Monday, May 09, 2005

US Bubbles Compared To Japan

At MSN Money the Contrarian Chronicler, Bill Fleckenstein, put together a great comparison of the Japanese bubbles and the current markets. "Here in America, we had a wild stock bubble. But when it burst, there were not a lot of bad debts and defaults to impair the financial system. Yes, we had a couple of sizable implosions like WorldCom and Enron, but they were more isolated events."

"I think a lot of people have dropped their guards and no longer worry about how nasty the financial environment could get. Why? Simply because the fallout from the equity bubble has seemed so manageable. Folks no longer worry that we might be forced to contend with a Japanese-like experience because, so far, we haven't. But that doesn't mean we won't."

"However, in the real-estate mania that Fed Chairman Al Greenspan has fomented..we see the complete abdication of responsibility in real-estate lending standards. This has been the major factor in driving prices to wild levels, and in allowing people to live beyond their means via the housing ATM."

"When our real-estate bubble bursts, and it will burst, we will be left with a financial system riddled with bad loans, as well as consumers who've not only lost their housing ATM, but also owe more on their homes than they're worth."

"Given our lack of savings and massive deficits, we could experience a recession much deeper, though probably shorter, than Japan's."


At 7:12 AM, Anonymous Anonymous said...

I sometimes wonder if these bubble was not created to trap the current generation of 20 and 30-somethings into mortgages they can't possibly pay-off. That way they will keep working and paying absrub taxes (to pay off the country's huge debt) without any time to stand up and fight for reform, nor the possibly to simply sell one's assets and leave the country altogether.

Mayeb the elitists want the people tied to this country, so they can't possibly find a better life in another nation?

At 7:46 AM, Anonymous Anonymous said...

I've been wondering the same thing, 7:12 AM. It's debt peonage.

At 7:52 AM, Anonymous Anonymous said...

We are all responsible for our own financial well being. There is no conspiracy to keep people in mortgage bondage. Americans are just overwelmingly dumb about their finances.

At 7:58 AM, Anonymous Anonymous said...

And how will all those 20- and 30-year-olds be able to pay any taxes to support the elitists when they're bankrupt and living in Hoovervilles (Bushvilles)?

At 8:24 AM, Anonymous Anonymous said...

"And how will all those 20- and 30-year-olds be able to pay any taxes to support the elitists when they're bankrupt and living in Hoovervilles (Bushvilles)?"

They will work like slaves and the elitists will take all of the wealth generated from their work.

At 8:48 AM, Anonymous Anonymous said...

Millions of relatively young people are simply not going to live in debt slavery.

The majority of them will simply walk away from their debts, declare bankruptcy and rent a cheap apartment once they perceive that they owe double their house's real value.

If things melt down in the next couple of years I would expect the next president to be a democrat and the congress to be heavily democrat. They are likely to be under heavy pressure to relax the recently toughened bankruptcy laws.

At 8:54 AM, Blogger John Law said...

they won't be homeless, they'll be plenty of condos available to rent cheaply!

At 9:02 AM, Anonymous Anonymous said...

"The majority of them will simply walk away from their debts, declare bankruptcy and rent a cheap apartment once they perceive that they owe double their house's real value"

Ahh, but therin lies the rub. The tougher bankruptcy laws that you alluded to will prevent the bulk of these people from declaring chapter 11 and most will be debt slaves for years to come under chapter 13. The democrats won't do anything to change this because they will be beholden to their corporate masters as much as the republicans.

At 9:21 AM, Blogger John Law said...

during the GD there were riots at some foreclosures. if anyone wants to get elected or reelected, they'll have to change the laws.

At 9:45 AM, Anonymous heartfullofseoul said...

Maybe we will go the way of Korea. South Korea fueled a credit binge by practically dropping credit cards from helicopters. The populace ate it up. The aftermath has been massive credit defaults and a banking bailout. The government tried to staunch the bleeding by forced hiring of hundreds of thousands of unemployed in hopes that their incomes would enable them to pay off their debts. It hasn't worked. Now some "experts" are suggesting that the solution is for the govt/banks to enact a sweeping "debt forgiveness". In other words, let millions of debtors off the hook for the bills they have run up.

Can you imagine the political firestorm if we had to bail out millions of indebted Americans who overstretched during this historic credit-fueled boom?

At 9:48 AM, Anonymous heartfullofseoul said...


More on Korea:

Who couldn’t use a little forgiveness? By Rod Peebles

February 20, 2005

Sometimes an idea is so clever you want to find out who came up with it, run up to him and shake his hand, pumping it back and forth, back and forth, until you are sure that he fully understands how much you appreciate his innovation. Or at least until security arrives.
That’s why I want to go to South Korea. The country is struggling thanks to the 2003 collapse of a consumer credit bubble.  Luckily for South Koreans, there is some creative thinking going on to help them work their way out of it.
Not everybody knows that South Korea had a credit bubble to begin with, and that’s understandable. The whole angst-riddled Y2K thing was happening just as the bubble got underway, and then after Y2K there was all that time spent on either selling water barrels or learning how to play steel drums. When a man is sorting freeze dried products alphabetically there’s no time for current events.
In a nutshell, South Korea had a consumer credit bubble because their corporate credit bubble had done what all credit bubbles do eventually, which is kick the economy right in the ribs. That’s just the destiny of bursting credit bubbles, no matter what central bankers tell you, even when they throw out the term “measured pace.”
In fact, the South Korea credit bubble was so big that financial historian Edward Chancellor talks about it in his latest work, "Crunch Time for Credit?", which explains all about speculative manias and credit bubbles, and why anyone who tells you that there is no housing/mortgage bubble in the U.S. should be forced to spend the day reading the fine print on a home equity loan application. (A related commentary by Mr. Chancellor is available here.)
Not only does Chancellor argue that the U.S. is undergoing an unsustainable credit bubble, he figures that a lot of the South Korean experience bolsters his argument - that argument being that central bank finagling in the wake of a speculative bust is not only ineffective, it’s like a man explaining why he forgot his anniversary – it does more harm than good.
According to Chancellor, South Korea’s credit bubble started with easy money in the business sector. Banks tripped over themselves to lure borrowers. As credit filtered through the economy, asset prices rose, making bank assets more valuable, thereby justifying even more loans on bank balance sheets. But like a fat man in a girdle, things were not what they seemed.
Korea’s economy in the 1990’s was much like Japan’s a decade before. Conglomerates played a dominate role, and tangled ownership (keiretsu) justified (as well as blurred) financial and speculative excesses. Government and businesses were a tight bunch, with lenders figuring that the former would bail out the latter, or even themselves, should the well-oiled machine run into a glitch.
Ultimately, the excesses proved (surprise!) unsustainable, stocks plunged, banks found themselves in trouble, business investment sagged and the economy hit the skids.
It was the perfect time for government fiddling. Chancellor notes that the South Korean government recapitalized the banks and stifled the flow of credit to marginal borrowers, but it couldn’t stop there. The temptation to start a new boom in the consumer sector was too great. South Koreans were fierce savers. If they could just be a little less responsible, the string pullers figured, they could keep the economy going. So the South Korean government set in motion its plan to promote profligacy.  It gave consumers tax breaks for using credit cards and made it illegal for retailers not to accept them. It eased credit related restrictions, including limits on cash advances. And, what must have sounded brilliant at the time, they started a lottery for credit card holders.   
South Koreans felt like the dog that found a steak under the table - they took full advantage of the situation. As did the credit providers. Bank representatives handed out credit cards right on the street. Many dangled nifty appliances, like electric tooth brushes or toasters, before savers to tempt them into borrowing. Credit worthiness, like the partygoer’s hangover, wasn’t contemplated amidst the euphoria.  
Chancellor provides several examples of just how hot the credit party got:
* Household debt jumped 67% from 2000 to 2003.
* Personal savings plunged from 23% in 1998 to less than 2% by 2002.
* By the early 2000s, half of consumer loans were real estate related, driving up housing prices 31% in less than two years.
According to the Asian Pulse, South Korean credit card bills hit $202 billion in 2003, up from a paltry $40.5 billion as recently as 1996.  
The problem with all that credit is all the interest and principal that comes with it. By November 2002, credit card delinquencies were coming in at 12%, double the year-earlier figure. Ultimately, the South Korean government decided to rein in the credit bubble. But it feared that stifling credit by hiking interest rates would blow a hole in their leveraged economy. So they decided to prick the bubble by decree instead. Credit card companies were forced to cut lending limits and to set aside stouter loan loss provisions. Rules on real estate lending were tightened, and property taxes on second homes were raised.
Although GDP has been largely positive the last five years, thanks to booming exports, the effects of the bust were as visible as those of the boom. Last year, South Korea’s biggest credit card company reported a delinquency ratio of 16%. Meanwhile, credit card usage fell by half, and bank lending to consumers shrank dramatically. Consumption has flagged for two years, and no wonder - an estimated 10% of South Koreans can’t pay their debts.
Banks and credit card companies may be sinking fast, but they’re still thinking quickly on their feet. And that’s why I want to go to South Korea--to shake the person’s hand who came up with the novel idea which allows South Korean financial institutions to solve their bad loan problems: They plan to hire thousands of delinquent borrowers so they can afford to pay back their debts. Not only will the debtors have more money, they can help banks track down and collect from other delinquents.
At least that was the plan a year ago when the Financial Times shared the Idea of the Century with the rest of the world. More recent ideas have become bigger and bolder. An economist at Barclay’s Capital thinks that to get South Koreans spending again, the government should forgive household debt. Wipe it clean by decree. The economist, Dominique Dwor-Frecaut, puts it this way in a December Financial Times story, “I think they need large-scale debt forgiveness.”
This is truly original thinking because moral hazard is traditionally reserved for the corporate and government sectors. Usually it’s the banks who are rewarded for lending too much or corporations or countries who are rewarded for borrowing too much. Evidently, Dwor-Frecaut figures that if a little moral hazard could be doled out while fixing the corporate credit bubble, why not let consumers in on the deal? “Now I think the trade-off is a little bit of moral hazard with economic growth,” the economist says as if a central banker in training.
Poor South Korea. Poor little unsophisticated South Korea. They were just too new to the consumer credit game to play it well. Like a teenager with a fine wine, they were unable to enjoy their pleasures responsibly. Luckily we Americans are veterans when it comes to credit and are able to handle our financial affairs responsibly. That’s why 30% of mortgage customers at IndyMac Bancorp are choosing the Pay-Option ARM as their financing of choice, according to the Wall Street Journal. This is the sophisticated mortgage for those who want a starting rate of 1% and want to have up to four payment choices each month. Sure payments can rise and there is the chance that those making the minimum might not even be paring down principal, but in a country where consumers go to Las Vegas as often as they visit the dentist, we understand the concept “roll the dice.”
And U.S. lenders are just as sophisticated as the consumers. For example, the chief economist for Quicken Loans shared their company’s discovery with the WSJ that “We know 0 percent is real popular with autos.” That’s why Quicken borrowers can pay “practically nothing” on their mortgage for six months.
According to the Journal, even if interest rates go nowhere, the default rate on borrowers who regularly make the minimum payment on Pay-Option ARMs should be 20% higher than that of traditional mortgages. That’s one reason worry warts wonder if rising interest rates could burst our own consumer credit bubble.
Where do they think we are?  South Korea?

At 9:52 AM, Anonymous Anonymous said...

"Ahh, but therin lies the rub. The tougher bankruptcy laws that you alluded to will prevent the bulk of these people from declaring chapter 11 and most will be debt slaves for years to come under chapter 13."

Yes the the bankruptcy laws will prevent people from filing bankruptcy. They will still stop paying their mortgages and let the banks foreclose, they won't have a choice when all those ARM's start adjusting, they just won't be able to afford the payments.

People were losing homes long before they had bk protection. Sure collection agencies will hound them, but you can't get blood out of a turnip.

The fact that their credit will be ruined will force many to live a "ghost" and "cash" lifestyle.

At 10:08 AM, Anonymous punchbowl said...

There are important cultural differences between the US and Japan that manifest themselves in both debtor and creditor behavior. On the debtor side, Americans are much more likely to simply walk away from their obligations and let the bank foreclose. On the creditor side, there is much less of a cultural imperative to keep broken institutions afloat (viz. S&L crisis) -- which means that creditors can't rely on someone stepping in and saving them (even if that would be in the best interests of the financial system). So I basically agree with Fleckenstein: the depression in the US will be much deeper than Japan's but also shorter. (Of course, in this case, "shorter" means less than 14 years.) Caveat: if the depression is so deep as to undermine basic financial structures (e.g. deep enough to induce FDIC failure or -- gulp -- default on sovereign US debt, printing presses notwithstanding), then all bets are off in terms of length...

At 10:17 AM, Blogger John Law said...

I disagree somewhat. we have the FDIC, we could bail out FNM and some banks. bernanke has already talked about helicopter money.

in the end, I think debt deflation will trump any helipcopter money.

At 10:39 AM, Anonymous Anonymous said...

I read a lot of talk about how the US government is heavily indebted. Not really. Balance sheets (B.100) in the Z.1 report at show that of the total outstanding debt of about $24 trillion, only about $4.4 trillion is Federal government debt. Given that GDP is almost $12 trillion, $4.4 trillion in federal debt is not all that significant. This debt could easily double in size without burdening the economy significantly. In fact, I expect it will double in the years to come, as the government runs massive deficits in order to cushion the shock of the housing bubble bursting.

My best guess as to the outcome of this housing bubble is a wave of bankruptcies to clean out the household and corporate balance sheets. Note that the new bankruptcy law isn't nearly as strict as some people allege. The new restrictions primarily affect people who earn more than median income, and even then judges have some discretion to waive the restrictions. I expect them to be using this discretion quite freely in the years to come. Also, recall that California mortgages are non-recourse. That means that homeowners can walk away from these mortgages anytime they want, without bothering about bankruptcy, and the bank cannot collect a deficiency judgement. For a list of which states have non-recourse mortgages, see table 1 at the bottom of this pdf file:

At 11:28 AM, Blogger Thomas said...

I truly doubt that the idiots who are buying into, and thus continuing to inflate, bubble-inflated real property won't be as bad off as some are making it sound. They'll lose their equity (if any -- nobody seems to be putting money down on property anyway anymore) and their credit will take a beating if they walk away from their houses, but those are things you can survive.

Even with the new bankruptcy rules in effect, most people aren't going to be "saddled with a lifetime of debt." You're only forced to file under Chapter 13 udner the new rules if you have a higher income than the state median -- and since the kind of event that triggers a foreclosure is often unemployment, many filers will not have much income at all.

Plus, Chapter 13 repayment plans are based on "disposable" income (although the allowances for necessities are ludicrously low), so people won't necessarily be on the hook for the full amount they borrowed.

Finally, many large states have antideficiency statutes that prevent purchase money lenders from pursuing their debtors for deficiency judgments if the sale of a foreclosed house doesn't bring in enough money to pay off the debt. That rule generally doesn't apply to non-purchase-money loans, but those are generally much smaller than the purchase money loans, and would be easier to pay off.

Since anyone buying a house in today's market will pretty much be paying 50% to 100% more than he'd pay to rent, I doubt many people will wind up homeless even if their credit is in the basement. Paying $2000 for rent when you're accustomed to paying a $3500 I/O mortgage ought to be downright refreshing to some people, and a low credit score won't necessarily keep you from renting a decent place. (I know this from experience, having taken a nasty hit because of unexpected and uninsured health-care expenses.)

No, the real damage is going to be to the lenders, the holders of mortgage-backed securities, and to the parts of the economy -- and the government -- that are addicted to bubble-driven growth. I see much more of a potential threat from damage to these sectors, and the potential for them to feed on each other and affect the macroeconomy, than from overextended homebuyers getting clocked by price declines.

As for the pure speculators -- they can all throw themselves from office windows for all I care.

At 12:17 PM, Blogger John Law said...

more on south korea

S Korean consumers spending again

South Korea bails out borrowers

Korean card debt hits new record

Consumer debt worry hits S Korea

At 12:59 PM, Anonymous Anonymous said...

Maybe this is wishful thinking, but it is possible we could have a wave of bankruptcy filings just before the new bankruptcy law takes affect.

Think about it - six months from now, maybe a couple of bad things have happened along the way, and all Joe Sub Prime Borrower understands is that he's in way over his head and the bankruptcy law is about to get tougher.

At 1:31 PM, Blogger SoldAtThePeak said...

And I think that wave of bankruptcy filings might be the "trigger" to burst the bubble. These "economists" always look for some "trigger" to burst a bubble (and then justify the housing market by saying there isn't a trigger to be seen). I'm already seeing scattered pockets of concern in the mainstream media. So, wider knowledge of the bubble combined with the wave of bankruptcies will probably push this thing over the edge. Look for mid-late summer to start, then build up to October.

At 11:31 PM, Anonymous Anonymous said...

US has less "cultural" issues in its financial system. So the pain should be quick...

I would be surprised if it takes more than 5 years to bottom out from the peak.

But we are also more creative...

At 2:24 AM, Anonymous Anonymous said...

I'm skeptical about claims that the U.S. economy can handle twice as much debt as a percentage of its GDP as it currently owes. The gov't has been collecting a lot less revenue as a proportion of GDP due to increasingly favorable tax treatment toward corporations, corporate tax evasion via Cayman Islands, and the huge tax cuts to high-earning individuals (amongst other tax injustices if I may call them that). So how on earth does it plan to pay down the debt, or even to keep it managed? How much of my taxes have to go to paying interest on the national debt before it's considered a problem? I think it's a problem right now.

At 7:24 AM, Blogger goleta said...

So how on earth does it plan to pay down the debt, or even to keep it managed?

Who else other than the middle class?
We're forced to move away from work and we're not qualified for affordable housing or most other benefits, yet the $1.25M midian-priced houses are not in the price range we can afford.

At 1:45 PM, Anonymous Anonymous said...


I liked your post and agree with many of your points. Here's another angle that I'd forgotten about is this scenario (courtesy of Patrick's Page):

Let's say you buy a house for $600,000, with a $500,000 mortgage.
Then the house drops in value to $400,000, you lose your job, or otherwise must move.
If you can't make your payments, the bank forecloses on you and nets $350,000 on the sale of your house.
The bank's $150,000 loss on the mortgage is "forgiveness of debt" in the eyes of the IRS, and effectively becomes $150,000 of reportable income you must pay tax on.

This will ensure that the person who is forclosed upon is still saddled with a heavy tax burden. Coupled with interest and penalties, this could amount to a problem that lasts for many, many years.

At 3:52 PM, Blogger Thomas said...

Anon 1:45 --

Is that really true, that the IRS considers a foreclosure sale at a loss to the bank, with no further recourse, a forgiveness of debt? My understanding of California's antideficiency statute is that it's not that the deficiency is actually wiped out, but rather that the lender is barred from bringing suit to collect the deficiency. The lender could still use its otherwise-unenforceable deficiency claim as an offset in a proceeding that the debtor might conceivably later have against the bank. (Granted, this doesn't happen too often.)


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