Thursday, August 16, 2012

Shadow Inventory and Housing

Mark Hanson has an interesting post on shadow-inventory and the housing market:
For years I have proclaimed that “no housing recovery will ever occur — or no dead-cat-bounce will reach “escape velocity” or become “durable” — unless the repeat buyer is leading the way.  This is because investors and first-timers are thin, volatile cohorts who have been known over history to leave the market literally, overnight.
Case in point, July Phoenix area home sales were down a whopper 22% MoM and 15% YoY to multi-year lows for July…demand “recoveries” are not supposed to come with that type of volatility. However, stimulus-driven short squeezes and dead-cat-bounces are.
The problem is that the mortgaged homeowner has always been the primary demand cohort. It’s not investors, first-timers or those who own their homes free and clear.  Rather, the mortgage-levered homeowner who tends to move every 6 to 8 years who provides most of the historic underlying support for macro housing.
This is a problem. Put simply, there are more houses today then there were five years ago but a full HALF of the primary demand cohort — repeat buyers — died due to negative equity, “effective” negative equity, poor credit or legacy HELOCs, all of which prevent sellers (repeat buyers) from paying a Realtor 6%, putting 10% to 20% down on a new purchase, and getting a mortgage for the remainder.  Put even more simply, housing “supply” has grown in the past 5 years and ready and able buyers have been cut in half.
I don't know if Mark's analysis is correct, but the stock-and-flow dynamics are critical when looking at supply and demand and therefore, ultimately, prices. I wish Mark would quantify to what degree the mortgaged homeowner is actually the primary demand cohort, and more importantly, whether they are the primary demand cohort on the margin (and therefore, the price-setter).

Tuesday, August 14, 2012

End of Bubble 2.0?

Sitting in Silicon Valley, it's easy to see how we might be in Bubble 2.0. Unlike the boom of the late 90s, this is a private affair, with sky high valuations and marginal businesses being funded by Angels, VCs, and individuals in private exchanges, whereas Bubble 1.0 was all about excessively high valuations in the public markets.

The Angel phenomenon is interesting, as there is a clearly social dimension to it. Those who made money in the first boom can get invited to cool cocktail parties if they invest in "it" companies even if they aren't starting "it" companies any more themselves. The Social Proof that runs Angel List and gets recycled through TechCrunch and Arrington is kind of like the Gartner/Forrester mill that populated hockey-stick graphs in spreadsheets across corporate America.

And like Bubble 1.0, there are real technological changes that support what's happening this time around -- the social graph is new, mobile is new, cloud computing is new, costs have fallen dramatically, etc. All true. All may not justify the valuations. So I'm not questioning the technology, I'm questioning the financing.

There was an important article announcing that Calpers is pulling out of VC:
The nation’s largest public pension fund, CalPERS, appears likely to slash its investments in venture capital in what could be a blow to this still recovering asset class... The California money manager’s new strategy, which it has discussed before, appears tied to flagging returns from its existing investments and concerns that taking a large enough stake in future funds is nearly impossible. CalPERS, with $239 billion in assets, needs to hold significant positions in new securities for them to have an impact on the bottom line... The pension fund this year has about $2.1 billion in venture capital assets, or 6% of a $34 billion private-equity portfolio that includes buyout, distressed debt and mezzanine funds. The new plan, which will be debated at an investment committee meeting on Aug. 13, would cut that allocation to less than 1%... The pension fund cites several reasons for the proposed move, “One is that venture has been the most disappointing asset class over the past 10 years as far as returns,” says Joe Dear, CalPERS’s chief investment officer. “Second, it’s very difficult for a large fund like CalPERS to gain access to the best venture partners in the size that makes a difference to our performance.”
A buddy of mine in the industry had some very interesting insights which I will share below (redacted appropriately):
This is clearly the right move for Calpers. Hopefully other big funds will follow suit. At those sizes you just can't move the needle and it is a really hard space to make money. A lot of brain damage for  less than 1 percent of your total portfolio. Even if you are wildly successful with 50% returns, you only increase your total return by less than 0.5 percent. You can't be wildly successful putting the dollars to work of Calpers because despite best efforts, you end up being the benchmark. They probably have about 30-50 VC funds to get $2 B invested. Big prestigious endowments can't get enough capacity even at their more modest sizes. Calpers move portends well for those who stay and do smart VC investing as the competition in capital raising rounds goes down and valuations are more reasonable.

There is still too much capital in VC which is a very small capital constrained niche of the investing world. $10 B a year would probably be enough capital, but we are still running at over $20 B / year raised. There is still pain to be had and more big money needs to be shaken out.

The problem with VC is people came up with risk and return expectations from historical data. They decided to allocate X% without regard for how much they could get into the best funds. They then just started investing in VC as an asset class with $s way to big for the best managers to absorb. To fill allocations they had to give money to lower quality managers in the name of chasing a historic risk and return which is only available on a limited pool of capital. As a result returns really suffered - they would have even without the spectacular implosion of the tech boom. The same thing is happening in hedge funds at the moment on an even more spectacular scale. At least money into VCs got spent in the real economy in ping pong tables and jobs.
Now that the public markets have said "no" to bubble valuations, and Calpers is saying "no" as well, will we see the private bubble pop?

Wednesday, August 01, 2012

Does Interfluidity still not understand?

I like SRW and I like his site. He and I have emailed a number of times and I know he understands MMT, at least in part. He may not buy the whole program, but he's certainly familiar with it. So I'm not sure what to make of long discursions like this one and this one about the nature of banking when it's all pretty simple. I'll forgive certain commenters for talking about "maturity transformation" because they don't know better, but I'm not sure why Steve still entertains the concept. The very term suggests that a loan of one maturity (say, a deposit) is somehow transformed into a loan of a different maturity (say, a mortgage) when this simply is not how it works. Loans create deposits, deposits are not "transformed" into loans. A bank may actively manage its maturity exposure, but that is fundamentally a different thing. There is no "transformation". And then there's the long exegesis on how a bank loan is suddenly real money because even if the borrower defaults, the seller (say, of the car) remains whole:
No. Not at all. The transaction that has occurred is fully symmetrical. It is as accurate to say that the bank is in my debt as it is is to say that I am in debt to the bank. The most important thing one must understand about banking is that “money in the bank” also known as “deposits” are nothing more or less than bank IOUs. When a bank “makes a loan”, all it does is issue some IOUs to a borrower. The borrower, for her part, issues some IOUs to the bank, a promise to repay the loan. A “bank loan” is simply a liability swap: I promise something to you, you promise something of equal value to me. Neither party is in any meaningful sense a creditor or a borrower when a loan is initiated. Now suppose that after accepting a loan, I “make a purchase” from someone who happens to hold an account at my bank. That person supplies to me some real good or service. In exchange, I transfer to her my “deposits”, my IOUs from the bank. Suddenly, it is meaningful to talk about creditors and debtors. I am surely in somebody’s debt: someone has transferred a real resource to me, and I have done nothing for anyone but mess around with financial accounts. Conversely, the seller is surely a creditor: they have supplied a real service and are owed some real service in exchange. It would be natural to say, therefore, that the seller is the creditor and I, the purchaser, am the debtor, and the bank is just a facilitating intermediary. That is one perspective, a real resources perspective.
I try to excerpt, but really, the whole thing continues in the same vein. The word "multifurcated" is used. The word "investor" never is. Here's a simpler description: When a bank makes a loan, it is making a credit decision. It creates the money out of thin air and credits the borrower, who usually turns around and buys something with that money, which the seller then deposits back in the bank (thus completing the circle of life). However, the borrower still holds a liability (the amounts owed) which mirrors a receivable that the bank holds. If the borrower pays back what he owes, everything is fine. If the borrower defaults, the receivable is written down, and the bank's equity is written down as well. The bank makes a credit decision when it makes the loan. Investors make an investment decision based on their assessment of the bank's wisdom in making credit decisions when they decide to invest in the bank. Since depositors are not and should not be making an investment or credit decision when they choose to save, they should not have those responsibilities put upon them (which happens to a limited degree today via FDIC insurance).