Ben Stein’s commentary
Posted on July 18, 2007 - Filed Under Business |
It is not often I comment on the overall economy. Reading this article, I nearly fell out of my chair.
Mr Ben Stein wrote this:
Subprime is a small
sector of the mortgage market, as I’ve said before. It might be 15
percent at most. The defaults and delinquencies in this sector might be
roughly 15 percent, which makes for a total problem rate of about 2.25
percent of the whole mortgage market.
If all this goes into foreclosure
(which is unlikely), it will realize about 60 percent upon liquidation
at the very least. That means the real loss might be about .9 percent,
or less than 1 percent. That’s a large number, but tiny in the context
of the economy.
Many articles, with commenters, are always railing about how bad the
subprime market really is. While I have always known the overall
problem is not as drastic as the media makes it, it is still a
problem. And when the media reports: "Sub-Prime exploded another 50%!"
they are often times refering to the overall percentage moving from 1%
to 1.5%.
He
also points out something which news outlets choose to ignore.
Foreclosures are always auctioned off. They do not disappear into the
ether, contribute anything.
This is not any attempt on my
part to ignore bad news. I just wish the media would be presented in a
fashion whereas the entire picture is revealed. Not just "cherry
picked" to generate the most sensational piece. But that’s why the
blogsophere exists. News available everywhere.
I’m surprised to
see this actually published somewhere. But I highly doubt Brian
Williams or Katie Couric is going to run with this story.
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9 Responses to “Ben Stein’s commentary”
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You must be too young to remember the Resolution Trust Corporation and the early 1990’s residential market in Southern California. Ben isn’t, though, and I’m surprised at his conclusion. Real estate is cyclical, and it’s not “different this time.”
You live in coastal Southern California, so you are largely insulated (so far) from the market problems in a lot of the country. Take a six hour drive east, and look at Phoenix, the best “local” example of the lending mess.
In Phoenix, particularly in the newer areas that were bought up by speculators and first time homebuyers priced out of the older areas, foreclosures and short sales are now setting market prices. Many of these homes were purchased using sub-prime loans, but others were purchased by prime borrowers that are upside down because of no/low down ARMS. Builders are unloading inventory at similar prices, because they are motivated sellers and will take losses if necessary. Lending standards are much tighter and rates are moving up, limiting the pool of buyers, so not much is selling.
The value declines and lack of buyers will pressure other non-sub-prime owners that need to sell. That will cause more short sales and foreclosures, and the market will drop more. At some point, the banks will find that they can no longer sell the foreclosed properties for what is owed, and the regulators will start pressuring them to unload the inventory. The market will drop again. Not a pretty picture.
The only thing that has saved the Phoenix market from freefall is the overall health of the economy. Jobs are still plentiful, and consumption is still strong. People are optimistic and many would-be sellers keep their properties off the market to wait out the decline. If the economy starts to feel the effects of the drop in values and if employment declines, things will get much worse. Much of Florida is already at that point.
You could say correctly that the sub-prime mess is not the only cause of the market decline, but it is a major factor. Ben’s math is interesting, but some lenders are sitting on double digit default rates on sub-prime loans and 4 to 5 percent on prime loans. This could have some interesting ramifications for the stock market as well.
So he thinks the subprime mortgage mess isn’t that bad? Yesterday, Bear Stearns announced two of their hedge funds that invest in subprime mortgages are now worthless. That’s a 1.4 billion dollar loss. At just one brokerage. I’m sure Ben Stein’s words are a comfort to the people that were invested in those funds. Links to the story are on my blog.
Yes, foreclosures are auctioned off - at a discount. I’ll gladly give Ben Stein 60 cents for every dollar he wants to give me.
Ben Stein is not talking about the subprime mortage market and the affect of its implosion on the economy; he is talking about the the stock investors in the subprime mortgage market and it’s affect on the markets.
While 1.4 billion dollar loss might be considered huge, it is only a tiny drop in the Bear Stearns 350 BILLION dollar assets (net revenues of 2.47 billion reported in 2nd qtr 07) and even smaller in the total stock market.
I don’t think the subprime market is the major factor causing an housing market downturn in Flordia and Arizona. Instead, I think it is the overproduction of new housing.
Any sweeping generalization with regards to any market is always open to criticism. I myself have stated this several times on this blog. News articles report the entire housing market is in disarray yet multi-million dollar homes are still selling quickly. Areas of the country, such as Oklahoma or Texas, are seeing between 6 and 10% appreciation since the market collapse. So has the market really collapsed?
The point of my article is not to belittle what is happening in the sub-prime world but rather to put it into perspective.
Let’s take your example Shaun. $1.4 billion dollar loss. The overall US economy is a multi-trillion dollar economy. $1.4 billion is less than 1%? Maybe closer to 0.1%?
I’m not an economist nor have I claimed to be. I just want all of the data laid out so I can get an accurate picture of what is occurring.
Certainly SoCal is not insulated from the effects of the market. Prices are off by 10% and will probably be off another 10% before the next upswing. I personally hope this occurs. One more property in my collection would be nice.
You’re right Shaun, 60 cents on the dollar? I’ll take that 7 days a week!
But you are missing the bigger point. The 1.4 billion loss was at *one* brokerage. Let’s go with your assumption that it represents just 0.1% of the US economy. What happens when Merrill Lynch reports the same thing? Then Smith Barney? Then Prudential? Then how about the home builders? Pulte just took a $70 million charge for “land impairment.” (So in the last two days, we’ve now lost 0.15% of the economy.) What happens when William Lyons, Fulton, and the other home builders start doing that? It all adds up. Even if each individual one amounts to 0.1% of the economy, it doesn’t take much to get to 1% or more. And damage to just 1% of the economy will be widely felt.
In this sea of data, let’s not forget that both personal and market psychology is a large factor in driving Real Estate prices. Would-be home buyers see news clips or read stories about the “sub-prime market meltdown” and falling prices and either hold off on making a purchase, or negotiate a little harder. This has the effect of lowering prices in general. One could say that the 1% of sub-prime related price declines are psychologically leveraged into a larger economic phenomenon.
That being said, I also agree with Another Investor’s point about the strength of the larger economy. Although mostly ignored in the drive-by media, the US economy is remarkably strong and bounced back from the 9/11 recession very quickly. This is propping up consumer spending and Real Estate to a large degreee. I believe that this is why the so-called bubble never really burst. In the last down-cycle in SoCal, the economy was facing a local depression. So, for now, things are “different this time.”
Shaun, this entire post is about the bigger picture. You’re stating facts regarding the sub-prime market and I’m talking in terms of the overall economy. I am unsure how much more big picture I can get. I have acknowledged the sub-prime market is a problem. But in regards to the big picture, it is a small portion of the economy. Tiny is one word that comes to mind.
For numbers, Mr Stein tells us the sub-prime market will be 0.9% of the housing market, which will be significantly lower for the overall economy. With that being said it is highly doubtful the subprime market will get to 1% of the overall economy.
When the other firms come out with their numbers, I’m sure the media will be full of articles talking about the “mass meltdown” of the housing market and the complete and utter devastation this will have on the US Economy. Before long, and their scenarios, we’ll all be out on the street begging for meat scraps and melting our tooth fillings for money.
Theory:
collapse of subprime -> (much) more inventory (REOs) through more supply (the REOs) and less demand (many less people can qualify + people less affraid to be “priced out forever”)
collapse of alt-a (ie subprime with higher FICOs) -> the same thing
stagnant RE prices -> less MEW (HELOC ATM) -> lowered consumer spending (might)-> economic recession -> more foreclosures -> same thing
That’s the theory…similar to what happened during the last RE crunch, but then the cause was attributed to loss of jobs -> same thing
Blaming the press for the downswing would mean that you should also credit the press for the upswing (especially with the LA Times starting their Real Estate section during that time, filled with upbeat appreciation tables and tales about multiple bids and people buying now for fear of being priced out forever)…meaning that the upswing was mostly due to the press instead of “fundamentals”.
“Although mostly ignored in the drive-by media, the US economy is remarkably strong”
Again, the theory is that, with a negative savings rate, the US economy (at least the consumer driven portion) is mostly being propped up by people taking out “equity” in their houses to buy consumer goods. Without continuing house price appreciation, this source of “income” goes away, and consumer spending declines, economy slows down, people get laid off, foreclosures increase, etc. (The theory goes on to say that wages for most people haven’t gone up as much as inflation over the past 5 years).
You choose which theory you want to believe, and you make your bets based on it.
- pasadena
The problem with Ben Stein’s analysis is that mortgage defaults aren’t just hitting the subprime sector, as Countrywide announced last week–softening home prices are leading to rising delinquencies and mortgage defaults among the most creditworthy borrowers.