Mis-Pricing the Risk

In the summer of 2000, I looked out this same window in a small house on an island in Maine and, watching the tide emptying and filling the cove, contemplated what it would take for Gore to win the 2000 election.

I had a lot of company in despairing that advisors had prevailed in persuading candidate Gore to stifle the environment as a campaign issue.

At the time, I was spearheading a campaign to stop the Clinton administration from allowing political insiders and powerful campaign contributors in Florida’s largest county, Miami-Dade, from hijacking a former military base at the edge of the Everglades and turning it into a privatized, commercial airport.

Voters were upset enough how Clinton and Gore both were avoiding the environment that the beneficiary in the November 2000 election would be Ralph Nader—as indeed he was in Florida.

To be fair, Gore advisors had a rationale for believing that “the environment’ was on balance negative. The air base fiasco was far from the only mistake made in that respect.

But the lesson is this: insiders, cocooned in political campaigns and preoccupied with the challenge of raising campaign cash from an economic elite, tend to mis-price specific risks that touch ordinary people and ordinary voters.

In this respect, Florida is again instructive to candidates who may be the next president of the United States.

Bloomberg reported (July 20,2007) on the weird manifestation of the housing boom and bust as dozens of construction cranes in Miami edge skyscraper condominiums toward foreclosure. “The oversupply will force prices down as much as 30 percent, the worst decline since the 1970s, and help push Florida’s economy into recession as early as October, said Mark Zandi, chief economist at West Chester, Pennsylvania-based Moody’s Economy.com, who owns a home in Vero Beach, Florida.”
Forget about October: the Florida economy is in a recession today.

“Thirty-seven new high-rise condos and 20,000 new units are being built in Miami’s 1,040-acre downtown, where sales fell almost 50 percent in May, according to the Florida Association of Realtors. The new units will join the 22,924 existing condos in Miami-Dade County that were for sale in April, according to Jack McCabe, chief executive officer of McCabe Research & Consulting LLC in Deerfield Beach, Florida.”

Government statisticians roll out serial reasons for optimism in the broader economy: employment remains strong, unemployment at 4.5%, and consumer confidence is said to be high.

But I’m on the side of the recent Wall Street Journal/NBC poll conducted July 27-30 showing that the nation’s economic mood is gloomy.

In coastal Maine you can feel it big time. “More than two-thirds of Americans believe the U.S. economy is either in recession now or will be in the next year.”

Florida is the epicenter of the housing bust in the United States, for the political connections between Jeb Bush’s election in 1998, W’s in 2000, and a cast of characters tied to the biggest speculative bubble in housing in Florida history.

Al Hoffman, the former chair of Florida-based WCI Communities crowed in 2003 to the Washington Post that development in Florida was “an unstoppable force”.

Indeed, during the housing boom local county commissions and the Florida legislature spent entire sessions making it harder and harder for citizens to intervene in protecting their water quality, their communities from bad development, and even from petitioning their own government.

Hoffman was campaign finance chair for Jeb Bush in 1998 and 2002 and national co-chairman for President Bush in 2000.

Today Florida’s housing markets are in tatters. The state budget is nearly $1.5 billion in the hole, as receipts from real estate transactions dry up.

WCI Communities’ stock price has plummeted. The company retained Goldman Sachs to explore options for the sale of its business or assets and can’t find a buyer.

The reason WCI Communities can’t find a buyer is that company decision-makers price its value at the other side of the economic chasm into which the fortunes of publicly traded homebuilders are falling.

So far, the presidential candidates are ignoring the distress, as if to avoid taking the hit when you are forced to mark an asset to the market and not some conjured value.

This is exactly the discussion that is ricocheting around Wall Street today and hundreds of billions of dollars of financial derivatives whose value is up in the air.

With each passing day and report of condo busts in Miami and production homebuilders leaning into the stiffest headwind in modern history, it is becoming clearer and—and with as much certainty as the tide moving in and out of Long Cove—that the defining issue in the 2008 campaign will be the unfolding maelstrom in housing markets across the nation.

David Leonhardt, in the New York Times “Keep your eyes on adjustable-rate mortgages” (August 1, 2007) dryly noted, “… the carnage in the mortgage market thus far has come even before the bulk of mortgages have reset.”

President Bush called it “the ownership society”. You don’t much about that anymore. Nor did you hear much about the recent visit to China by HUD Secretary Alfphonso Jackson who was rebuffed in his effort to persuade the Chinese to buy more US mortgage debt. In early July, Jackson told the Chinese, according to Bloomberg: “Mortgage securities offer China’s central bank better returns than U.S. Treasury bonds at the same level of credit risk.” Is that so?

“The peak month for resetting of mortgages will come this October, according to Credit Suisse, when more than $50 billion in mortgages will switch to a new rate for the first time. The level will remain above $30 billion a month through September 2008. In all, the interest rates on about $1 trillion worth of mortgages, or 12 percent of the nation’s total will reset for the first time this year or next. A couple of years ago, by comparison, only a marginal amount of mortgage debt—a few billion dollars—was resetting each month.”

The odds of containing the financial contagion in mortgage markets to a few hedge funds or just the matter of financial derivatives tied to housing and not the massive markets in corporate debt before November 2008 are low.
Wall Street and the current administration are applying tremendous pressure to keep traders from marking risk to market. It has been a Herculean effort and the sweat is showing.

The economic tide is now running as inevitably against Wall Street as it does here on Long Cove: on one side, millions of homeowners at or beyond the point of distress as they struggle to meet the costs of maintaining high mortgages in falling property markets, and, on the other side, holders of petrodollars and the beneficiaries of America’s trade imbalances who are disinclined to make bad investments, or, to be scammed.

Ordinary people and most voters aren’t up to the challenge of understanding the risks in financial derivatives. But the signals are everywhere.

The candidate who can tap into the frustration around collapsing home markets and the proliferation of unsustainable risk to the economy will be the next President of the United States.

ALAN FARAGO writes about the environment and politics. He can be reached at alanfarago@yahoo.com.

Alan Farago is president of Friends of the Everglades and can be reached at afarago@bellsouth.net