Through the ceaseless efforts of financial engineers houses have been transformed into assets - financial assets. In this blog I have written numerous times how a simple mortgage spawned a series of related financial instruments, from simple CMOs all the way to synthetic CDOs, CDO cubed, or even CPDOs. One single mortgage could insinuate itself into literally dozens of such financial constructs, particularly through the widespread use of CDSs. What's more, homeowners frequently used their house as security for home equity loans, which are nothing more than speculative home margin loans. In other words, we have turned the previously conservative housing market into a volatile financial market. Thus the title of this post, a la Dow Jones.
PIMCO's Bill Gross is now frightened of the possibility that house prices will decline by as much as 10%, if the government doesn't step in to bail out homeowners (and bondholders, of course).
But now that we have turned housing into finance, complete with securities, derivatives, leveraged plays and rampant speculation, is there a realistic way to stop the Dow(n) Homes Index from heading...down? In my opinion, no. The process of assetizing, financializing and margining houses is so far advanced that the decline will only stop when housing once again reflects its fundamental value, i.e. when homes are valued as secure places to live and raise families for a long time, as opposed to volatile trading and collateral "sardines". This means that a buyer has to have something like 20% down and obtain long-term predictable financing that requires a reasonable portion of his/her disposable income.
Houses ARE assets; but they are long-term, non-fungible physical assets belonging to one or two individuals that need them to fulfill their most basic human need of shelter. They cannot realistically be used as collateral backing super-complicated, volatile market instruments that go up and down with "the market". Square pegs don't fit inside round holes, no matter how fine you slice and dice them - they are always square.
Meanwhile, despite all the hubbub about the Discount window, accepting ABCP as collateral, providing $25 billion loan exceptions for banks with brokerage subs, etc., it has all had zero effect on the ABS market. As one can see from the ABX and CDX charts below, CDS spreads (i.e. measures of credit risk) are still very high. Given the stockmarket's furious bounce up (another supposed measure of risk) we are currently getting curiously mixed signals. (Arbi, anyone?).
Can anyone provide an explanation why stocks are signaling "all clear" while CDSs keep yelling "duck and cover"? Is it perhaps because the Dow Jones is followed by 300 million Americans who are suddenly clutching their pocketbooks closer to their chests, while CDS's are followed and traded by only a few thousand professionals?
And something else... I have started following weekly jobless claims as a gauge of what is happening to the "real" economy. The latest figure was announced a couple of days ago and it was significantly higher than expectations (334.000 vs. 320.000) but no one spoke about it. Notice how the latest data from BLS show 5 weeks in a row with higher claims.