Month in Review: August, 2007
[Previous months in review available here: Jul 07, Jun 07, May 07, Apr 07, Mar 07, Feb 07, Jan 07]
In August, even as half of America and two-thirds of Europe was at the beach or in the country, the subprime mess metastasized out of its demographic enclave, infecting the broader capital markets, and its implications dominated our coverage, with two big posts, the first highlighting the challenges of restructuring non-performing loans, in To mark it to market, to mark it we go: Part 1, the delinquents, and Part 2, blockages, which featured this primer:
Because foreclosure sounds so ominous, few people think their way past the deed transfer. What actually happens or doesn’t happen?
When thinking about foreclosure and workouts, we must always distinguish three things:
Part 3, motivations shrieked:
Wrong!
It’s about at this point that I started scrawling unkind and intemperate phrases in the article’s margin, because what follows from here is completely wrong about motivations and blockages.
– and Part 4, reverberations, finished up with this:
“I don’t think there is anything in the entire securitization process that is at all focused on the borrower’s interest,” said Kirsten Keefe, executive director of Americans for Fairness in Lending.
Except lower rates, lower closing costs, a cornucopia of new loan products such as interest-only that consumers eagerly took up.
“Everything they do is, ‘How are we going to make a profit, and how are we going to secure ourselves against risk?’ ”
In so doing, they have delivered very low interest rates and a multiplicity of options. And now that housing’s in its crumple zone, they’re backing up, but slowly and awkwardly. We need to keep pursuing the right policy questions.
“It is difficult to understand. It seems brutal, it seems harsh …”
“It is life and it is death. It is the greatest blessing and the greatest curse in the universe. You do not have to understand it. Your comprehension or lack of it, your approval or your disapproval, will in no way alter its operation.”
Roger Zelazny, Creatures of Light and Darkness, page 25
I was similarly unsympathetic to the rating agencies in a month-ending five-parter, A symbiote’s life is not a happy one, Part 1: blaming the raters, Part 2: the happy duo, Part 3: who influenced whom?, Part 4: look around you, and Part 5: why rating agencies?:
Who then is the Commissioner of Rating Agencies? Not the NYSE – its chairman Richard Grasso, himself was tarnished for having received a gargantuan pay packet.
Surprisingly, there is none. Long-time market investor John Mauldin (whose readership dwarfs mine) nominates one, and makes a very plausible case for his candidate:
Second, the rating agencies need to restore their credibility. Warren Buffett’s Berkshire Hathaway owns about 19% of Moody’s. I would suggest that Mr. Buffett step in take over the company (much as he did with Salomon years ago) and put his not inconsiderable credibility on the line for all future ratings and the inevitable re-ratings that are going to be done.
The Panic of 1907 was solved by the credibility of one man, J. P. Morgan, who stepped in to provide liquidity.
When you’re rich, you both need and can provide liquidity
This post fetched some pointed criticism from one of my Wall Street friends, who asked tartly if I had any evidence of culpability or peculation, of which I have none, knowing only what I read in the newspaper. The point of a Commissioner, as perhaps I could have explained better, is not to conduct a witch hunt or to act as a special prosecutor, but rather to be someone whose personal brand is so strong that when he or she vouches for the probity of another, everything is prepared to believe it.
I must restore balance from this disturbance in the financial Force
The Panic of 2007 is not a problem caused by lack of liquidity. It is a problem caused by lack of credibility. Morgan could (and did) provide liquidity. Buffett can (and should) provide credibility.
The markets will come back. So will the concept of rating securities. But not necessarily every agency within that niche. Mauldin adds a cautionary postscript:
And someone of similar stature needs to step in at S&P and Fitch. (Can Volcker be summoned into the trenches yet one more time?)
If not – well, the world can function perfectly well with only two rating agencies instead of three.
Shifting focus from the immediate to the epochal, I highlighted a fascinating, densely researched, and possibly world-shaking study, to which I tried to do some limited justice in Cities: why and how they scale: Part 1, the grand theory, Part 2, the pile of evidence and Part 3, the implications:
AHI translation: When we went looking for data, we found it, and we can measure the numbers.
We present an extensive body of empirical evidence showing that important demographic, socio-economic, and behavioral urban indicators are, on average, scaling functions of city size that are quantitatively consistent across different nations and times. 7301-7302. [Page numbers refer to the PNAS text.]
Translation: It didn’t matter what decade, what continent, or what city: we found that scale activities changed at roughly the same rates all around the globe, suggesting these are the demographic equivalent of Planck’s Constant.
Cities as consumers of energy and resources and producers of artifacts, information, and waste have often been compared with biological entities, in both classical studies in urban sociology and in recent research concerned with urban ecosystems and sustainable development. Recent analogies include cities as ‘living systems’ or ‘organisms’ and notions of urban ‘ecosystems’ and urban ‘metabolism.’ Are these terms just qualitative metaphors, or is there quantitative and predictive substance in the implication that social organizations are extensions of biology, satisfying similar principles and constraints? 7302.
Translation: We haven’t read AHI’s writings about housing finance ecosystems, but if we had, we’d agree.
Highly complex, self-sustaining structures, whether cells, organisms, or cities, require close integration of enormous numbers of constituent units that need efficient servicing. 7302.
Since both organisms and cities are big complicated interdependent operating systems, we have at least a plausible basis for looking at the data.
Cities are at least as Rube Goldberg machines:
Rube Goldberg stands in front of an x-ray and sees an idea inside his head showing how to keep shop windows clean.
Passing man (A) slips on banana peel (B) causing him to fall on rake (C). As handle of rake rises it throws horseshoe (D) onto rope (E) which sags, thereby tilting sprinkling can (F). Water (G) saturates mop (H). Pickle terrier (I) thinks it is raining, gets up to run into house and upsets sign (J) throwing it against non-tipping cigar ash receiver (K) which causes it to swing back and forth and swish the mop against window pane, wiping it clean. If man breaks his neck by fall move away before cop arrives.
Before turning to the city-as-metabolic-body analogy, the authors — both of them are physicists by training — start by observing that since animals are biological, they are bounded by physical constraints like body size:
Remarkably, almost all physiological characteristics of biological organisms scale with body mass, M, as a power law whose exponent is typically a multiple of ¼ (which generalizes to 1/ (d+1) in d-dimensions). For example, metabolic rate scales as B x M ¾. Because metabolic rate per unit of mass decreases with body size, this relationship implies an economy of scale in energy consumption: larger organisms consume less energy per unit time and per unit mass. 7303.
Because strength varies as the square and mass as the cube, larger organisms have more internal organs and core processes, and an ever-greater share of the energy is devoted to keeping the beast alive and mobile. Big things move more slowly, and reach a natural size limit.
Don’t expect him to hop
We find robust and commensurate scaling exponents across different nations, economic systems, levels of development, and recent time periods for a wide variety of indicators. This finding implies that, in terms of these quantities, cities that are superficially quite different in form and location, for example, are in fact, on the average, scaled versions of one another, in a very specific but universal fashion prescribed by the scaling laws of Table 1. 7303.
This finding, if it stands up, would be little short of revolutionary, because it says that future characteristics of a larger city can be extrapolated precisely from its current size and characteristics.
Who we are when small holds the essence of who we will be when large
The authors divide the scalars into three groups: those that go linearly with population, those that rise faster (increasing returns from networking effects), and those that rise slower (economies of scale). Because the table condenses down its data into a power-law variable beta, a bit of explanation may help. When the authors speak of an increasing beta, they’re measuring the rate of growth in the quantity as a city gets larger (measured in number of people).
Adapted by AHI from authors’ data
Thus, if a Small city has a patent rate of 1x, when the city becomes Medium sized (growing to 3x its original), it will be producing 35% more patents per capita. It’ll be 35% more competitive. If it makes the leap to a Large city (10x the Small size), its patent rate will be 86% higher. Bigger cities are smarter.
Wages too rise faster than the rate of population. Bigger cities are richer. Move to a city 10x your current one and your earnings will probably rise 32%. (So too will your housing prices!)
Higher prices and operating costs are two of the reasons why homeownership, particularly in cities, occasions shifts in behavior and attitude, as I spotlighted acerbically in The problem of owning and Reality bites: the challenge of saving, and more sympathetically, at least in relation to utility costs, in Counting kilowatts:
“Experimentation with prepaid-service meters is part of a broader trend that is changing the electric meter from a dumb recorder of kilowatt hours consumed into a conservation tool capable of helping people monitor their use and which will allow utilities to talk directly to customers.”
Numerous experiments that confirmed that biofeedback works; show a person (say) his heartbeat and he can calm himself down.
Visualize lower utility bills … calmer now?
Utility electro-feedback is even more direct, because you can just turn the thermostat down or up, slide the window closed or open, or flip the light switch off. In short, by making the connection between use and cost manifest, you invite conservation.
“Billions of dollars are being spent by utilities to install advanced meters that track the amount of energy consumed at different times of the day…”
That knowledge is a two-edged sword, for it also empowers the providers, the utilities, to use variable pricing.
“‘m in charge and you’re my creation.” “No, I’m in charge …”
Even in August, there was news, as David Bistricer, seeking to salvage his star-crossed effort to buy
Regaining optionality. A seller who’s gone to agreement and seen the buyer come a-cropper may have lost confidence in that buyer’s ability to close. There’s every reason to step back, take a deep breath, and evaluate options.
I thus expect that the sellers will decline the proposal on general principles, although they will probably cite the regulators’ refusal to approve as their reason as well.
“I don’t think this Hail Mary pass is going to get completed,” said one executive who has talked to the sellers.
Unfortunately for Mr. Bistricer, each group — regulators and sellers — can point to the other as its reason for not moving forward.
Around the world, we looked at China: home is where the votes are, and the larger problem of the undocumented (and therefore invisible and extra-judicial) poor in Precious in the sight of the law, plus the Rights and wrongs of first refusal, and in continuing news, I observed that, to no one’s astonishment, Wal-Mart continues unrelenting in its quest to get into the finance business, in We’re baaaank!
We’re just looking for an edge