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Ilargi: One of the few things that Stoneleigh and I occasionally disagree on -and there really are but a few- is the rate at which real estate prices will decline. I proudly and steadfastly maintain that it will be 80+%, while she insists it will be 90%. Once you do the math, it’s obvious that’s no basis for a healthy disagreement. We basically even agree on this one. Bummer!

The reactions to the fact that Stoneleigh mentioned her 90% prediction in her latest interview with Max Keiser are amusing. Not least of all Max’ own immediate one, jokingly suggesting the segment may need to end up on cutting room floor for being too extreme. Mostly, though, I’ve seen tons of people say that Stoneleigh is a loony doomer who has no idea what she says. Thing is, that would make me a loony doomer as well, and no, you ain’t getting away with that one.

Of course we see where people are coming from; no-one who hasn‘t thoroughly thought this true could possibly see an 80-90% drop in home prices, and most who have can’t either. However, that’s where the Big Picture enters, stage left in five.

What we have been predicting for the past five-odd years is first and foremost a credit crunch and collapse, across the western world. That is, available credit will decrease ever more, until there’s hardly any of it left. And that in turn will have grave consequences across economies, including real estate markets.

Our economies run on credit, it’s their lifeblood. Take it away, and they will stop running. Not altogether, but to a very large extent. Shipping letters of credit are getting harder to procure; the Baltic Dry Index is once more tumbling as we speak. Nearly everything you find in your stores is bought with credit; if storeowners would have to pay in advance for what they haven’t sold yet, they wouldn’t be able to.

Now imagine that coming to a grinding halt.

Similarly, real estate purchases practically all involve the use of credit. For anyone to be able to afford a home with the cash they have, home prices will have to come down a lot. Which is precisely what they will do. However, by that time, those among us who do have the cash will think twice before using it to buy a home. Home purchases will never go down to zero, but they can come down a lot. Like prices, purchases can also fall by 90%. there’s a solid link between the two. As Becky Barrow reports in the UK Daily Mail:

UK mortgage lending to hit 30-year low in 2011 from a £110 billion-a-year peak down to just £6 billion

The mortgage freeze will continue next year, with net lending expected to slump to its lowest level in 30 years, the Council of Mortgage Lenders warned yesterday. It predicts that net mortgage lending will hit a low of only £6billion, a paltry amount compared with the peak year of 2006 when £110billion was handed out. Net lending is the total amount lent by banks and building societies after subtracting the money paid back by homeowners.[..]

The speed of the meltdown is remarkable. In 2008 – the year of the bail-out of the banks – net lending was £40billion, but the situation has got dramatically worse since then.

In 2009 net lending was £12billion and this year the total is predicted to be £9billion. The CML’s figures, published yesterday, also reveal that last month was the worst November for a decade. Gross mortgage lending, which is the total handed out, was only £11.1billion, the lowest level in the month of November since 2000. This year gross lending is expected to be £135billion. In its peak year of 2007 it was, £363billion.

It is somewhat ironic, even if it should be downright frightening too, that at the same time the British population has stopped taking out mortgage loans almost altogether, their government has stepped up its borrowing with a vengeance. From Hugo Duncan, also at the Daily Mail:

Britain slides further into the red: Monthly borrowing hits record £23.3 billion

George Osborne was given a pre-Christmas shock yesterday as Britain dived deeper into the red. Borrowing jumped to a record £23.3billion in November despite the Chancellor’s austerity drive, according to the Office for National Statistics. That is £777million a day and £5.9billion more than in the same month last year.[..]

A collapse in confidence in Britain’s ability to tackle the deficit could send the economy into another tailspin. The Government has borrowed £104.4billion in the first eight months of the fiscal year – only just below the £105.1billion this time last year. City economist 155billion in 2010-11 – less than the record £156billion deficit racked up by Labour but more than the £148.5billion planned by the Chancellor.

Andrew Goodwin, senior economic advisor to the Ernst & Young Item Club, said: ‘These figures really are a bolt from the blue and will ensure a miserable Christmas for the Treasury. ‘The November figures pretty much wipe out all of this year’s reduction in one fell swoop. ‘It will provide more fuel for the sceptics who question whether the Government can really achieve the scale of public spending cuts that it plans.’ The national debt rose to £971billion at the end of November, or 65.2 per cent of gross domestic product, another unwanted record.

Debt interest payments jumped from £3billion in November last year to £4.5billion this year – or £150million a day. State spending last month was more than 10 per cent higher than November 2009 at £53.9billion, while tax revenues were up just 3 per cent at £36.7 billion. The Government has outlined an £81billion package of public sector spending cuts to reduce borrowing to £35billion in 2014-15.

Ilargi: Like so many other countries, Britain tries frantically to avoid the inevitable looming credit disaster. Not that you would know it for listening to the local politicians:

The Prime Minister insisted the coalition was on a ‘rescue mission’ after Labour ran up the UK’s biggest ever deficit. ‘I don’t think that’s an exaggeration,’ said David Cameron. ‘Just look at what’s happened in Ireland, Greece and southern Europe. Just eight months ago, we were on a similar track.

‘Make no mistake, the country was in the danger zone and it has taken this coalition making difficult decisions to pull us out of that danger zone.’ Mr Cameron also insisted Britain’s AAA credit rating was safe, interest rates were down and ‘confidence is being restored’.

Ilargi: Still, with a braindead housing market (check), severe austerity measures (check) and a government that’s plunging itself into debt so deep it has to fear international bond markets (check), it’s safe to say that Britain is very much mired in that danger zone.
In the US, Jason Philyaw at Housing Wire writes:

US mortgage applications down 18.6% last week

Mortgage application volume continues to decline with a huge drop last week, as interest rates remain on an upward swing and demand for refinancings plummets. The Mortgage Bankers Association said its market composite index decreased 18.6% for the week ended Dec. 17 on a seasonally adjusted basis. Unadjusted, the index fell 20% from the prior week.

Refinancing applications have decreased for six consecutive weeks and volume is at the lowest point since the end of April after another 24.6% drop last week. The seasonally adjusted purchase index fell 2.5% last week. The unadjusted purchase index declined 4.9% and was 8.4% lower than a year earlier.

Ilargi: Optimists may try to claim that maybe we have scaled the worst of the downturn; a net lending fall from £110 billion to £6 billion in Britain could certainly make one wonder how much worse it can get. Well, home prices haven’t really come down in Britain. Or Canada. Or Holland. And they will do so. The British example of falling net lending in the private sector combined with fast rising public lending should serve as a warning sign to every western country.

I know what many will say: the US has managed to stave off the worst so far, and at first glance that may appear correct. Still, just a scant few seem to realize at what price that has been achieved.

Huge efforts and vast sums of money are spent to keep the stock markets looking healthy (Stocks flirt with pre-Lehman crash levels, says the headline). After all, that’s where everyone will look first for signs of either downfall or recovery. However, the financial sector, just to name an example, is very prominent in those markets. And the financial sector is dead and gone if and when home prices start falling in earnest. Most of the sector would already have died without the trillions in public money that were squandered on it by politicians convinced that supporting the banks is either the best for their countries or for their own political careers, whichever comes first.

The levels of exposure to real estate debt for banks in any major western country are at best unhealthy. In Canada, it’s 50%; in other countries, it can’t be much lower. it’s where the easy money has been in the first decade of this millennium, which we’re about to close. It might be a bit less in a country like Germany, when it comes to domestic real estate, but German banks have jumped in all over southern Europe, so that’s no consolation either.

Exposure to direct mortgage debt is one thing. Exposure to the securities and other derivatives written on that debt is quite thing another yet. And a much bigger thing to boot.

Mark-to-market accounting has been suspended indefinitely for now. That’s the main reason things still seem “normal” around us. The idea behind what replaced it, mark-to-whatever accounting, is that all the paper that can today not be sold for more than pennies will someday be worth a dollar again, or even more. For that to happen, though, home prices would have to either rise or at least stabilize. And for that to happen, in turn, banks would have to start lending again, and people to borrow.

The British example of a 30-year low in mortgage lending says that’s highly unlikely. Since UK home prices have hardly come down at all, while they rose like crazy for much of the past decade, it shouldn’t be too difficult to figure where British home prices are headed. And if nobody is either able or willing to take out mortgages, prices must come down. It then becomes simply a matter of price discovery.

As long as everyone just stays put, and nobody dies, pretense can go a long way. But if people do move, or pass on, and homes need to be sold, they will sell at increasingly lower prices. You can’t sell unless you have a buyer, and there’s very few of those left. Even if most western nations have swallowed up large swaths of mortgage debt and risk from their banks. Even if Fannie Mae and Freddie Mac threaten to eat the US economy whole with their present debt and leverage levels even today, let alone with adding additional commitments going forward.

There is one factor that outplays all others when it comes to the real estate market: employment. In Britain, “official” unemployment stands presently at some 8%, with youth unemployment at 20%. In Spain, overall unemployment is 20%.

In the US, the picture is deliberately kept as murky as possible. Official U3 unemployment is at 9.8%, but when tens if not hundreds of thousands of workers every single month are moved into the “no longer in the workforce” category, following the U6 number, which is 17-18%, might paint a more truthful picture.

The problem that emerges form this is that even if the banks would be willing and able to lend, which they’re not and they won’t be because they’re broke, and therefore dead without incessant infusions of public funds, there still would be a severe housing crisis, simply because the pool of borrowers has been diminished below the level that could potentially keep “healthy” borrowing numbers intact. And don’t forget that, moreover, a growing part of the working population greets you at Wal-Mart or flips your burgers at Wendy’s, and those folks too, along with the jobless, are out of the real estate market for a long time to come, if not forever.

In Canada, 20% of GDP is construction related. It can’t possibly be much less in the UK or US. In Spain, it was even higher until recently. And you can’t take 10-15% or more out of an economy that already struggles and not feel a sharp pain. Moreover, you will see a snowball effect. Less real estate purchases, less jobs in construction, in banking, and eventually at those sectors that catered to them. Which leads to less real estate purchases, and so forth.

This can’t go on forever. You live on the money your governments have borrowed from your own children (90% of which went to the banking sector to begin with). Now, I don’t know how many children you already have or are planning for, but there will be a perceived limit to what your offspring can service in debt, and when we cross that limit, the international financial markets will either make us stop it altogether or force us to pay interest rates we can’t afford.

That is to say, borrowing from ourselves to keep our illusion alive of a “normal” life must and will stop. That will lead both to major jumps in unemployment, and, as stated above, that in turn will lead to even worse housing markets.

This is inevitable. We must come off our credit “sugar” high, and we can’t do that by applying more credit. That will mean scores of jobs created by that sugar high will disappear as well. The jobs that were not have all been moved elsewhere in the world. No healthy job market, no healthy housing market. Period.

So when do we see this come to fruition? Well, price discovery in a housing market, which is always prone to inertia, since people can stay put and fool themselves about the true value of their homes, can take a while to develop. But it will come. US banks will at some point need to offload foreclosed properties, They play a delicate game between the marked-to-whatever value they carry the homes for in their books, which makes them appear solvent, even as they get no income from the homes, and, on the other hand, getting that income. Banks are desperate for cash-flow, but for now, who cares if the Fed provides cash at 0.0078%?

The way we at The Automatic Earth see it play out is that the entire house of cards will fall within 2-5 years, and, within that timeframe, sooner rather than later. While there can be any number of inside and outside factors that can speed it up, we see practically none left that could slow it down. Of course there can be people in a few years time who claim by hell and high water that their homes are still worth $500,000, but they will have neighbors who sold for $100,000, $50,000 or less. Price discovery can be in the eye of the beholder, until you must urgently sell.

There are people in many countries and regions who feel that their particular place is different, and they do so for a variety of reasons. But nine out of ten of them are wrong. Even in China and Brazil, which today look to be relatively healthy economies, the western credit collapse will cause unequalled mayhem. Russia may fare a little better, but only for the richest part of its population; then again, that will be true around the globe.

For the remaining 99% of the population, the combination of deleveraging and depression, a double barrel that guarantees a self-reinforcing positive feedback loop, will be gruesome and cruel.

People have complained about the fact that we have warned last year about what 2010 would bring, pointing at the stock markets, which appear just fine and normal. But, as we’ve always maintained, it’s better to be a year early than a few minutes late, and moreover, if you look at the numbers of foreclosures and long-term unemployed, and the number of Americans who are on foodstamps today (1 in 7), maybe it’s time to realize that what we think of as normal is something we left behind years ago. Even to ponder that from the very beginning of this now closing decade, with the huge run-up in real estate prices through out the western world, things have never really been normal.

It’s perhaps just that when you can go out and buy homes and cars on credit, and iPod and iPads for Christmas, it is mighty tempting for the fickle human brain to see that as “normal”. Meanwhile, your home values will return to what they were in, say, the 1970’s, or even before that. It might be a better idea to see that as “normal”. Then again, prospects for economic growth were much better back then. Maybe try 1950.

The human brain is lousy with diminishing returns and receding horizons. It excells at perpetual growth. Great at the impossible, bad at reality. So bad we’d rather invent our own reality than face the one we must face. Until we can’t. In the end, what we’ll be left with is a small group of rich people buying up real estate for pennies on the dollar. Which is of course no different from what happened in the 1930’s.

Nothing new, nothing special there. What we fear will be new and special is the degree to which we will see our economies and societies crumble; there are precious few signs that it will be better, let alone different, this time. And that’s why the only disagreement Stoneleigh and I have is between an 80+% and a 90% decline in home prices. Across the western world. On average.

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