John Robb's Weblog

Will the Center Hold?

Sobering testimony from Nouriel Roubini from the Stern school of Business. In addition to his strongly argued belief that we are headed for a severe recession, that may last up to 8 quarters, he also laid out a black swan event (one that he believes isn't a low potential event anymore, but rather a real possibility). This Black Swan hinges on the shift from home to house. If the majority of the American middle class makes a shift to "economic man" from the historical "American dreamer", we are all truly hosed:

I will argue that currently the most important first-order risk for financial markets derives from the likelihood that 10 million to 15 million households may walk away from their homes if – as likely - home prices fall another 10% in 2008 and further in 2009.

Thi would lead to systematic banking failure (on top of a bear market and the host of other financial failures in associated markets we are currently seeing):

What will be the consequence of losses of over $1 trillion and, possibly, as high as $2 trillion? That would wipe out most of the capital of most of the US banking system and lead most of US banks and mortgage lenders – that are massively exposed to real estate – to go belly up. You would then have a systemic banking crisis of proportions that would be several orders of magnitude larger than the S&L crisis, a crisis that ended up with a fiscal bailout cost of over $120 billion dollars. And the worrisome part of this scenario is that – with home prices likely to fall by 20% or more – this scenario of systemic banking crisis is becoming increasingly likely.

This could plunge the US into some very bad times. It would also likely trigger a reset in middle class expectations about the future (as in, "you can never progress, but you can fall hard.") If this occurs, it will likely apply to an upsurge in domestic terrorism as well. Why? A precipitous collapse in expectations, particularly if this collapse is seen to be unfairly imposed by external factors, is often a major reason for terrorism. While this usually occurs on an individual level and at the margins (which limits its occurrence), we would be manufacturing it en mass with this crisis.

Home to House

Excellent article by John Leland in the Times that runs with the idea that we have shifted from the idea of home (emotional/moral commitment) to house (investment/legal).

Christian Menegatti, lead analyst at RGE Monitor, said the firm predicted more homeowners would walk away from their homes if prices continued to drop, regardless of their financial circumstances. If home prices drop an additional 10 percent, Mr. Menegatti said, 20 million households will owe more than the value of their homes.... When homeowners see houses identical to their own selling for much less than they owe, Mr. Menegatti said, “I wouldn’t be surprised to see five or six million homeowners walk away.”

“It’s not a moral decision,” Mr. Maddux (founder of "You Walk Away") said of foreclosure. “The moral decision is, ‘I need to pay my kids’ health insurance or my car payment so I can get to work.’ They made a bad decision, but they shouldn’t make more bad ones just because they have this loan.”

This shift in thinking is going to do a considerable amount of damage to communities nation-wide. It will also transform the relationship of the American middle class to debt across an entire range of products (requiring a shift to legal remedies, as in tighter bankruptcy laws, rather than relying on moral commitments). Too bad this potentially existential damage was inflicted for just a relatively low dollar "greater fool" financial scam...

This greater fool scam: Junk loans (essentially, mortgage-based derivatives) attracted consumers by the boatload because of the American "dream" to own a home, the promise of upward mobility, and their attractive teaser rates. Tens of millions responded. In turn, the historical moral commitments of homeowners to pay their mortgages provided the low foreclosure rate data that allowed junk loans to gain a higher rating than they deserved, which in turn allowed them to be packaged/sold as securitized products to ignorant banks in search of low risk investments that fit their charter.

Doom and Gloom

Check out the leading bit on this OnPoint by Howard Davidowitz.

Farther Adrift

More signs of the US adrift without a counter-insurgency strategy in Iraq. Note the mistaken assumptions, produced by our incoherent approach, in the para below:

The U.S. military acknowledges that it is caught in the middle of a political struggle. "Yes, they are frustrated," said Lt. Col. Ricardo Love, commander of the 1st Battalion, 38th Infantry Regiment, who works in Baqubah, the provincial capital. "They think we can make the government of Iraq do anything. We tell them we don't control the government. But they think we are the mighty power."

A Broken Legal System?

A sign of stress (economic and social):

For the first time in the nation’s history, more than one in 100 American adults is behind bars, according to a new report.

As things tighten (ala Tainter), old solutions begin to stress the system:

“We tend to be a country in which incarceration is an easy response to crime,” Ms. Urahn continued. “Being tough on crime is an easy position to take, particularly if you have the money. And we did have the money in the ’80s and ’90s.” Now, with fewer resources available to the states, the report said, “prison costs are blowing a hole in state budgets.” On average, states spend almost 7 percent on their budgets on corrections, trailing only healthcare, education and transportation.

Hilarious corporate response

Southwest on YouTube.

MMOCs? (Massively Multiplayer Online Corporations?)

For years, I've wanted to turn a game into a real company that produces real products. The problem was the way in. Kluster looks like it might have a way in (he was also able to leverage Chris Anderson's "free" concept into a slot at TED). It's a variation of McLuhan's thesis: to a large enough crowd, any intractable problem is easy to someone.

More on housing prices

More bad news:

The 8.9 percent year-over-year decline was the largest in the 20-year history of the index, as housing was pressured lower by a huge supply of homes for sale, rising foreclosures and tighter lending conditions

Going to see "the biggest decline" or the "lowest number" in the history of the "index" etc. a lot over the next two years.

Big surprise in inflation

1% at the wholesale level last month. Welcome to stagflation! Note that this jump is the biggest since the last oil shock:

With the January jump, wholesale prices have risen over the past 12 months by 7.5 percent, the fastest increase since the fall of 1981, when the country was in a deep recession.

Here's some Joseph Tainter to think about: What happens when a civilization's "free" energy input becomes expensive? Higher order processes (complexity added to correct/smooth lower order problems) will begin to produce negative returns. As these systemic failures begin to cascade, the natural reflex is to add more complexity to solve the newly emerging problems. This in turn fails due to excessive negative returns on effort, which will bring on a full collapse. Fortunately, there is an out: simplify the system rather than adding another layer of complexity. This returns the system to positive territory.

Wow

Wish I had this kind of promo for "Platforms!" The entire "free" thing seems so 1990s.