Australia | Aug 22 2007
By Greg Peel
There is no doubt about it – the world has changed. No matter how often one bangs on about how insignificant subprime mortgage defaults really are to the global economy, it’s too late. The cat is out of the bag. Investors globally will now be far more suspicious and risk averse than they were two months ago.
Until next time. But that next time will probably be a long way away.
The news wires ran hot this morning with figures released from leading US “foreclosure data firm” RealtyTrac. Mortgage foreclosure filings in the US rose to 179,599 in July – 9% above the number in June and 93% above July last year. One in every 693 American households were affected by a foreclosure last month.
The worst states hit were those in which housing prices had run the hardest previously, such as Nevada, where a 215% annual jump in foreclosures sees one in every 199 households in trouble. In Detroit Michigan, home to America’s ailing automobile industry, foreclosures jumped 70% from June alone affecting one in every 97 households. In 2007 to date, 1.1 million foreclosures have been processed and RealtyTrac suggests this number could easily surpass 2 million by year’s end. Christopher Dodd, chairman of the Senate Banking Committee warned last night the foreclosure rate had reached a 37-year high and as mortgage resets kicked in up to three million people could lose their homes.
RealtyTrac’s figures, however, need to be taken in the correct context. Firstly, this is the spiel one is confronted with when calling up the RealtyTrac website:
“At RealtyTrac you can buy homes at half price. Search the largest real estate property foreclosure database for free – Search over 1,000,000 homes. At RealtyTrac you can buy bank homes, NOD, auctions, HUD, VA and govenrment owned house foreclosures. Try our 7-day trial and find a the property for sale you are looking for. Find bargain homes, property, real estate and save 30-40% off market value. Realty Trac .com is the nation’s #1 database of pre-foreclosure, auction and REO Properties.”
That’s right – RealtyTrac specialises in foreclosure sales.
Secondly, RealtyTrac’s figures are always brought into question. CNBC has made this observation in the past:
“Here’s the deal. RealtyTrac gets its total number of foreclosures – 176,137 in May – by adding up “default notices, auction sale notices and bank repossessions,” according to their press release. Does that mean that some properties get counted multiple times? You bet it does.”
…Just as much was made by the bulls from a surprising jump in mortgage applications one week in July, when it was pointed out that you can make multiple applications and still not get a mortgage.
There is no denying that the “subprime” crisis has moved into a wider scope. Many Americans, those with subprime, mezzo-prime and even prime mortgages and equity loans will definitely lose their homes. Commonwealth Research cites defaults on risky mortgages as one reason risk in general is being reassessed globally. The other is a perceived reduction in investor appetite to fund leveraged buyouts.
On the subject of the latter, one (reliable) report notes that prior to July 24, private equity buyouts represented 40% of all merger & acquisition activity in the US. After July 24, that number has fallen to 9%.
Commonwealth Research analysts see recent financial developments as a “crisis of confidence” rather than an economic crisis. This has driven a reassessment of risk. Spreads on corporate bonds have suddenly risen to their highest level since 1998 (when the last credit crisis occurred after LTCM). By contrast, yields on government bonds have appreciably decreased.
The analysts believe that eventually some of this panicky risk repricing will be wound back, but some will be “permanent “. They should probably listen to Sean Connery (never say never) given history will always repeat, but the drift is obviously that it will take a long time.
While not an “economic crisis”, the analysts suggest the crisis of confidence can still spill over into the real economy, just as it did after 9/11. It was 9/11 that prompted the Fed to lower the cash rate to 1% and keep it there for a year. It took another five years to bring rates back to normal, but by then the damage had been done. And now here we are.
Comm Research believes the Fed is now on the horns of a dilemma, facing an “unpalatable decision” at its next meeting on September 18. A rate cut would provide insurance against the crisis spreading further into an otherwise healthy US economy, but it could also reinvigorate risk-taking. For the record, Comm Research is tipping a 0.5% cut in September.
The analysts expects rates will go on hold in Europe, the UK, Canada and Japan, and expected increases in Australia may even be delayed.
“Higher risk premiums – if permanent – will have far reaching and long lasting economic effects,” say the analysts. They will be felt most in the centre of risk reassessment – the US. But Australia, as a member of the globally interdependent financial markets, will also be affected. The analysts have modelled the Australian economy assuming a 1% increase in investment risk premium.
What the numbers suggest is a 1% ($10 billion) reduction in GDP will transpire over six years. Business capital spending will fall, resulting in a reduction in output. Employment will not be significantly affected, but productivity (due to lower output) will. This will lead to lower consumer spending and lower real wages.
Foreign capital will flow out of Australia causing the Aussie dollar to fall. Import prices will rise and push up the CPI. Demand for imports will thus fall, as will demand for local products.
Gloomy.
However, Comm Research wraps up their discussion with this caveat:
“The model simulation covered here illustrates how a higher risk premium influences the economy. Actions by central banks are also important. For example, central banks cutting official rates would provide an offset to higher market interest rates.”
…Which basically brings us back to where we started.
