It has been the best of times and the worst of times, depending on your perspective. Economists are calling the recession of 2001 the mildest downturn in recent memory. Stocks went down as company profits fell, but consumer spending remained firm putting a floor underneath the economy. Although stock prices plummeted during the last three years, the loss in equities has been made up by housing appreciation.
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....Last year cash out financing allowed consumers to pull out over $200 billion in equity from their homes which went towards consumption.
Lower interest rates are making it possible for homeowners to pile on mortgage debt at a record pace. The mortgage debt of the average homeowner is at a record level as is the delinquency rate for loans insured by FHA. Delinquency rates rose by 12.59% in the latest quarter, up sequentially from 11.65% in Q1. The rise in mortgage debt has shrunk homeowners' equity to 54.3%, a new record low. Consumers have been transferring credit card debt onto their mortgages through home equity loans. Consumer credit card debt nationwide has risen by 53% in the last decade, but has fallen from an average of $4,486 to $4,126. The drop in average credit card debt can be attributed to cash-out refinancing, home equity loans, and credit lines.
Your Neighborhood Bank
Banks have turned into aggressive lenders in the real estate market. Bank lending has moved away from business lending and commercial construction and is now heavily concentrated in residential real estate. The redirection of bank capital towards the residential market is the main factor fueling the housing boom. It has become a self feeding frenzy as rising housing prices encourages more lending in the sector, which further fuels prices. As home values rise, it creates additional collateral which can be borrowed against and redirected towards consumption. The strength in retail sales has been highly correlated to rising housing prices and mortgage refis. Without an appreciating real estate market, the consumer consumption binge would come to an abrupt end.
Nationwide housing prices just hit a post-war high rising 17.5% year-over-year.
Your Local Businesses
If the consumer and housing sector have remained strong, prospects for business have been less than stellar. Business conditions have remained weak, profits have been hard to come by and capital spending is lethargic.
Economists and analysts are optimistic that business conditions will improve, eventually picking up the slack that could emerge from the consumer sector. What makes economists and analysts so optimistic is the run up in stock prices this year from the March lows. Stocks haven’t suffered as much as a 10% decline since March. Every month the indexes go higher.
The only problem with these numbers is that they aren’t real. The actual earnings according to GAAP aren’t doing as well. The earnings that everyone is using these days are the operating numbers which look much better.
Today’s announcement by Motorola one day ahead of schedule is a good example of the spin that is being applied to earnings reports. Several weeks ago Motorola warned that sales and earnings may be lower due to manufacturing delays of their new line of phones. The earnings report comes out a day ahead of schedule. The company was anxious to get some sort of good news out following Friday’s Moody’s downgrade of the company’s debt to one notch above junk bond status. The company reported earnings of $116 million, up from $111 million the year before. This translated into six cents a share the same as one year ago. Essentially the company’s profit was flat. They have fallen from Q4 2002, and Q1 and Q2 of this year. Motorola’s share of the mobile-phone market has dropped to 14.6% from 26% in 1996. Operating profits for the phone segment of the business has fallen 39% to $147 million in the latest quarter. Profit margins have been cut by a reduction in selling prices from $147.50 to $145.
This market--like the economy--rests on a false set of assumptions and hopes. The economic numbers are getting better, but they are heavily massaged. The earnings numbers are improving, but they are also reconfigured. Stocks continue to trade up on fictional earnings and Wall Street pretends to not know the difference. Everyone is celebrating because prices are up and that is all anyone is paying attention to. The rising debt levels of the consumer, rising mortgage delinquencies and maladjusted corporate balance sheets are ignored. The focus has been on rising prices, rising home prices and rising equity prices. The bubble in housing and the return of the stock market bubble is ignoring deteriorating economic and financial fundamentals. The debt levels look good only when compared to inflated home and equity prices. All anyone cares about is that prices are rising again for stocks and housing inflation continues. The rising asset prices are simply another form of asset inflation, a product of the largest monetary inflation efforts in history. Like all inflated assets that rise parabolically, they become subject to a deflationary bust. The bigger the rise, the larger the bust when it arrives. The recent NASDAQ crash of 2000-2002 should be a subtle reminder of what can happen when prices get overextended. The next bust could very well end in a crash, and when it does this time it will involve both equity and housing prices. A bust in equities is different than a bust in real estate. Falling stock prices only impact the owners of stocks as well as a few brokerage companies. A collapse in real estate prices impacts both the borrower and the lender simultaneously.
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