Real estate's major impact on today's ever-changing economy

Adhvith Dhuddu, CT regular columnist

Wednesday, January 30; 12:00 AM

The housing market's tumble late last year, which started out as a normal correction in home prices, is now ominously appearing to have opened the Pandora's Box of a liquidity and credit crisis. Discouraging data released over the last few weeks has only dampened the sentiments of the economy and worsened the housing market outlook. Although a stimulus package has been announced recently, many fear it to be too little and too late.

A closer analysis of the real estate market will reveal a profuse amount of disturbing data confirming that this is just the beginning of a slump in home prices. For the first time in decades, sales of new homes dropped by 26 percent last year to stand at 774,000, exceeding the old record of a 23 percent decline in 1980. Likewise, sales of existing homes plunged 13 percent last year (biggest drop since 1982), and construction of new residential buildings dropped by close to 25 percent, again a record drop, the largest since 1980.

The average market price of a home is largely determined by the supply-demand relationship, and during the last six months demand declined. Unfortunately, supply has either increased or stayed constant. The inventory buildup of close to 2 million homes exceeds the medium term need of 1.5 million, and it would take close to a year to eliminate this backlog (given the economy doesn't enter a recession and grows normally at 2 to 3 percent). This will undoubtedly create an imbalance, leading to lower home prices in the future. Sellers have already been cutting their asking price to move homes out of inventory. Prices of new homes will be dented the most, as old and used homes tend to find a market in a depressed down cycle. Other credible proxies, like the stock prices of Home Depot and Lowes, also hint a significant slowdown.

Remember that a majority of borrowers use their house value as collateral for loans, and in the case of rapidly declining home prices, banks and lenders usually prompt faster and bigger payments fearing a rise in defaults. The subprime crisis found its roots for this exact reason. A double whammy of declining home prices and increasing number of defaults sent the banks and lenders into a spin, leading to multi-billion dollar write-downs and revaluations and tighter lending standards.

Housing has a significant 4.5 percent share in the GDP calculation, and unfortunately, because only new home sales are counted, gloomy GDP numbers could surface to push the country into a recession (two negative quarters of GDP growth confirms a recession).

The woes of the economy only pile up, as the weak dollar is attracting foreign buyers to stock up on U.S. homes. Although this has its own pluses and minuses, a surge of foreigners buying U.S. homes is the last thing we need when in the process of cleaning up our own mess. The only silver lining of a weak dollar is the surge in exports, which many optimists feel could overwhelm the housing market slump and prevent a recession.

Only a crisis often forces corrective action. This is clearly happening now, as the stimulus package not only puts money into the hands of consumers but is trying to revamp Freddie Mac and Fannie Mae. The approved package will now allow Freddie and Fannie to approve bigger mortgage packages by increasing the loan limits. This way, more loans are approved and liquidity remains average.

The biggest fear is the potential of this slump slipping over to other sectors of the economy. Just as homes are used as collateral, other assets, such as stocks, mutual fund holdings, etc., are also used as collateral. If asset prices across the board start to decline (stocks already have), the problems could multiply to get out of control. Recently, for the first time in 23 years, the president of the International Monetary Fund appealed to many nations to stimulate their economies to avoid a liquidity crisis.

Last week, the Federal Reserve convened an emergency meeting to cut interest rates by 75 basis points, preventing a crash in the stock markets. Again, this broke all records and was the biggest one-time cut in interest rates in two decades. All these numbers draw parallels to the housing slump and banking crisis of 1980, and we could well be at the start of a long drawn real estate market crisis. We can only hope that a recession or a slowdown doesn't convert to a long, drawn-out depression.

Online link to this article:

http://www.collegiatetimes.com/stories/2008/01/30/real_estate_s_major_impact_on_today_s_ever-changing_economy

Demystify America's credit meltdown, potential recession

Adhvith Dhuddu, CT Regular Columnist

Wednesday, January 16; 12:00 AM

Historically, the root of all financial innovations and the origin of most global financial meltdowns has been (ironically) the United States. Although this is changing with a leveled playing field and the democratization of finance, the source of the most recent credit turmoil has been the United States, and unsurprisingly, this is where subprime securities first found their market.

The recent financial credit crisis is creating jitters around the world among central banks, private banks, and other financial institutions. Even now, six months after the damage was discovered, no one knows the true extent of the ramifications. The "R" word is being tossed around freely and economists fear a global slowdown in business and investments. The crisis is far from over, but a root cause analysis will help understand what is going on and, more importantly, how and to what extent it affects us.

Understanding the ABCs of liquidity and how its game has changed since the emergence of securitization helps us assess the situation better. Central bankers primarily use two instruments to control the flow of money (or level of liquidity) in the economy. They are calibration of reserve requirements for banks and modification of interest rates at which banks can borrow from central bank (the banker's bank) and inter-bank loan rates.

By these mechanisms, central bankers not only control the capacity to which a bank can lend out money, but also the level of inflation. Excess, or easy credit, can lead to surplus liquidity, which might later translate to high inflation for a country.

Normally, a bank's balance sheet is supposed to include the money loaned out, helping keep tabs on how fully loaned out they are. But the ability to "securitize" a loan helped them move it off their books. Institutional and individual investors who invest in debt primarily use two methods to securitize debt in order to make it more accessible. One way is to group all the loans and divide that cluster into smaller units to sell as bonds. And the other, more complex, way is to eliminate default risk and lock in interest rates using credit default and interest rate swaps, respectively.

So once the bank's loan is sold off via securitizing, disappearance of the loan from the bank's balance sheet essentially frees up the capacity of the bank to lend out more money. This obviously renders the reserve requirements frivolous because as long as the bank can keep selling off its loans to individuals investing in debt, they can keep lending out more and more money. Central banks have no control over this phenomenon because there are no controls over how much debt can be securitized or how many loans can be sold off, thereby losing control over liquidity and money flow in the country.

This vicious cycle created an environment conducive to extremely cheap credit and outrageous asset prices (which is why real estate prices rose from 2001 to 2006). Like all good things, this came to an end when a higher-than-expected number of home owners defaulted and triggered a chain reaction leading to lower home prices and a decrease in demand for home building materials. Eventually cheap credit became a thing of the past even with the Federal Reserve continually lowering interest rates.

We are a credit nation and a chief ingredient for our growth is access to cheap credit. But as the cost of borrowing increases, everything from savings to expenditures and investing will experience a slowdown.

The Dow Jones has gotten off to its worst start in 16 years and is down over 5 percent in the first two weeks of the year. This is just the beginning, and we can expect more woes to follow. Credit will continue to be expensive, and individuals with adjustable rates on their mortgages, car loans and student loans will have to shell out more for their monthly payments.

Unemployment rates may rise and uncertainty about the economy will continue. Economic recession is now more of a possibility than a probability. The best investment strategy during these troubling times is to stay in cash to wait for opportunities (preferably in non-dollar denominated currencies) or invest in safe havens such as gold and silver.

Online link to this column:

http://www.collegiatetimes.com/stories/2008/01/16/demystify_america_s_credit_meltdown__potential_recession

Power shifts pose problems for U.S.

Adhvith Dhuddu, CT Regular Columnist

Wednesday, January 23; 12:00 AM

The rise of BRIC countries (Brazil, Russia, India, and China) in the last decade has transformed the world in many ways. Significant changes in political, economic and social battlegrounds will result in a power struggle and the future will see a shift in the balance of power. Prosperity and economic muscle will dictate in large part the new power centers of the world.

The United States largely derives its superpower status from its resilient economy, powerful military and terrific political and legal structures. The U.S. will continue to remain a superpower but will lose a significant amount of its market share in the global power equation over the next few decades.

A slow migration of power to the East is a phenomenon that is already underway. Although many Asian countries are not necessarily beacons of economic and political freedom, the potential muscle they will obtain cannot be ignored. India and China, commonly referred to as "Chindia," are poised to be leaders in Asia, offering remarkable opportunities in many arenas.

China's story is an awe-inspiring one. For more than two decades it has experienced positive GDP growth at close to 5 or 6 percent compounded. It has become a country with the highest number of mobile phone users, highest number of engineering graduates, largest producers and consumers of steel and other metals, largest textile market and second largest energy market, and it still has a long way to go. One can only comprehend the advancement of China by visiting and exploring the country.

India is not far behind at all. It, too, boasts similar accomplishments and is on track for long-term financial stability and sustainable economic growth. With the advantage of a democratic process, free press and dominant English-speaking population, the future clearly looks sanguine.

Thomas Friedman eloquently described the rising economies of India and China in an interview a few years ago. "India and China," he said, "are two six-lane super highways. In China, the super highway looks excellent with perfectly paved roads, clean sidewalks and bright streetlights. Here there are one billion people traveling at a very fast pace. Often there is a speedbump called political reform and at such a high speed, some people get thrown out and left behind when they land back on the road with a thud. So what matters here is not the pace of reform but how well the economy and politicians can drag along over a billion people to avoid an internal uprising by the ones left behind."

"In India on the other hand, the superhighway is not very well done with many ditches and holes, broken streetlights, wrecked sidewalks, etc. Here one billion people are traveling at a normal pace but off in the distance, it smoothens out into a perfect six-lane superhighway with shining bright lights, no potholes, no bumps and a buoyant future. But the only question here is whether this image is a mirage or an oasis. So what matters here is India has the potential to become prosperous if they can overcome many economic and political barriers."

Two other important geopolitical regions in the coming decades are the Middle East and South America. Often our perception of the Middle East is clouded by the war in Iraq and tensions with Iran. This region is flush with cash and young people are more capitalist than ever before. Economic and financial hubs such as Dubai and Abu Dhabi are ever expanding, offering some remarkable opportunities. Other countries such as Bahrain, Egypt and Oman are quickly moving up the economic ladder, welcoming new businesses and investments. Many of these countries fared extremely well in a recently released report discussing the ease of doing business in different nations.

South American economic powerhouses such as Brazil and Mexico cannot be ignored. Brazil is a BRIC country and economists predict Brazil to be one of the top five countries (in terms of GDP) in a decade or two. Brazil has come a long way from a gloomy and murky economy to a vibrant, transparent and thriving one. It has reformed many policies by opening up its markets, established credible regulatory bodies to help sustain economic growth and become an energy-efficient nation. It fared extremely well in the ease of doing business report.

We can only hope that this rebalancing of power unfolds peacefully and does not trigger a cold war between U.S. and China.

Online link to this column:

http://www.collegiatetimes.com/stories/2008/01/23/power_shifts_pose_problems_for_u_s_