economy is so horrifying that one has to see political upheaval following on.

How do these two topics tie together? Well, if Roach is right and there is no way to soft-land the current imbalance in global economies, then the only way to get things back in sync is to have a discrete event (or, in less technical terms, one hell of an economic and political shock). My own hunch is that that tipping point is going to come when the "appetite for risk" shifts from the currently absurdly low levels to something more in touch with reality.

Comments

[(Anonymous)]

I find that when I think that something is wrong in the markets, I expect rapid re-adjustment to something more sane ... and am disappointed.

The British housing market makes no sense whatsoever to me. I've waited to see falls of 25 to 40 per cent for a few years now and apart from London, where the market is showing slight falls, I've just sat back and been amazed as it continues to stay at ridiculously high levels. It's like the cartoon character who runs off a ledge and continues in the same direction. I realise that I totally failed to realise how little new residential homebuilding there was going on, but even so. It looks as crazy to me now as it did five years ago.

DY

[(Anonymous)]

How do you measure house prices on a compartive scale? What would you trade to have no where to live? There is simply no sense in trying to place a value on a house in an absolute sense, by saying 'it seems it is too cheap or too expensive'. Of course you can't put a price on having nowhere to live, but you can put a price on not buying a house - renting. How do we measure renting? Monthly or weekly payments. And so the only comparitive scale we can use for buying a house, within this country, is through comparisons with rental payments, and even then it is a long way from direct one. So then, the house-prices becomes more a less a reflection of the price of money, on a week by week or month by month basis, which of course has been very cheap.

Ridiculous though it may seem, the price of a house is the wrong metric to consider when trying decide whether the housing-market is under or over-valued, at least in the medium term, it's all about bang for buck - as I'm sure you economists know.

chaos

* of course there are other drivers, but buying somewhere to live is the likely reason for a house purchase

house prices

[peterbirks.livejournal.com]

The problem with London house prices is that they are influenced by so many varying factors. As chaos says, the majority driver in a house purchase is finding somehwre to live. But it is slightly more complex than this. Let's look at the choices for the purchaser:

a) Buy somewhere in London or buy somewhere else which makes for a longer commute time to London.
b) Buy somewhere in London or buy somewhere else that entails getting a new job (or not taking up a job in London but taking up a job somewhere else).
c) Buy somewhere in London or rent somewhere in London.
d) Buy an investment property in London or buy somewhere else.

People invariably claim that they have "no choice" in matters where they most definitely have a choice (the "I have to have a car because I live 30 miles from where I work and there's no public transport" is the most frequent type of false "I have no choice" argument). If the market moves pricing far enough, people realize that they do, after all, have a choice. It just isn't one that they want to make.

Anyway, before I run out of space, my point would be that there are factors supporting London prices which do not support prices outside London. That does not mean that the price level is sustainable. If you are getting more bang per buck by renting, then rent. If you would get more by buying, then buy. If you have an interest-only mortgage, there is no difference between renting and buying except in the latter case you are punting that house prices will increase relative to average earnings. Since they appear to be at an all-time high in this respect, continuing to rent makes a lot of economic sense. Just try to build up a big bankroll so that you can buy when the downturn reaches its nadir. Buffett got the end of the dotcom bubble wrong by two years and he may get the dollar's fall wrong by more than that. But, eventually, reality catches up with the market.

Re: house prices pt 2

[peterbirks.livejournal.com]

As chaos also says, unless you are buying a second property, a house purchase is a horrible paradox for most people. This is because (a) it is the biggest financial action they are likely to take in their lives, and yet (b) it is an action where non-economic factors also play a massive role.

It's all very well saying that renting rather than buying makes economic sense, but most people want to own a home. It provides a sense of security, a sense of well-being, and (and lets accept sex differences here) for females it's a sense of a "home" rather than a "house". Men can live in a place for 10 years and it will still have no personality. Women will be in their new home for 10 minutes and it will have been "personalized" in at least one small way. If you are a couple, women are frequently the drivers behind buying rather than renting, and no arguments along the lines of renting making more economic sense will be any good. The response will be "but it isn't ours!" One would be tempted to say that, if you have a mortgage, it isn't yours either, but this line doesn't seem to work well either.

People want to buy homes because they want to start a family, or to have a sense of "settling down together". It's part of life's journey for couples in their early 30s. To deny the wish to purchase is not to question the ecomnomic sense of purchasing, but is to question the strength of your relationship.

So, my advice would be, "buy, but don't buy somewhere as big as you plan to buy in five to eight years' time". That way, everyone is happy.

Re: house prices

[(Anonymous)]

I suspect that in reality 'catch up' will only occur when interest rates rise and then it may just be a slow down rather than a crash, but the forecasts are, I believe, still long-term low.

I suspect the problem with our absolute valuation of house prices lie, naturally, through comparison of our life-experinces of them. If during our life's experience interest rates have been generally high, then house prices have been generally cheap (though we perceive them as normal). Which brings me back to the problem of trying to value a house in an absolute sense, it's impossible. With other luxuries or products we use we can trade them off - it is meaningful to trade leather seats and alloy wheel against a higher spec home entertainement centre, or a new pair of trousers against a new pair of shoes, but we can't trade homes in an absolute sense.

I was thinking, imagine if one can, that you took into our society a group of people who had no experience of money (but valued our society the same as us) and asked them to value different commodities through some process of balancing/trading off (& given the prices of some items). They'd probably do ok and arguably similarly when trying to put those non-essentials on some mental weighing scales and arriving at financial valuation for the different prodcuts. But what about pricing up a house? I reckon they'd not have a clue what price to put on it and they'd differ wildly in their estimations. It would be an impossible thing for them to measure, and so how would they know what is cheap and what is expensive? However, if you asked them to divide up their monthly wage between what they'd wish to spend on food, clothes accommodation etc I'd suspect they'd fairly quickly arrive at at similar solutions (allowing for perosnal preferences) - once they realised what their money would buy them. And consequently they'd trade happily trade off the monthly contributions required for, say, two holidays a year against the extra required to buy a detached rather than semi-detached house. So you'd expect them to quickly & fairly confortably price up a range of houses based on what they would have to pay per month.

This indicates to me that this is how we prefer to measure/value house-prices: it is meaningful. If interest rates are long term low, then current prices may not be overvalued at all. It's rather annoying that, 5 years ago, I measured house prices in an absolute sense, based on my previous years of loose monitoring of these prices, accompanied by of course a changing sense (with age) of value-for-money, which distorts judgement even more, especially for a gambler.

* That all said, other qualitive measurements indicate that some correction is needed E.g. expensive cars outside cheap houses, young professional couples barely able to afford a 1-bedroom flat. One would have though there to be an inevitable correction and re-ordering to bring things back into line.

Re: house prices

[peterbirks.livejournal.com]

I like your "non-money" society experiment. It makes us look more carefullly at what we are trying to say. What, exactly, are we asking these people to value? The utility of having somewhere to live? Or the utility of somewhere to live plus the prospect of this being much cheaper in 30 years's time when you have paid off the mortgage? And, on renting vs mortgages, the utility of a fixed repayment versus a repayment that may vary over time?

It all comes down to the fact that the purchase of a hosue is not a single economic transaction. It is an action that obtains a utility (somehwere to live). It is also an investment. It is also a gamble (in that you are "gearing yourself up" in the whole property market by borrowing to buy the house in the first place). This is why valuing it is so hard. Because, if you buy, you aren't even measuring the utlity against current monthly spend. You are measuring the utility against future spend, agasint future inflation and against future interest rate movements. In the end, your head spins and you just sign onthe dotted line and pray that you get lucky. People who bought in early 1989 did not get lucky, while people who bought in 1996 got very lucky indeed. But they both got the same "utility" value from living in their house.

Re: house prices

[(Anonymous)]

You've drawn on more points than I alluded to. But you've also highlighted my points, the enigma of it all, the reasons and benefits for buying a home are complex, too complex and so absolute valuation is so hard. And so the valuation is simplified to affordability coupled with a bit of risk management. The people valuing the property market, the buyers and sellers, arguably should care about many of these issues you economists raise, but don't, they measure how best they can, and so in the medium term they matter: its almost a chartist vs fundamentals argument.

Ultimately, though, it's that utility of living in a house that makes absolute valuation nigh on impossible. What wordly pleasures would you accept to sacrifice your home and take up shelter in a tent?

chaos

Would you explain

[iadams.livejournal.com]

exactly what your 44bps refers to? It sounded initially like you were decrying the flatness of the yield curve by reading the TED (Ten year treasury vs 3mo EuroDollar) spread, than you started on about coprporate defaults. Any particular credit rating and tenor you were looking at there? Time was when a AA+ ten year would have been cheap at 44 over treasuries.

Did you mean T-Bills (the really short stuff), or T-Notes/Bonds? TBills+44 on 3mo commercial paper is a different prospect from Treasuries+44 over 5 years for the same credit.

Not (for once) simply being picky, I'm just trying to understand your data point. Your general point about risk transfer causuing a market misperception of aggregate risk remains valid of course.

PS My games weekend has been fixed for 8/9 Ocotober - any interest?

Re: Would you explain

[peterbirks.livejournal.com]

Sorry Iain, that paragraph wasn't particularly clear. I wasn't writing about the flat/inverted yield curve.

The 44 basis points was the aggregate yield spread on the Lehman Brothers Investment Grade Index. As far as I understand it, that is the average percentage of all corporate bond offerings over treasury offerings for the same timespan, although I'm not absolutely certain of the technicalities of how Lehmans construct the index to which I was referring.

So (as I interpret it), Lehman take T-bonds maturing in December and compare them with corporates maturing in December, and T-bonds maturing in 2012 and compare them with T-Bonds maturing in 2012. How they "weight" the various bonds to obtain that 44bps figure, I don't know.

Does that clear things up at all? I could hunt down the technicalities of how Lehman go about it, I suppose