Consider the Everything Bubble

5 neat datas on freight, bailouts, small banks, CRE #winning, and recession-proof mattresses. Finally, what if everything we knew about the last 15 years is just . . . wrong?

5 Great Datas to unlock the secrets of the universe:

• Freight fear, when shipping is a leading indicator

• You call it a bail out, but I call it smashing the debt ceiling

• Small banks, rawr

• CRE is winning (in just one sector, but definitely losing badly everywhere else)!

• “Sir, this is a recession-proof mattress” and we’re all discount shoppers now

1 big think to make you sleep well at night (after you’ve concluded that Random Walk is obviously wrong):

• Consider the Everything Bubble, or how we have both too much and too little real estate at the same time, and revisiting priors is hard.

Scatterplots

Freight fear

Tender-rejections, i.e. when a shipper says “no thanks, I’m too busy to ship your stuff” are reaching pandemic lows:

That’s a pretty good indication that economic activity is slowing down. Also, another reminder that every shortage becomes a surplus:

So much freight

Random Walk eagerly awaits the arrival of tractor trailers to the used car market, to help alleviate the car shortage.

Going Broke Smashing the Debt Ceiling

The United States Treasury is running out of cash:

It turns out that it may have overestimated its revenues, as tax collections come in below expectations:

Gosh, it sure looks like the UST did a poor job of managing its assets and liabilities. Fortunately it has a good marketing department, such that it has rebranded “bailout” to “raising the debt ceiling.”

¹

Perhaps the debt ceiling is too low (although I doubt it), which is a separate question of whether or not it should be raised, and under what conditions (I don’t know the answer, but, if yes, then probably cautiously). I still find it rather unseemly to simultaneously lecture others about risk management, while you’re burning runway faster than a Series B startup in 2021.

Small Banks, Rawr (reprise)

Additional evidence that small banks have managed to stick their deposits:

Crisis? What crisis?

I’m not really sure what’s going on here. Deposits are probably too few to really make a difference (which is maybe why people aren’t bothered enough to move them, either because they’re FDIC insured or because chasing yield isn’t worth the effort). Another possibility is that the folks who deposit in small, local banks, just don’t pay attention enough to the news cycle to know or care?

Meanwhile, the Little Dutch Boy is hanging in there, doomsayers be damned (h/t

Daily Chartbook

):

Deposits are stabilizing and loans are . . . growing?

These are reasons for cautious optimism.

Good news for CRE (reprise)?

Not all CRE bets have been bad, just most of them:

Industrial/Warehouse REITS outperform

Random Walk’s finger in the air guess is that the yellow line (healthcare) creeps up, while the red line (Industrial/Warehouse) creeps down.

Meanwhile, people don’t have to super-commute anymore (because they can work from home):

While ex-metro housing markets, like Scranton, PA continue to thrive in the post-office world:

. . . and the effects of the big city Brain Drain abound:

None of these are terribly good signals for an office building recovery. The good news, if you can call it that, is that dry powder is starting to come off the sidelines (for the bargain hunting):

[i]n recent weeks, Blackstone sold the Griffin Towers office complex in Santa Ana for $82 million, or about 36% less than the firm paid in 2014, say people familiar with the matter. Principal Financial Group sold a Parsippany, N.J., office building for $14.3 million, down from the $52 million it paid in 2008, according to participants in the sale. 

The tower at 350 California in San Francisco, valued at $300 million in 2019, is expected to trade at about $60 million, or roughly 80% below that previous valuation. 

Oof.

Sir, This is a Recession-proof Mattress

Speaking of counter-cyclicals, everyone is a discount shopper in a downturn:

Wendy’s WEN 0.00 is growing up market. It joins McDonalds and Chipotle as discount offerings having nice starts to an otherwise middling 2023.

Here’s another discounter with apparent tailwinds: “off price” retailers appear to gaining visitors at the expense of branded apparel chains:

As Random Walk has previously surmised, crowding at the low-cost options is a function of: (a) grimmer times, generally; (b) the fact that lower-income earners are relatively better off by the worker shortage; and (c) that higher earners are doubly pinched by (i) higher service costs, and (ii) a contraction in the credit markets (where leverage helped make them wealthy).

²

Just as expected, wage cuts are coming at the top:

Great Wall of Text

Consider the everything bubble

Random Walk senses something not quite right in the discourse around the banking reset, interest rates, the debt ceiling, real estate and the broader state of affairs. These things are deeply linked, which everyone knows, but somehow they’re not being not linked enough, or linked correctly—I can’t quite put my finger on it, but I’m trying.

We have too much invested in real estate and also not enough

My latest attempt is to posit some cognitive dissonance between two recently popular claims that “we have a banking crisis” and “we have a shortage of homes.”

On the one hand, we now know that investing in real estate at historically low interest rates is bad (for banks):

• Banks now have a lot of real estate investments that no one really wants—not necessarily because the tenants aren’t paying rent—but because the banks sorely overpaid for that rent. If a bank charged 2% for risk that now fetches 4%, that bank overpaid.

• We call that buyers regret “unrealized losses” . . . at least until banks need to sell those assets (because they need the money), at which point they become realized losses.

• That realization—that banks have lots of unrealized losses because they invested too heavily in real estate—is the banking crisis in a nutshell. If only they hadn’t invested in real estate quite so much, things wouldn’t be so bad.

On the other hand, conventional wisdom also has it that we have a “shortage of homes” and therefore more real estate investing is good:

³

• In order to solve the “affordability crisis” we need to build more houses. It’s supply-and-demand, you see.

• Indeed, the “supply shortage” has been exacerbated by homeowners who are “trapped” by the extremely beneficial terms of their mortgages. Why sell your home with a 2.5% mortgage so that you can buy something new with a 6.5% mortgage?

• That isn’t to say that homeowners are stressed—quite the opposite, mortgage delinquencies are still at or near historic lows.

• That’s also why everyone seems to be long suburbia now, because whatever happens, supply-demand favors those single family suburban homes;

  ⁴

• Put it all together, and if only we invested more in real estate, especially suburban real estate(?), then things wouldn’t be so bad.

You see where I’m going with this . . . both of these statements cannot be true (in any way that’s good):

• if only we’d invested less in real estate, then things wouldn’t be so bad

• if only we’d invested more in real estate, then things wouldn’t be so bad

That no one is selling, doesn’t mean we need more to sell

To put an even finer point on it, another way of saying that “individual homeowners are ‘trapped’ by their cheap mortgages” is that they can’t find anyone who can afford their home at now-prevailing rates. If they had to sell, it would be at a loss (and so they prefer not to sell). Individual homeowners are, in other words, sitting on piles of unrealized losses.

⁵

Remember, banks are people too, y'know.

In fairness, it’s not as bad for homeowners as it is for banks because (unlike the banks) homeowners don't have to sell their assets to fund their operations (so long as they stay employed). What is true, however, for both banks and homeowners, is that “not-selling” (or “holding to maturity”) isn’t an indication of a supply-shortage. To the contrary, “not-selling” is because they overpaid and don’t want to admit it (and hopefully won’t have to).

Think of it this way: if CRE investors will have to throw-in more equity and higher interest payments when refinancing time comes because all the banks will have assigned a lower value to those real estate assets, while their LTV requirements stay the same or higher . . . then homeowners would be in the exact same position (if they had to refinance). That they don’t have to refinance doesn’t change the fact that the value of their homes has declined—the sticker price of all financed assets goes down when financing costs go up. And yet, once again, declining asset values does not usually signal “under investment.”

Consider this, as well:

In contrast to 2008, we have had

• less household growth, i.e. demand, but also

• more construction and more unit growth (in multifamily), i.e. supply.

More supply and less demand than in the run-up to the “housing crisis” doesn’t exactly scream “INVEST MORE IN REAL ESTATE” either.

Zoom out further, and consider the doom charts: flatlining “household” populations (i.e. demand), alongside climbing inventory:

The blue line goes flat, while the white line goes up. Why?

Once again, fundamentals (at least cut this way) aren’t howling “supply shortages”—if anything, they’re saying “slow down.” We’ve built more than what demand would suggest we ought to, inspired primarily by the free money we all agree we ought not to have.

⁶

Why is everything so confusing?

So why do people keep unreservedly insisting that supply-demand dynamics for housing are basically bullish? Or that building more will solve the “affordability crisis?” How can one simultaneously believe that banks are going bankrupt because they invested too much in real estate, and also that the problem is that we haven’t invested enough in real estate? Or that we should be worried when banks have huge parts of their balance sheet tied up with real estate assets they can’t sell, but also not-worried when people have huge parts of their balance sheets tied up with real estate assets they can’t sell?

It can’t all be about duration mismatch, or the lack thereof. The dots aren’t connecting. Why?

• Well, at some level, it’s because the “housing shortage” claims have been around for a long time, and there may be some truth to it, at least in some markets. Also, it’s fair to say that suburban homes are a better bet than urban multifamily, and also believe that both bets could use some cold water.

• There’s a tendency to conclude that there is no crisis, because this crisis doesn’t look like the last crisis;

• At another level, at least some people are just foolish (or optimistic, but also foolish)—“building more” where density drives value should not be confused with “building more” where not-density is the point. Making things cheaper and the same is good. Making things cheaper and worse is not good.

• Perhaps Random Walk is just being unfair and fighting strawmen . . . people perceive the tension, they’re just cautiously optimistic in the ways homeowners are in fact different than banks (not unlike Random Walk).

If you’re content with those possibilities, read no further. If you’d like to peer wild-eyed into the abyss, please continue.

My affordability, is your deflation

At yet another level—and here’s where it gets scary—is that they’re right, but for all the wrong reasons: building more would make housing more affordable . . . in the same way that new 4% Treasuries made SVB's assets more affordable.

⁷

Say, for example, you’re a big homebuilder.

• Let’s assume for a moment that the cost of building a new home is roughly the same as it was before, in terms of parts and labor.

• The variable part, at least when it comes to interest rates, is the part you finance: the land. If financing costs are higher (but demand stays roughly the same), then you the builder will pay less for land than you would have before.

• Cheaper land is good, if you’re the one buying the land (and not so good if you’re the one selling it). It’s also good for your customers because you can (and will) pass those savings on to your buyers.

• The net result of building more, in this case, is that the 2023 buyer buys a brand new house—identical to one you sold to a 2021 buyer—for a fraction of the price.

Now, the 2021 buyer may be “trapped” by her very low mortgage rate and refuse to sell at a loss, but when an identical home sells nearby for a fraction of the cost, she might nonetheless start to “realize” her “unrealized” losses. In that sense, building more would drive down costs, but not because we have a shortage of homes, but because we have a shortage of homes built under the prevailing high rate environment. It’s the same dynamic as recently issued treasuries (yielding 4%) driving down the cost of older treasuries (yielding 2%)—and it has nothing to do with a shortage of treasuries.

If you’re an affordability advocate, you may say “so be it, your loss is my gain.” But therein lies the dark heart of a free-money driven asset price bubble. You can’t pop it on a go-forward basis without causing considerable pain to everyone who participated up until now. The Fed torpedoed its own balance sheet and already sunk four banks in the process . . . do we really want to see what happens when “affordability” goes nationwide?

Hey, cool, let’s be more like Italy where housing is super-affordable:

the southern Italian town of Laurenzana in 2021 offered up its own abandoned homes for about a buck each . . . More recently, the southeastern Italian town of Presicce offered up to $30,000 for interested residents to purchase unclaimed homes. Similar efforts have also taken place in Greece and Spain.

Again, this isn’t just a pandemania phenomenon.

As per above, there’s an argument to be made that all of the previous decade-and-a-half’s appreciation of home equity is attributable to lower rates, and not supply-and-demand. People/demand has not grown for almost twenty years, while supply growth has continued apace. A very plausible reason assets would nonetheless appreciate is if there’s just more money to go around, i.e. the bad sort of inflation the Fed is fighting right now.

Deflating that appreciation would have pretty significant widespread implications, to put it mildly:

68% of consumer borrowing is tied up in real estate investments . . . there is no universe where a “realized” repricing to real estate passes without considerable pain. In other words, we have enough housing. If we suddenly realized that actually we have more than enough, Wile-e-Coyote would give us a perfect 10.

If you’re someone like Home Depot, who makes money of home-equity financed renovations and the like, the softening you just reported is no temporary thing if all the home equity takes a permanent haircut.

The everything bubble

Consider finally that perhaps it’s not just housing.

I’m going to do an irresponsible thing and eyeball a lot of charts I’ve just seen from the first time and then make some wild inferences. In this case, the charts in question are the Fed’s estimates of industrial capacity and utilization. There is just something deeply discomfiting (to the naked and uninformed eye) about these:

Everything is flat

Doesn’t it look like pretty much all our output (except oil) has been flat since the ‘08 financial crisis (which just so happens to be when we started filling the void in our souls with very low interest rates)? Isn’t weird that all the labor growth also went to the task of spreading this freshly borrowed money around?

So many things to manage

Yes, yes, it’s because we rotated over to a service economy etc. etc. and so of course industrial output would fall, and nothing to see here. Yes, maybe, I don’t know. I’ve already copped to recklessly eyeballing things.

But, alternatively, what if everything—not just housing—is a cheap money bubble? What if all that GDP growth we’ve been counting since then is just our credit card bill getting bigger and bigger? That would be bad, right?

When you invest this much in the future, the future had better be bright

The optimists have correctly pointed out that despite all the tightening, consumer spending is basically flat, YoY. Great. We're all gonna make it. But if “flat” is the new normal, that would be very bad indeed—so many of our assumptions about asset-prices (and our ability to repay our debts) are premised on compounding growth. “No more upside” would change the outlook very quickly.

⁸

This too is supposed to be a scary chart because “serious delinquencies” for the youngest borrowers are rising right now:

But what jumps out at Random Walk is that serious delinquencies were rising before the pandemic (even as early as 2014).

Here’s another cut, this time by loan type:

Are consumers really that much better at buying houses than buying cars and other stuff, or is that houses get extra-special 30 year super-low interest loans that kick the can down the road? Remember that Back to Normal is a Siren Song . . . but normal wasn’t necessarily so hot to begin with.

Stuff under the hood

Anyways. To bring it all home, one reason why people may simultaneously say “we invested too much in real estate” and “we need to invest more in real estate” is because it’s far too terrifying to link the Fed’s war on free money to the the last 15-20 years of ALL of the inflation. People have been real estate experts for far longer than the Fed’s been fighting inflation. Why should the latter cause one to rethink the former?

⁹

I mean, sure, the last 2-3 years created some wild times, but before then, it was fundamentally sound growth. Maybe. Hopefully.

As my buddy Stan Drunkenmiller says, “when you have free money, people do stupid things. When you have free money for 11 years, people do really stupid things. So there’s stuff under the hood that’s starting to emerge.”

Please please let it be something simple, like an oil change.

1. A further nod to the marketing department, despite the dire warnings, it seems very unlikely that Treasury will start defaulting on bond payments before it stops paying government contracts, employees, etc.—bondholders are likely to be the last folks harmed.

2. Yet another data point suggesting that pain from the cost-of-money increases is worse the closer one is to the source:

3. Random Walk has made this observation in the past before, although my thinking on it has evolved, and I’m now starting to think it may be more wrong than right.

4. Axios did its best to summarize a year’s worth of Random Walk. The New York Times has also recently gotten in on the fun. A venture-backed Single Family Rental acquisition platform just minted itself a unicorn. Everyone now loves the ‘burbs.

5. Losses which will hopefully stay “unrealized” provided homeowners don’t need the money, (which they might, if they lost their jobs, for example)

6. Approximately $430B of home equity was unleashed during the pandemic, via home equity financings (and refinancings).

7. Similarly, whether affordability is good or bad depends on when you entered the game.

8. Consider also the disappointment in China’s reopening. China has reopened, but with less vim and vigor than what was expected, which is consistent with a nation undergoing secular demographic decline . . . like ours.

9. As my friend BMH says, it’s like the inverse of the Great Depression mindset, whereby that generation would not abandon its negative priors despite all the success.