Latest House Price Inflation News (Slowdown)

phlash

Well the FTSE is down another 150 points! Ouch, thats got to sting some people.

Generali

mystic_trev wrote: »

Can you give us a quick rundown on todays thoughts a Big Bank G? Is the fall in the DOW / FTSE another 'blip' or could it be the start of something much bigger?

The main drivers according to Big Bank (and others) seem to be:

1. Big American mortgage provider (AHM) had it's line of credit cut last night. They're not really sub prime though. (BTW, $300mio worth of mortgages have been approved by AHM that now cannot proceed because AHM don't have the cash. I wonder what happens to people that have exchanged contracts?)

2. MacQuarie (Aussie bank) have said that one hedge fund is facing losses of at least 25%. They've stopped people withdrawing their cash from it.

3. Credit derrivatives markets now ranking debt from Bear Stearns, Goldmans and Lehman Bros effectively as junk.

4. Rumours of another big Bear Stearns hedge fund going bust.

5. To a lesser extent, it's a case of "The sky's falling in, the sky's falling in!"

The big story seems to be contagion - can the problems of US sub prime bad debts be contained to that market or will they spill over into the real economy. Markets are pretty jittery from the market reports I've read, lots of quoting of the Buffetism, "It's only when the tide goes out you can see who's been swimming naked".

Effect on the UK? I'd get any borrowing sorted out pronto if you're going to need it. I wouldn't borrow at all unless genuinely necessary.

Guy_Montag

Generali wrote: »

3. Credit derrivatives markets now ranking debt from Bear Stearns, Goldmans and Lehman Bros effectively as junk.

I presume this means that the money borrowed from BS etc (for example by hedge funds & private equity), can't be sold on. So are BS etc carrying the debt themselves hoping that confidence will be renewed in the market & they'll sell it on later? Or are they selling it to anyone who'll take a punt? Does this mean they've stopped lending?

Generali

Guy_Montag wrote: »

I presume this means that the money borrowed from BS etc (for example by hedge funds & private equity), can't be sold on. So are BS etc carrying the debt themselves hoping that confidence will be renewed in the market & they'll sell it on later? Or are they selling it to anyone who'll take a punt? Does this mean they've stopped lending?

The fears are many fold. Among them:

1. Margin. A lot of assets are bought on margin. That means you put up a %age of the value of what you want to buy and borrow the rest. This magnifies returns. The problem is, if the assets held fall in value, you get a 'margin call', ie a request for more cash. If the fund hasn't got the cash, they have to sell their assets to make the margin call. This can depress asset prices and lead to more margin calls. More margin calls lead to more sales and so on. This is pretty much what happened in 1929. That leads on to fear #2:

2. Where does the buck stop? There is a lot of borrowed money out there. A lot of that has insurance that the lender has bought against not getting their money back. Who holds that? Nobody knows. It's spread among a load of banks, insurance companies, investment funds etc. When a bank buys this sort of lenders insurance (usually with something called a Credit Default Swap or CDS) they don't have to hold as much in reserve so can lend more.
What happens if loans start to go bad and the banks can't call on their CDSs? The reserves suffer and they have to call in short term debt (eg overdrafts).
Look on the DFW site to see the state some people are in. How many of them could repay their overdraft at a moment's notice?
This leads to fear #3

3. Asset prices fall off a cliff. What happens next? The bank's reserves are down. Perhaps BIS (Bank for International Settlements, the Central Bank of the Central Banks) lowers reserve requirements temporarily so the banks can sort themselves out. Banks need to get their reserves sorted fast. How to do that? Recall all the borrowing you can and bankrupt those that can't repay. Refuse to roll over credit lines, again bankrupting those that can't pay. Asset prices fall quickly in this case as nobody can borrow money to buy up the bargain basement stuff so banks will sell for what they can in a 'fire sale'.

That this might happen is not the same thing as saying it will happen. Markets are driven by greed and fear. At the moment fear has the upper hand.

Generali

Very interesting reading the overnight reports from the credit market this morning (if you're me that is!). There's very low liquidity in credit markets although at least the writers have stopped using words like 'mayhem' and 'madness'.

CDS spreads (ie the cost for a bank to insure against credit default) have increased markedly across every sector over the past month.

mystic_trev

Generali wrote: »

CDS spreads (ie the cost for a bank to insure against credit default) have increased markedly across every sector over the past month.

Thanks for your posts Generali, which I always find very informative and interesting.

I assume most Banks / BS mortgages are securitised. What effect is the current Credit Crunch going to have on those wanting a loan / mortgage in the near future? Will the amount the Banks lend dry up? Or will it be a case of much higher IR's as the Banks / BS will be able to charge more for a limited amount of funds available?

Generali

mystic_trev wrote: »

I assume most Banks / BS mortgages are securitised. What effect is the current Credit Crunch going to have on those wanting a loan / mortgage in the near future? Will the amount the Banks lend dry up? Or will it be a case of much higher IR's as the Banks / BS will be able to charge more for a limited amount of funds available?

Actually not as many as you'd think in the UK and Europe. Some companies go down this road (Northern Rock and B&B I think) but most don't - we don't have the same set up with mortgage brokers as they have in the US.

The main effect so far of this credit squeeze has been this. When a company borrows money to buy another, they go to a bank to advise them and sort out financing. The bank will lend the company the money and then syndicate the loan, that is parcel it up into bite sized pieces and selling it on to other financial institutions. It does this to reduce risk (better to have a small piece of 500 loans than all of 5 loans if one goes belly up!).

The problem now is that all the money to buy these loans has gone. The appetite for risk has dropped so investors are after safe havens like government bonds. The banks are now stuck with these massive loans on their balance sheets (to the tune of £250,000,000,000 according to The Times this morning) and so will be less able to lend money to you and I.

In effect, the money available to be lent will fall (i.e. supply drops). If the demand for this borrowed money remains the same, what happens? The price will rise (as any fule no). What's the price of money? The interest rate.

If there is a credit crunch occuring (and it is still an if) then there are 2 ways out. One is for the BoE to say, "Fine. This is the result of inflation getting out of hand. We'll drive inflation out of the system once and for all." They let the money supply fall, funds for lending dry up. This has the following impact:
1. Asset prices drop and investment with it.
2. At the same time, people who rely on borrowed money to finance consumption can't do this any more so consumption falls.
3. Investment and consumption falling = GDP falling* (unless government spending or exports rise to take up the slack. Government spending can't rise as the govt is already living beyond it's means. I suppose exports could rise but I don't see it).
4. GDP falling (for 2 consecutive quarters) = recession
5. Recession = people lose their jobs. Misery all round but it ends after a bit and we all go back to normal.

Alternatively, the BoE can try to print more money to inflate the economy out of trouble. That's how we got into this mess in the first place and would be a stupid and dangerous thing to do IMVHO. I also think it's the most likely outcome.


*This is by definition. As any good economics student will tell you:

GDP = private consumption + investment + government spending + (exports-imports)

Guy_Montag

Generali wrote: »

Actually not as many as you'd think in the UK and Europe. Some companies go down this road (Northern Rock and B&B I think) but most don't - we don't have the same set up with mortgage brokers as they have in the US.

The main effect so far of this credit squeeze has been this. When a company borrows money to buy another, they go to a bank to advise them and sort out financing. The bank will lend the company the money and then syndicate the loan, that is parcel it up into bite sized pieces and selling it on to other financial institutions. It does this to reduce risk (better to have a small piece of 500 loans than all of 5 loans if one goes belly up!).

The problem now is that all the money to buy these loans has gone. The appetite for risk has dropped so investors are after safe havens like government bonds. The banks are now stuck with these massive loans on their balance sheets (to the tune of £250,000,000,000 according to The Times this morning) and so will be less able to lend money to you and I.

In effect, the money available to be lent will fall (i.e. supply drops). If the demand for this borrowed money remains the same, what happens? The price will rise (as any fule no). What's the price of money? The interest rate.

If there is a credit crunch occuring (and it is still an if) then there are 2 ways out. One is for the BoE to say, "Fine. This is the result of inflation getting out of hand. We'll drive inflation out of the system once and for all." They let the money supply fall, funds for lending dry up. This has the following impact:
1. Asset prices drop and investment with it.
2. At the same time, people who rely on borrowed money to finance consumption can't do this any more so consumption falls.
3. Investment and consumption falling = GDP falling* (unless government spending or exports rise to take up the slack. Government spending can't rise as the govt is already living beyond it's means. I suppose exports could rise but I don't see it).
4. GDP falling (for 2 consecutive quarters) = recession
5. Recession = people lose their jobs. Misery all round but it ends after a bit and we all go back to normal.

Alternatively, the BoE can try to print more money to inflate the economy out of trouble. That's how we got into this mess in the first place and would be a stupid and dangerous thing to do IMVHO. I also think it's the most likely outcome.


*This is by definition. As any good economics student will tell you:

GDP = private consumption + investment + government spending + (exports-imports)

At what point does printing money cause Weimar-ian problems of hyper-inflation? Is there a tipping point where suddenly you can't control it?

Apart from destroying my savings, what other problems does high (but not hyper) inflation cause. Say we had a inflation at 10-15%?


Thanks for the education G.

Generali

I'm not sure that there is a tipping point for hyperinflation or even really a definition of where regular inflation becomes hyperinflation.

1. Inflation destroys economies. It creates costs to individuals and businesses just trying to keep up with it (e.g. if inflation is at 10% and you get an annual pay review, by the time your next review comes around you're 10% poorer than last year). The poor tend to be hit hardest by this as they have less discretionary spending to cut back as their income is cut by inflation through the year.
2. Investment is directed to trying to keep up with inflation rather than on what is most productive.
3. Worst of all is the impact it has on those living off fixed incomes, notably pensioners. They have the value of their pensions destroyed, a lifetime of work inflated into nothing.
4. Investment is reduced as it i harder to be sure of future interest rates in a high inflation environment
5. Unless the FX rate falls at the same rate as inflation is rising, exports will become less competetive
6. Assets and the income from those assets tend to rise with inflation. This is a transfer of reletive wealth and income from poor to rich.

kingkano

Alternatively, the BoE can try to print more money to inflate the economy out of trouble. That's how we got into this mess in the first place and would be a stupid and dangerous thing to do IMVHO. I also think it's the most likely outcome.

My understanding of economics is rudimentary so please forgive me. Doesn't this mean they will be fighting themselves?? Printing money promoting inflation and raising interest rates to cut inflation? Have I misunderstood?