Swedish Housing Still a Bubble

My view is still that Sweden is in a housing bubble, like most western European countries. Signature "ju" asked me on a forum why I don't compare to incomes, which have risen in Sweden over the last years. So I did some more number crunching, and here's an improved version of my Swedish housing bubble graph, with a green line for inflation adjusted mean income. I've also included housing price data up to Q2 2007 and trend lines (thanks to "Kons" for suggesting trend lines).
(Data source SCB. FPI=Fastighetsprisindex småhus, Mean Income=Sammanräknad förvärvsinkomst. 1975=100 for housing prices, 1999=100 for incomes)
As you can clearly see, housing prices in Sweden have risen much faster than the average income (I only have income data for 1991-2005), so while inflation-adjusted incomes have indeed risen, we are still in a housing bubble. How far will housing prices fall?
  • A fall down to the trend line is about 30%.
  • A fall down to the average for 1975-2003 is about 45%.
  • A fall down to the lows of the early 1990's is about 55%.
This is the whole of Sweden, and obviously the bubble is worse in "hot" housing spots. So I've made a corresponding graph for housing prices in the Stockholm area (thanks to "Kons" for suggesting this).
As you can see the graph is slightly more "bubblish" than for the whole of Sweden.
  • A fall to the trend line is about 30%
  • A fall to the average for 1975-2003 is about 55%
  • A fall to the lows of the early 1990's is about 65%!!
Many people will of course say "it can never happen, there will always be a strong demand for housing in our capital city", but I boldly predict today that inflation-adjusted housing prices in Stockholm will probably on average go down by 65% over the next few years. Be warned, and don't forget where you heard it first. And I might even be optimistic. Considering the excesses on the upside, we could very well have similar excesses to the downside when the bubble finally bursts. And if you don't believe it could happen, don't forget that history has proved that all bubbles eventually burst, even though few believe it is possible when on the upward slope of the bubble.

Now housing bubbles burst slowly, so the process will take a few years to play out. I expect "experts" to call a bottom in housing many times during the coming years, but prices will still keep on falling.

Now what effects will such a large fall in housing prices have on the economy? Large effects, of course. Many people will be stuck with loans way bigger than the value of their home. But maybe we should ask the question the other way around - what economic events could trigger such a large fall in housing prices? Read what I have previously written on this blog about potential dangers in the world economy, and you will get some hints about what might cause such a powerful recession.

Speaking of housing bubbles, the top economic advisor of the Spanish prime minister came up with some unbelievable quotes last week:
A residential real estate slump in Spain, where prices have almost tripled since 1997, is "unthinkable," the top economic adviser of Prime Minister Jose Luis Rodriguez Zapatero said. [...]
"To talk about severe adjustments or a meltdown in prices is ridiculous," Taguas said in response to reports pointing to an end of the Spanish real estate boom. "That sort of crisis is unthinkable." [...]
The Spanish banking system is also solid enough to withstand rising financing costs triggered by the fallout from the surge in defaults in the U.S. subprime mortgage market. A run on mortgage- lenders such as Newcastle, U.K.-based Northern Rock Plc or funding difficulties like those at Countrywide Financial Corp. in the U.S. are "unthinkable" in Spain, Taguas said.

Remember those quotes and remind Mr. Taguas about them in a few years' time!


Extreme Events

For now, the global financial markets seem to have calmed down. But the "background noise" of bad news is still there. Since late 2006, 159 US mortgage lenders have already broken down in some way, and new ones are added to the list every week. Housing prices are still falling in the US, and the bubble seems to be about to pop in Europe too, where Spain and the UK seem to be first in line for a major housing bubble correction. Prices of oil and cereals are still rising sharply. The US dollar continues its fall. The interbank rate (e.g. LIBOR) is still well above 6 percent. Many businesses find it hard to get loans or to roll over their loans. Bloomberg reports:
"The U.S. commercial paper market shrank for a sixth week, extending the biggest slump in at least seven years"
"Commercial paper investments have declined $354.5 billion, or almost 16 percent, since the week ended Aug. 8"

I can't believe that everything is now well after a number of extreme events in August and September:
  • At the beginning of August, some banks obviously had major problems, and central banks all over the world had to inject liquidity to keep the wheels going, on a scale not seen since September 2001, and in some cases never seen before.
  • The US FED unexpectedly lowered the discount rate by ½ percent on 17 August.
  • There was a "run on the bank" in British Northern Rock 14-18 September. When was the last time we saw a run on the bank in Britain? This was so serious that US Treasury Secretary Henry Paulson suddenly decided to fly over to London to meet the British Chancellor of the Exchequer Alistair Darling. On 18 September the British Government announced that they would guarantee all deposits at Northern Rock. Whew! Crisis averted for some time.
  • Little more than a month after Ben Bernanke said that inflation was his main worry, he lowered the Fed Funds rate and discount rate by ½ percent on 18 September. This of course caused the US dollar to fall like lead.
  • Saudi Arabia did not lower the interest rate this time. They have so far followed interest rate changes in the US, and their currency is pegged to the US dollar. This of course raises fears that they will now unpeg their currency from the US dollar, which would cause mass exits from the US dollar and possibly a dollar collapse.
So what are we in for next? Crude oil is now definitely above $80/barrel. The US$ has dropped about 3% in one month. Foreclosures in the US jumped up by 36% in August, which is up 115% from August 2006! And there are still loads of ARM mortgages awaiting interest rate resets over the next couple of months.

I guess there will be a few weeks of calm before we see the next extreme event. How many extreme events can the world financial markets handle before an avalanche is set off? Don't forget that everything is tied up by trillions of dollars in derivatives.

If we get bankrupts increasing because of the problems for companies to get loans, we will see a test of the credit default swaps (CDS). The amount of CDSs outstanding is equivalent in size to total world GDP. It's already doubtful whether many issuers of CDSs can live up to their promises. And who holds all these CDSs? Default by a big enough company somewhere in the world could thus cause a cascade of bankrupts and defaults, since both the issuer and the holder of a CDS might go down, in their turn bringing down other holders and issuers of CDSs.

There are even more interest rate swaps and currency swaps than CDSs. What happens to the issuers of these when interest rates and currencies start to move quickly and in unexpected ways? And don't forget that many hedge funds speculate in these kinds of financial instruments.

Like the Chinese curse says: "May you live in interesting times..."


The R Word

Some really bad US job statistics hit the news this Friday. Non-farm payrolls were -4000 jobs instead of the expected +100,000. This is the first time in four years that job growth was actually negative. On top of that the preliminary figures for June and July were revised downwards substantially. And, to make matters worse, 592,000 people left the workforce, meaning that they have probably given up trying to find a job. Now the "R word" is sure to come any day soon - recession.

Treasury Secretary Henry Paulson's comments on the job statistics are priceless. He's desperately trying to instill comfort when this news has probably convinced even the most hardened optimists that the US economy will make a hard landing, and pessimists now predict a crash landing. Some quotes:
"it takes a while for confidence to return"
"A while" - ha - it will probably take years to sort this mess out.
"The economy will continue to grow in the second half of the year"
Oh yeah? That would be sensational. First this "unexpected" drop in jobs, and then he expects us to get another surprise when we suddenly see job growth again in September or October. Does he actually believe this himself?
Paulson, who had a regular breakfast meeting with Fed Chairman Ben S. Bernanke today, said he had "great confidence'' in the central bank.
"Helicopter Ben" is probably glad to hear that there's still at least one person who has not lost confidence in him.
"But I feel quite strongly that we have a resilient economy."
Well, let's hope that, but don't bet on it. Things might break quicker than Paulson can say "resilient economy".

The Mortgage Situation
Higher unemployment will of course lead to more people falling behind on their mortgage payments. Foreclosures have already hit an all-time high of 0.65 percent during the second quarter of this year, making this the third consecutive quarter in which a record is set. Delinquencies are also up - 14.82 percent of subprime loans are behind in their payments, but delinquencies in the prime area are also up from 2.58 to 2.73 percent. Expect this to turn worse.

Housing prices are sinking, partly because it has become much more difficult to get a loan. More foreclosures will also mean more houses for sale on an already saturated market. Expect housing prices to sink much more.

To make matters worse for the poor foreclosed home-owners, if the house sells below the amount of the loan, and the rest of the loan is forgiven by the lender, the amount forgiven is taxed as income for the borrower. This could lead to really serious problems for many people who are already in trouble.

There have been proposals (notably from George W. Bush) to bail out home-owners in some way to alleviate the effects of the current housing mess. However, with a recession coming on, where is the government going to find funds for such a bailout? A recession means less tax money coming in, so the only alternative is to borrow money. But borrow from whom? Most Americans don't have any surplus to put into US bonds, and foreign investors will be unwilling to invest more in US government paper if there is a major inflation risk. And that brings me to the subject of...

Apart from moving the stock markets down, the bad jobs news on Friday also took the US dollar down by more than 0.6 percent. The US dollar index (against other currencies) is now definitely below 80 and has now broken its 15-year low. Expect it to fall further unless some miracle news turns up. This means that all imported stuff will be more expensive in the USA.

To counter this bad trend for the US$, the only thing the FED could do would be to increase the interest rate, but what's really needed to alleviate the current domestic economic situation is an interest rate cut, which is what everyone expects the FED will announce on September 18. So the FED basically has its hands tied behind its back when it comes to fighting inflation.

Besides, there are two inflation factors over which the FED has no control - food and energy. I know that the "core inflation" figures the FED prefers to watch exclude food and energy, but in the real world food and energy prices have strong effects on the economy. People just cannot live without them. Food prices are rising sharply, as I have said before, due to a global shortage of wheat and other grains. President Bush could do something about this inflation factor, however, by cutting all subsidies to the grain-to-ethanol business. Of course this would mean a disaster for that business, but it would probably be a big help in fighting inflation. Though I don't expect him to do this, since he's too committed to it.

Oil prices are also rising, in case anybody failed to notice. On this Tuesday (11 September) OPEC will have a meeting to decide their production quotas. It is highly improbable that they will increase their production, since they probably cannot (this has been thoroughly analysed at The Oil Drum). OPEC will probably keep production at the current level, thereby keeping world market prices high. This means that the slightest disruption in this tight market could send oil prices upwards. Goldman Sachs already expects oil prices to hit $95/barrel this year (they're at about $75 now).

Many Companies in (Potential) Trouble
The current credit crunch is also a severe threat to the economy. Even if the FED lowers its rates, many loans (commercial and private) are tied to the LIBOR. The 3-month LIBOR is currently up to 5.70 percent, thereby increasing interest payments for all loans tied to it. It has also become much harder to actually get a loan. Outstanding commercial paper has contracted by nearly $300 billion over the last four weeks (source: Credit Bubble Bulletin). So many businesses will have a hard time due to either higher interest payments, lack of funding, or both.

Of course, all businesses connected to the housing boom are in even worse trouble. For example home builder Beazer received notices of default this week from a bondholders' group, while luxury home builder Hovnanian reported losses for the fourth quarter in a row.

For mortgage lenders you can watch the Implode-o-meter to see them going down one by one. The biggest one, Countrywide Financial, announced on Friday that they will cut 12,000 jobs (20% of their workforce).

Countrywide also seem to have been into some shady stuff too. They even seem to have neglected sending required paperwork to the IRS. Is this the beginning of another Enron-style scandal?

It is also getting harder for mortgage lenders to get funding. Citigroup announced that their First Collateral Services unit won't accept new clients for "warehouse" credit lines, which provide cash to mortgage banks so they can fund home purchases and refinancings. Does this also imply that Citigroup sees problems with their current clients? How many bad housing loans are actually connected to Citigroup in some way?

Citigroup also might have other troubles. Like many other banks, they have so-called SIVs (Structured Investment Vehicles) and conduits, which operate separately from the bank and are not on its balance sheet, but generate investment profit (hopefully) for the bank. According to Wall Street Journal, Citigroup "owns about 25% of the market for SIVs, representing nearly $100 billion of assets under management". If these SIVs start going bad Citigroup might have to help them out or take on some of their losses. Now according to Wikipedia, Citigroup, apart from being the world's largest bank is also the world's largest company (by assets), so hopefully they can sort out quite large amounts of problem debt.


Venezuelan Overnight Rate 120%

Bloomberg reports today that "Venezuela's interbank overnight rate soared to as high as 120 percent after the central bank said it would halt some of its lending operations to financial institutions." This has led to a serious liquidity crisis. It also seems this was a very quick decision that surprised some banks. Ouch! When will we begin to see banks toppling there?

This liquidity crisis does not seem to be isolated to Venezuela, but is a trend that is showing up in other "emerging markets" countries too. According to Marketwatch Russia also has problems with little or no liquidity in the markets, and several smaller banks have had to shut down lending.

Don't forget that Russia and Venezuela are two of the world's biggest oil producers. So trouble there could mean higher oil prices. Ouch again!

And if a couple of "emerging markets" experience financial crises, this could well have effects worldwide, cf. the crisis of 1997/98.


Grain Crisis?

Recent world news on grain supplies is definitely not comforting. Planet Ark (Reuters) report that drought is once again hitting the Murray-Darling basin in Australia. This will probably mean another bad harvest, unless they get rain over the next few weeks.

As I have reported before, wheat and other grain prices on the world market have recently been rising considerably. This is due partly to bad harvests in many parts of the world, but a surging demand for grain to make ethanol for fuelling cars is one of the most important factors in these rising prices. The ever increasing population on this poor planet of course also increases demand for grain, as does the increasing affluence of some countries, such as China and India, which creates more demand for meat, thereby increasing demand for grain to feed the livestock. Global grain stocks are now at a 26-year low after several years of harvests not keeping up with demand.

As world market prices keep rising, we will probably see more big producer countries protecting their own interests, as they don't want to export so much grain that they don't have enough for their own people. Ukraine, the world’s sixth largest wheat exporter, has already introduced prohibitively high export tariffs. Now Russia also considers stopping wheat exports. This has led import-dependent countries such as India and Egypt to panic buy, leading to still higher wheat prices on the world market. What we will see soon might be some LIFDCs (Low-Income Food-Deficit Countries) totally priced out of the market. As I said the other day, Zimbabwe already seems to be there. This in turn would lead to severe economic stress on international aid organisations providing food relief.

What is currently just a spike in world market prices for grain might quickly turn into a disaster for some countries. Even not-so-poor countries that are dependent on imports might find themselves in a difficult situation. If there simply is no grain for sale on the world market, it doesn't matter how much you are willing to pay for it - you just cannot get any!


Zimbabwe Breaking Down

Zimbabwe is in big trouble. They have just failed to raise money to pay for 36,000 tonnes of wheat, which is currently sitting in the harbour of Beira in Mozambique. Zimbabwe needs about 450,000 tonnes of wheat per year, but are currently producing less than 80,000. This is because of insufficient power available for irrigation. Agricultural production has fallen sharply over the last decade. Besides, Zimbabwe lacks foreign currency to pay for diesel and petrol needed for power generation, tractors, etc.

The prospects for this country are bleak. Just take a look at the following figures:
  • Official inflation rate currently at more than 7600%. This means that what cost $1 a year ago now costs $77!
  • Unemployment rate of 80%.
  • More than 40% of the population have HIV/AIDS.
  • Life expectancy is 37 years for men, 34 years for women - lowest in the world.
  • 25% of the population have fled abroad. Another 4% are displaced within the country.
The political mess is just getting worse, with human rights violations in every imaginable area. It's just a matter of time before the country disintegrates in riots and civil war, as I see it.
Someone said "Any society is just nine missed meals from anarchy". If no grain shipments reach Zimbabwe soon they will be there soon.