Negative Equity

Felix Salmon points to this post on Calculated Risk on homeowners' negative equity. Key highlight:

CoreLogic reported today that more than 11.2 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the f irst quarter of 2010, down slightly from 11.3 million and 24 percent from the fourth quarter of 2009. An additional 2.3 million borrowers had less than five percent equity. Together, negative equity and near-negative equity mortgages accounted for over 28 percent of all residential properties with a mortgage nationwide.

In addition there are two noteworthy graphs. One shows negative equity by state. Fortunately, Pennsylvania is 48th. Finally, being near the bottom of the rankings is good. The second graph shows the distribution of negative equity. A rising proportion of such homes have more than 25% negative equity, a level at which it is hard to believe any rational person will not walk away. So more defaults may be imminent. And from the first graph we know that these are likely to be concentrated in a few states.

More on Credit

The President told the bankers they have to start lending to help us get out of the recession, and that they owe us this:

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Mr. Obama said. “Now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.”

The President argues that credit difficulties are hurting small business:

President Obama reiterated his call Monday for the nation's banks to increase lending, saying that he was getting too many letters from small businesses unable to borrow money.

The story seems to be that the recovery is now held back because of a lack of credit. It is hard to understand what model might suggest this. The normal story is that we suffer from a lack of demand. Many observers, like Paul Krugman, have been arguing that we need more stimulus to fuel the recovery. That seems like what we need is more demand. In a recession the demand for loans declines. That is why the yield curve steepens. The quantity of credit extended depends on supply and demand. Given how low interest rates are, it is hard to believe that the recovery is really being stifled by a lack of credit supply.

Sure, we hear a lot about the troubles small businessmen are having obtaining credit. And surely banks are busy improving their balance sheets. But it must primarily be a lack of demand which hinders credit from flowing. Banking is a competitive industry. If there were companies with good collateral that were trying to borrow it is hard to believe they could not get credit.

More likely, the problem is that the quality of collateral is quite poor right now. Banks don't need more real assets. What kind of paper can companies pledge in a recession? Given that bank regulators want banks to improve their balance sheets this pressure must be what is limiting loans.

Fiscal Stimulus, Again

Jim Hamilton's recent post on the stimulus hits the nail right on the head. The point is not that fiscal stimulus cannot work, as some argue. If you could change some textbook G in a continuous fashion like a TV dial it could work in a time of massive unemployment. But that is not the world we live in, so real programs must fill in the spending. But Hamilton's key point is that we need to think of the type of crisis we are in. If the cause of the recession is the piercing of a housing bubble and a credit crisis it is not clear that public works is the answer. We need to get the financial system working properly again.

I also agree with Jim that helping States with budget shortfalls to prevent further layoffs is a good idea.

Bank Bailouts and Losses

Representative Barney Frank and many others complain that recipients of TARP funds have hoarded funds rather than issue new loans. I find this argument perplexing. If there was a huge demand for credit that is going unfulfilled, perhaps it makes sense. But as we spiral into a Keynesian recession the demand for credit, at least by able borrowers, has fallen significantly. De-leveraging is taking place because banks are not sure if anybody else is credit-worthy. Since the banks got in trouble by lending too much it is not surprising that they hold reserves to maintain some semblance of solvency.

And then we read, in today's Post for example, that unexpectedly large bank losses are complicating the federal government's rescue plans. As they note:

The problems are intensifying the pressure on the incoming Obama administration to allocate more of the $700 billion rescue program to financial firms even as Democratic leaders have urged more help for distressed homeowners, small businesses and municipalities. Senior Federal Reserve officials said this week that the bulk of the money should go to banks.

This should hardly be a surprise. Given the massive de-leveraging we are experiencing, and the fact that a new wave of foreclosures are coming. Moreover, it is not clear that all of the troubled banks have recognized their losses yet. Under these conditions would you lend?

Frightening Picture of the Day

Frightening picture of the day. This is the corporate cost of borrowing in real terms, from Paul Krugman. Inflation expectations are taken from the difference between 20 year Treasury bonds and 20 year TIPs. You can really see the sharpening of the crisis. A key part of this is the decline in inflation expectations.



A related piece of information is that the spread between high yield bonds and Treasuries rose to 18.6% on Wednesday. The spread was only about 8% in August.