OK, Today is Scary

Unemployment rose to an "official" level of 6.7% today as DOL reports 533,000 jobs lost just last month. This is the worst jobs report in 34 years, since 1974. Merry Christmas indeed.

The name of the game in any recovery is not the Dow, it is not financial stocks, it is not even rising house prices (which are a lagging indicator).

By far the most important leading indicator of a possible turnaround in the overall economy is J-O-B-S. Without jobs, and without confidence in jobs and employment overall, there can be no confidence in the economy, no confidence in one's personal income, and no confidence therefore in new personal or business spending. And that means no quick turnaround.

This means houses will continue to be difficult to sell, although by no means impossible.

On CNBC just now, a trader referred to the jobs report as a "lagging indicator." This may be a technical point, but for most people not on the floor in Chicago or New York, the employment statistics are a tremendous insight into the true state of the economy and the longer term trend.

And when we are measuring economic statistics by the decades in terms of new lows, and not month-to-month, the jobs reports becomes an important forward indicator.

Employers do not like to get rid of experienced employees out of short term pessimism. When employers let employees go, you can be assured that executives believe the company will not be replacing those jobs in the short-term.

The only "silver lining" (I know, I know...) is that oil prices just fell over $1 per barrel, to lows not seen since 2004. It's not 1984, but it's relief. But of course, if you don't have a job to commute to, the price of gas becomes highly irrelevant. Who wouldn't pay 3x per gallon just to keep their job?

And who knew six months ago that it would feel gloomy to fill up my V8 with premium gas under $2 per gallon?

The only true good news is that Europe is in worse shape than we are, which means that although we're not doing well, investors should not be pulling money out of the U.S. any time soon. If another region in the world starts to pull away ahead of the U.S., then... well let's not talk about it unless we have to. So far, so "good."

Indeed.

What I Want to Know Is...

Here's what I want to know: Why in the world is congress giving American car makers such a hard time over a $35 billion loan, when the government has already allocated about $1 trillion for financial companies including American banks?

For instance, about $20 billion last week was allocated to Citigroup to prevent the failure of that massive bank. There was no public debate, no congressional approval... just an announcement. And make no mistake, Wall Street rallied, and it was the right thing for the government to do for the sake of America, and not for Citigroup's executives (jail them for all I care).

So why are the American car companies being publicly flogged for requesting a combined $35 billion -- less than 5% of the federal bailout law -- to get through this historical economic crisis?

Well, here's part of the answer, I think. Why does America only have 3 car companies to begin with, and all of them headquartered in the same failed midwestern city of Detroit? Isn't that odd for these modern times? There are no auto headquarters in California, or Texas, or Ohio, or Missouri? I could make a strong case for each.

If the Japanese and Koreans are going to force our industry out of business, and if we're going to let them do so, and largely with manufacturing plants even on our own soil, then why in the world can't America produce American competitors to beat the Japanese and Koreans? Maybe there's not enough competition within America and between American firms. Why would that be?

The thrust of the problem, I think, is that America has become hostile, even prejudiced, against American manufacturing. That's why it's held on in the city of Detroit, no innovation, no expansion, just old... thinking... and old... organizations.

Our primary concern as Americans right now needs to be American jobs. Without confidence in our jobs, America can never recover from this economic morass. Frankly, I don't know anyone right now who does not fear their job security at some level or another.

A rule of thumb is that a tenth of a percent of the unemployment rate equals about 100,000 jobs. Analysts suggest that a failure of "Detroit" could lead to a total loss of 2 million American jobs. That means unemployment would skyrocket by 2 entire points -- to maybe 8% (bear in mind that new calculation methods of unemployment make 8% equal to maybe twice that several decades ago).

So why is there a debate? I think Americans are tired of being ashamed of their auto industry. The truth is that Detroit has been making good cars in recent years, actually. Most people blame the unions. However if the unions did not exist at all, then Detroit would have to face the fact that their "failures" are really due to executive failures and a collective lack of imagination in design and understanding of market demand more than anything. To wit: GM and Ford decided just a couple of years ago that their best strategy was to create the big gas guzzling line of bland SUV's that had been so profitable for them. (There's not much room for a profit margin in a small, entry-level car.) Well, that was just the wrong decision and terribly short-sighted.

Global players such as Japanese and Korean firms have long marketed to European and Asian markets, of course, where highly dense metro areas require small, small cars. Even Mercedes produces the "Smart" car that is exotic in these parts but common on the streets of any major European city.

Maybe we need more than just 3 American auto companies. Maybe we need more competition. Maybe a California start-up will take a chunk of the market with advanced hybrid and electric technologies. Whatever happens, now is a time not for destroying our auto industry, but for paving the way for serious American innovation. History shows that when America innovates, the world has no choice but to follow.

I think it's time that America realizes that it's just as serious and worthy to have leading manufacturing sectors as it is to have leading technology and professional service sectors.

And congress should stop playing games with millions of jobs that underpin America's challenged middle class.

Best Explanation of the Crisis We Face

While I know DailyKos has become somewhat of a progressive bogeyman among the partisan right, not entirely unreasonably, some of its editors (authorized regular columnists) have extraordinary credentials who I find worth the read despite the partisan orientation. Frankly, the real polemics can be found in the largely unregulated "Diaries" posted by registered users in the right column. That can take a lot of sifting to find quality content.

That aside, on a technical basis both in accuracy and writing skill, this is the best post I've seen yet explaining the current state of the crisis that has been unfolding over a year now. It's critical to understand that what started as a "subprime mortgage" crisis last year has now expanded to reveal certain "shadow" financial instruments that Warren Buffett himself famously called "Financial Weapons of Mass Destruction" in a 2002 memo to his shareholders. The post I'm highlighting was written by a blogger named "Devilstower," however don't be fooled: this is no teenager proverbially blogging from his mother's basement in his pajamas.

In his November 16th post, the author reviews the biggest threat to our financial system currently, and that's the fallout over the failure of the "Credit Default Swap," a derivative that is essentially unregulated "insurance" at best, and worse, outright "gambling with no bookie." From his intro:

In essence, credit default swaps are (or were) nothing but insurance policies for loans. And yet in 2007 the total number of credit default swaps traded far exceeded the value of all loans. In fact, it may have touched $70 trillion dollars, which puts it above the gross domestic product of the entire planet.

Yes, $70 TRILLION. That doesn't mean the money exists, it just represents the value of all the "bets" outstanding. It's easy to see now what Buffett was talking about way back in 2002 when the government, regulators, and certainly investors had no clue what these things were really about.

If a person goes bankrupt and cannot pay back a loan, and the person insuring the loan for the lender cannot pay the insurance payout that was obligated, then the lender must bear the entire cost of the loan failure. In turn, the lender either a) cannot lend more money because of the loss it must now cover, or b) the lender may also be an insurer on another failed loan to another institution and now itself cannot pay out. This is over-simplified, but it's easy to see how multiple failures like this set off an extraordinarily dangerous chain reaction of radioactive proportions. That is what the nation is dealing with in large part right now.

I do not believe that now is not the time to begin diagnosing how we got into this mess. If we wait until we are out of this mess, history shows we are far less likely to bother with an accurate diagnosis that could lead to effective future protections. 2008 Nobel winner Krugman:

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

One answer ... is that nobody likes a party pooper. While the housing bubble was still inflating, lenders[, investment banks, and money managers] were making lots of money... Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?

There’s also another reason the economic policy establishment failed to see the current crisis coming. ... [T]he crisis of 1997-98... showed that the modern financial system, with its deregulated markets, highly leveraged players and global capital flows, was becoming dangerously fragile. But when the crisis abated, the order of the day was triumphalism, not soul-searching.

Time magazine famously named Mr. Greenspan, Robert Rubin and Lawrence Summers “The Committee to Save the World”... who “prevented a global meltdown.” In effect, everyone declared ... victory..., while forgetting to ask how we got so close to the brink in the first place.

So now, following is Devilstower's very important point to build on Krugman: the current crisis can largely be traced back to a piece of legislation passed in 2000 and signed into law by President Clinton with bipartisan support, clearly before anyone except a few really understood what they were doing:

In 2000 Republican economic hero, Phil Gramm, with the assistance of a small legion of lobbyists [and Democrats], created the Commodity Futures Modernization Act [signed into law by then President Clinton]. Along with ushering in the Enron disaster, this bill provided the one thing that credit default swaps needed to grow and mutate -- invisibility. Thanks to the CFMA, not only were credit default swaps unregulated, they were impossible to observe directly. Like black holes in deep space, you could only spot swaps by looking at how other things acted nearby.

So, now you've made a loan to someone, and you're worried about it. I want to offer you a credit default swap so I can collect the fee. Trouble is, I don't have the assets to cover your loan. So how can I... hold on, credit default swaps are so unregulated that no one says I actually have to be able to deliver on my promise. Hey, over here! Have I got a swap for you, and it's a bargain.

So now the CDS is a means of moving the risk, but the risk is still as high (or higher, since the original lender might have been better able to cover the loss). In fact, credit default swaps have gone from being a risk mitigator, to a risk magnifier.

A risk magnifier indeed. And most of this, along with most of the activity of private hedge funds (extraordinarily aggressive investment funds using massive amounts of loans with very little cash reserves), went completely unregulated and unmonitored. So a big part of the current problem is that nobody can really figure out just how much of this stuff is really out there in the market and in what form.

Contrast this with the heavy regulation, for the public and investor good, required of public securities overseen by the SEC and also required of insurance products. The regulatory requirements for these classic instruments are legion, but they are designed to increase the availability and accuracy of information in the marketplace so that both investors and regulators can make the most informed decisions about their market choices.

It should go without saying that $70 trillion in undisclosed "positions" (bets) in the marketplace is not immaterial to the decisions that investors and regulators were making in the last 8 years before this crisis. But congress, through the 2000 CFMA, let all of this go under the radar, unregistered, unregulated.

Here's the crux of how things went so wrong and got so out of control. Again from Devilstower:

Swaps are unregulated. No one says I have to have enough resources to cover the swap, and even better, no one says I have to offer the swap to the person who actually made the loan! Hey buddy, see that loan over there? You may think it's iffy, but I think it'll hold up. In fact, I'm so sure it will, I'll sell you a credit default swap on it that pays off if it fails. You don't make the loan, you don't have to pay off on the loan, you don't have anything to do with the loan. You just pay me the fee. And if that guy loses his money, you collect. How sweet is that!

This mutation is enormous(...) At this point, credit default swaps [became] completely divorced from the original function. A single loan can be covered by multiple swaps. There's a complicated fiscal term for this. It's called gambling, and at this stage, that's all that remains of those little "insurance" policies. They no longer protect anyone from anything, they just offer a chance to place enormous overlapping side bets on everything.

So there it is. An instrument sold to congressional accomplices on both sides of the aisle and an unknowing, unsuspecting market as a "risk mitigator" actually mushroomed in a cloud of unregulated, invisible massive $70 TRILLION side bets with no bookie.

Financial weapons of mass destruction indeed.

The Dynamics of Real Estate Pricing

There are far too many dynamics that affect real estate pricing to discuss in one post of course. But one important one, time and again that we see, relates to price adjustments, how to make them, and when to make them.

Our experience shows that price adjustments are most effective:

• early in the listing period; in other words, get the price right up front and price for the market you are in, not for the market you want to be in, and

• in fewer, more dramatic increments to get a "bang" in the market, especially since any interested parties will be watching the property for significant movement, and also it takes a dramatic incremental move to expose the property to new price-point buyers in the market. $5,000 increments over time will accomplish little more than a slow ineffective leak in the price with little to no impact... resulting in a lower sale price and longer time on market.

This is of particular interest right now because of parallels with the larger discussion about the best size and scope of government responses to a slowing economy. While it is natural and correct to be concerned about future deficits, most economists seem to agree at this point that doing too little right now is a far greater risk than doing too much.

From the recent Nobel-winning economist Professor Paul Krugman this
morning:

The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.

The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.

The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.

This is remarkably parallel on a macro level to what happens when a property is on the real estate market. Incremental adjustments are fine when the market is on solid footing - sometimes small moves can be effective -- in tight markets. But as Joe Kernen on CNBC Squawk Box this morning keeps mentioning a very instructive quote from Barrons over the weekend: "Now is not the time for the Fed to act like a blushing virgin." Adds Kernen, "This is the time to be a big ol' hooker..." (See 1:40 mark for discussion of rescue size, 1:51 for quotes, and don't miss discussion of oil price impact/non-impact at 1:15 mark in video.)

In other words, in extraordinary market challenges, the markets require bold action, bold responses. This is a time to pull out all the stops, and leave everything on the road, including mixed metaphors.

Success in the market right now requires bold action, and it requires a recognition by sellers of the true nature of this market right now. Sellers who can adapt to current market conditions and offer appropriate market incentives, including price, will be today's winners in the market. Ironically, they will sell for more and they will sell faster, both of which bring the optimal financial outcome.

It is what it is right now. And no amount of clapping is going to make this a different market. Sellers ignore this at their own financial cost.

Pay No Attention to Averages

Okay, seriously, this is getting way out of hand. The national media keep reporting national numbers related both to commercial and especially the housing market that are averages.

First, let's review the difference between an "average" and a "median," because you'll see both terms thrown about.

• An average is a generalized number meant to represent any particular instance as a generic example. So, if there are 3 houses on a street worth i) $100,000, ii) $200,000, and iii) 400,000, then the average is $100k + $200k + $400k divided by 3 = $233,333 is the average price. But how useful is that if you're trying to figure out what your house is worth one street over? (Hint: Not very useful at all.) So averages are generic. And they're fine when the set of numbers being averaged fall into a close range.

• A median is the number for which 1/2 of all things are above, and the other 1/2 are below. So in any neighborhood, if the median price of a home is $200,000, then that means that half of the homes in the neighborhood are priced above $200,000 and half of the homes are priced below $200,000. This is more helpful, but still does not tell the whole story.

So an average is really just a melting pot of statistics, and the bigger the pot, and the more things thrown in all melted together -- well how much does that average number really tell you? Not a lot, especially in real estate.

An "average" would be okay when talking about the national housing crisis if all parts of the country were experiencing basically the same problems and had the same history and outlook. But that's not at all the situation. There are parts of the country where the housing bubble absolutely exploded like Dutch tulips, beyond all reason. In other parts of the country, such as in Houston, housing prices never really accelerated all that much as new supply kept up with new demand.

Consequently, Houston is not seeing the same downturn that many other parts of the country are seeing -- because Houston never really saw the run-up that other parts of the country were seeing in the past 5 to 10 years. So Houstonians really need to look at their own local data to get a better grip on the local housing market and should really disregard the national reports when thinking about the local market.

The story in Houston right now is that while the number of sales are down over 20% year-over-year right now (last year there were about 20%+ more sales happening), the prices of those sales are actually holding firm within a couple percentage points, in stark contrast to the national statistics and especially the national averages.

In the future, we should discuss What Really Drives Real Estate Values of What You Own, and also what's behind the statistic "Average Months of Inventory." Both are confusing, even to people in the industry.

Update November 25, 2008: Here's another story with a big "price plunge" headline that Houstonians should ignore.