What happened in Vegas, this time, didn’t stay in Vegas. There, 2 out 3 houses are upside down: they owe more than their homes are worth.

Nationwide,

the number of borrowers who are underwater climbed to 20.4 million at the end of the first quarter from 16.3 million at the end of the fourth quarter. The latest figure represents 21.9% of all homeowners, according to Zillow, up from 17.6% in the fourth quarter and 14.3% in the third quarter.

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The bursting of the housing bubble is arguably the main factor behind the current recession. So it makes sense people would be checking the housing market and looking for a sign of reversal of the downward trend. Even back in 2007, BusinessWeek was already hoping for a reversal of fortune.

Last time I checked, it seemed the crunch would take longer than expected. Yet six months later there are signs prices are returning to where they should be. at least according to a housing affordability ratio based on median household income and median house prices.

Last data for the median household income from the Census Bureau is from 2007. Applying the nominal Home Price Index from S&P Case-Shiller (last data is for the 2008 Q4), and adjusting for inflation using the Consumer Price Index from BLS, we are reaching again the 3-3.5 range.

Median Home Price / Median Income

Median Home Price / Median Income

The question now is whether there will be a soft land or an overshoot, with prices drilling down the historical range. With the deepening recession, there is no reason for prices not to go beyond current bottoms, especially in specific markets. Detroit, for example.

The Federal Reserve Bank of Philadelphia produces a state-level coincident index combining four indicators: nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). This index has been around since 1979.

And since 1979 (thanks to Calculated Risk for pointing out), throughout four recessions, there was a never a moment when indexes for consecutive months were negative for all 50 states… until now.

Number of states with positive growth

Number of states with positive growth

Recession is widespread, no state is spared:

Red states

Red states

Detroit Electric. Yes, there is such thing.

Detroit Electric was an automobile brand in Detroit, Michigan, from 1907 to 1939. They manufactured electric cars, powered by a rechargeable lead acid battery, and advertised as reliably getting 80 miles between battery recharging. The company was in business until the stock market crash of 1929, when filed for bankruptcy and was acquired and kept in business on a more limited scale for some years building cars in response to special orders.

Then in February 2008 , almost 100 years later, China’s Youngman Automotive Group said they were reviving the 100 year-old electric car brand.

And an year later, in March 2009, Detroit Electric announced a partnership with Proton, Malaysia’s largest automobile manufacturer, to mass produce the E63, an all-electric sedan. Under the agreement, Detroit Electric will license two Proton vehicle platforms and contract the company to assemble the electric vehicles that will be marketed under Detroit Electric’s brand, providing Detroit Electric with a cheap manufacturing base.

The E63 will be a four-door sedan with two range options: either 111 miles for $23,000 to $26,000 or 200 miles for $28,000 to $33,000. The company plans to introduce the car in Europe and Asia in February 2010 and then in the U.S. a few months later. The quick turnaround will be possible by outfitting Proton’s existing car models with Detroit Electric’s engine design instead of designing a whole new model.

Old Detroit Electric ad

Old Detroit Electric ad

Wasn't me.

Wasn't me.

It all began with the “conundrum”: the disconnect between Fed-based short-term rates and long-term mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. In theory, long rates are the geometric average of expected future short rates plus the risk that increases with duration of the instrument. So tightening short-term rates should be followed by an increase in long-term rates, say the 10-year Treasury notes.

During previous monetary policy tightening cycles (88–89, 94–95 and 99–00), the 10-year Treasury yield (green line) responded to increases in the federal funds rate (purple line):

Short x Long

Short x Long

But during 04-05, there was no response. Fed rates went up but long term rates remained. Something different was happening then.

Back in 2005, before the Senate Committee on Banking, Housing, and Urban Affairs, Greenspan admitted his disbelief:

Long-term interest rates have trended lower in recent months even as the Federal Reserve has raised the level of the target federal funds rate by 150 basis points. This development contrasts with most experience, which suggests that, other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields. […] For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.

Now, in a long Wall Street Journal piece, Alan Greenspan tries to convince us the Fed didn’t cause the housing bubble. He blames it on the global decline on long term rates rates (and thus mortgage rates as well) spawning the speculative euphoria. And the cause of this global decline? The fall of Communism and consequent rise of China:

U.S. mortgage rates’ linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

The presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export-led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.

That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble.

From 2002 until late 2004, foreign officials purchased millions in Treasury securities. More specifically, Asian central banks had consistently increased their holdings of foreign reserves while boosting exports, mainly to the U.S. An incredible economic growth led to record-high trade surpluses, that were in turn invested in U.S. and European Treasury bonds, compensating the usual effect of short-term rate hikes.

Foreign Purchases x 10-Year Treasury Yield

Foreign Purchases x 10-Year Treasury Yield

Nor any drop to sell.

At least that’s what they want us to believe:

The latest government records show U.S. inventories are bloated with a virtual sea of surplus crude, enough to fuel 15 million cars for a year. Inventories have grown by 26 million barrels since the beginning of the year alone.

Sounds like a lot. But those “15 million cars” are a drop in the American auto bucket: in 2006 there were 251 million registered passenger vehicles in the US, with 54% as regular cars and 40% as SUVs and pick-up trucks.

Weekly crude oil reserves as in days of supply

Weekly crude oil reserves as in days of supply

This extra inventory actually represents 25 days of supply, although the annualized average is closer to 22 days. Better than the 18 days of 2003-2004, but still a far cry from the 1980s, when supply would last 26 to 28 days.

Weekly oil reserves (excluding strategic reserves)

Weekly oil reserves (excluding strategic reserves)

In absolute numbers, today’s reserves of 350 million barrels match the normal reserves for most of the 1980s. In fact, it wasn’t until 1994 that reserves started to creep down and oscillate heavily. If we are “bloated with a virtual sea of surplus”, what would we say of those 12 years when reserves matched today’s?

Oil imports have been steady for four years while demand slumped. But global economy will eventually turn around and demand will rise swiftly. For something that springs out of the ground, one would think oil production would be able to keep up with consumer whims, but things don’t really work that way. When the demand hike happens, we might see a sudden rise on oil prices as producers scramble.

(Crude oil stats: Department of Energy)

There is nothing sacred anymore: the U.S. government will exchange up to $25 billion in emergency bailout money it provided Citigroup Inc. for as much as a 36 percent equity stake in the struggling bank.

Meanwhile, Fed Chairman Ben Bernanke told the Senate Banking Committee: it’s not nationalization, it’s just partnership.

We don’t need majority ownership to work with the banks. I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary.

Existing shareholders would see their ownership stake shrink, and the bank is eliminating all dividends on common shares. Shareholders didn’t like the terms and C lost 38% in one morning. I guess they wanted government that give away money but not take any stake. And wanted cherry on top. And some whipcream.