the housing crash

last may, i cried “bubble" and was promptly ridiculed as housing continued to boom.

“just wait,” i would say, “until 2007.”

now, home prices are dropping and interest rates are rising, along with defaults. and yet, there remain steadfast believers in a swift recovery. some are self-delusional investors; others are the realtors and mortgage brokers whose livelihoods depend on public perception. most unfortunately, though, even many lenders and analysts cannot see the forest for the trees, each intensely studying a tiny piece of an enormous system without fully grasping that the entire mechanism is on the verge of collapse. a quote from AmeriCredit Corp. c.f.o. Chris Choate (in an a.p. article) sums it up: “Unless you can draw some correlation between those [defaults] and what is going to happen to the consumer's job, we really don't see that that would have a direct impact on our portfolio.” well, lurking below their radar is just such a correlation – an economic feedback loop that threatens to turn otherwise isolated incidents into a systemic shock. this phenomenon was explored by Yale economist Robert Schilling in his excellent book, “Irrational Exuberance” (whose title is a tongue-in-cheek homage to former Federal Reserve chief, Alan Greenspan).

to understand why the housing collapse will soon reverberate through our economy, we should start at the beginning. housing began its meteoric rise when the fed dropped interest rates to historic lows, cushioning the dot-com collapse. cheap credit and novel mortgages brought new buyers into the market, making low up-front payments and believing that they could afford higher future payments thanks to rising wages or – better yet – by simply refinancing when their home value rises, as appeared inevitable. some buyers took this to extreme, financing 100% to purchase multiple homes on speculation. and even those on the sidelines were cashing out with junior mortgages, liquefying half of all appreciation over the last five years.

the end result was over $10 trillion in outstanding mortgages (less the approximately 20% paid to financiers) -- not an alarming number, in and of itself. what should concern us is that more than $2 trillion are adjustable-rate mortgages that reset in 2006 and 2007.

the chips are down, and struggling homeowners are counting on rising wages or home prices to come through. but as in any bubble, speculative prices were mistaken for real demand, and the resultant oversupply is sending prices even lower. if prices fall far enough, even another round of rate cuts won’t make refinancing a winning proposition.

the other hope is that wages will increase, but our economy is dangerously dependent on consumer optimism, and we have no reason to keep spending! we’ve already bought everything we need for the next five years – homes, cars, appliances – all paid for not with more or higher wages, but thanks to (highly questionable) asset appreciation. in fact, last year, americans spent more than they made for the first time since the great depression! and to the extent that income has increased, most of it has been in real estate and the new “service economy.” naturally, as housing deflates, realtors and construction workers will be fired in droves. and the service economy is highly dependent on discretionary spending, but we can’t keep spending, even if we wanted to. with home prices falling, we’re losing access to consumer credit, which recently fell by the largest amount since 1992.

meanwhile, wall street seems little concerned, with markets rising on great expectations for consumer spending. and so, the last five years of investment in capital and labor have assumed that home price appreciation would translate into permanent wealth. there go our best-laid plans.

add all of this together, and you see the downward spiral we face. mortgages reset and, lacking the collateral to refinance, the least creditworthy enter default. this puts more houses on the market, further depressing prices. as credit falls and real estate suffers, expectations and consumer spending wither, hurting the economy and employment. at this point, the trend doubles back onto itself, sending more people into default and putting more houses on the market, ad (nigh) infinitum.

elsewhere, stocks will falter, but the brunt of this contraction will be felt by hedge funds that bought mortgage-backed securities without regard to risk.

but i still have my eye on the biggest hedge funds of all, Fannie Mae and Freddie Mac. they cannot legally diversify their investments, so they have leveraged mortgages into the trillion-dollar range using nothing but other mortgages to “hedge” their risk, if you can even call it a hedge. if homeowners refinance in the next year, the twins will be left unable to cover their liabilities.

the scariest thing i've ever heard was when a Freddie employee told me, last year, that "as long as real estate prices don't go down, we're fine."

all this, and we haven't even mentioned the dollar. throw in the fact that china may not need our purchasing power anymore, and their release of foreign reserves could force the dollar to unforeseeable lows, bringing the twin deficits home to roost.

i just hope we'll learn that we're no exception to the rule of command economies. they just don't work.

hold on to your hats.

by the numbers: biofuel

if you haven’t heard of biofuel, you’re an utter loser and you obviously don’t watch enough television. they’re going to wean us from opec’s teat, save the american farmer, stop global warming, bring peace to the holy land, and solve the jonbenét ramsey murder-mystery, all by next summer. the catholic church recently canonized biofuel based on these three miracles. everyone wants to get in on biofuel. john kerry is considering ethanol as his running-mate for 2008, and george bush recently betrothed his eldest daughter to bio-diesel (although this may simply have been a mix-up with the actor, “vin diesel,” of whom the president is a huge fan).

some things in the last paragraph are exaggerations (i’ll leave it to the reader weed them out), but they capture the spirit of the moment. i think – and i might be all alone on this – but i think that maybe, just maybe, all the biofuel hype warrants some scrutiny.

if for no other reason, we should be suspicious because republicans are on the bandwagon. does anyone really buy a 180° turn within the last year? of course, there is now a (much) stronger argument for independence from foreign oil, but the war was never about oil… at least we’re not supposed to think so.

sadly, the reason that biofuels have political support is that they are effectively massive farming subsidies – political chocolate covered by a thin, environmentally-sound shell.

witness the fact that we’re supporting what are pretty much the worst possible crops for biofuel production: wheat, soy, and corn. the best crops are sugar beet, sugarcane, cassava, and sorghum. unfortunately for us, they come from, respectively, france, brazil, nigeria, and india, none of which is likely to win out over middle-america, in the foreseeable future.

i certainly don’t mean to imply that any of this is new. we’ve been standing in the way of international agricultural trade since the 1930’s. it’s just different, now that politicians can hide behind the mask of environmentalism.

rhetoric aside, what people really want, and need, to know is, are biofuels cheap, and are they clean?

biofuel cleanliness is debatable, but supporters probably have it right. on the upside, their net effect on carbon levels is definitely low because plants take carbon out of the atmosphere as they make biofuel material. on the downside biodiesel currently releases many times the nitrous emissions that gasoline does, but technological improvements can help to bring that down, and other biofuels don’t share that problem.

what does merit close scrutiny is the question of whether biofuels are “cheap” – in the economic sense, as opposed to the price sense.

people are usually only concerned with energy conservation and want to make sure we’re getting more energy out than we’re putting in. but given our propensity for massive resource depletion, we should consider the material resources used in biofuel production.

on a yearly basis, current technology can extract 6 tons of biomass (the stuff biofuels are made of) out of an acre of arable land, which can then be converted into about 400 gallons of biofuel. unfortunately, biofuels will only ever be about 70% as effective as gasoline, turning 400 gallons of biofuel into about 280 gallons of gasoline.

so, all you need to feed our gasoline habit is about 497.5 million acres of land. unfortunately, that’s 108% of the arable land in the united states. so much for self-sufficiency.

i must admit that i’m being a bit pessimistic. if you believe the optimists, we can quadruple the biomass yield and cut our fuel needs in half, taking the amount of land down to 37.9 million acres, or 8% of the nation’s arable land.

i’m a man of science, and i think that productivity miracles can happen, but they aren’t easy. unfortunately, biofuel faces more than an uphill struggle, it’s an uphill struggle in the rain with people jumping on its back and throwing stuff at it.

there are other things that require arable land, like 300 million mouths, a number that keeps growing. oh, and we haven’t mentioned the fact that most parts of the nation are depleting their aquifers at a rate that will halve current irrigated acreage by 2030.

there’s just no getting around the fact that oil is about a billion years of biofuel production, distilled into sweet, sticky alkanes. our energy demand is a rather high hurdle, and the first step to clearing it must be an apolitical, economical approach that weighs the realities of all alternatives. eliminate the subsidies and the barriers to trade, let people decide how scarce oil is and will be, and let entrepreneurs meet demand. that’s what we do best.

fire, brimstone, and global warming

i have a confession to make. i have not seen "an inconvenient truth," and i probably never will. if you think this means i shouldn’t critique the film, rest assured that all evidence presented is on the internet, and that i have seen it.

i refuse to go because i don't like propaganda films, even if packaged and sold by the manifestation of bland that is al gore. i say propaganda because i think the chances of finding objective truth in a movie theatre are about the same as finding a fortune cookie that actually forecasts my life.

speaking of forecasts, i should get down to what this article is really about: global warming.

and intelligent design.

what does global warming have to do with i.d.? well, it depends on what you mean by "global warming." if we take it to mean that the earth's average temperature has risen as of late, and nothing more, then global warming and i.d. have very little to do with each other. but that simple definition of global warming is like the part of intelligent design that says, "look, there are humans!" -- no real controversy, there.

what ties global warming to intelligent design is the way we fill in the gaps.

nietzsche said it best: "nature has installed man in the midst of illusion." somewhat counter-intuitively, this is not a statement about the world around us. rather, his brilliant observation is that the human mind imposes order upon its surroundings -- even when there is none.

and order is just a hop, skip, and a jump from intelligence.

consider the snowflake. each is unique, a variation on a theme whose exquisite structure might lead us to believe that every flake is hand-crafted by the likes of jack frost. but we know better. random gusts of wind interact with water's molecular geometry to render crystalline structures in unmistakable – and beautiful – hexagonal patterns.

characters like jack frost are omnipresent in human history. this is because we have a strong tendency towards anthropomorphism, the attribution of human characteristics to non-human phenomena. and such bias makes sense, but only as a cognitive convenience. it took hundreds of years of experimentation and deduction before we could say anything about snowflakes. in the meantime, how much easier was it to just chalk them up to some deity or mythical character?

but here's why it’s really great; we innately know how to influence human behavior, making personification even easier when the phenomenon is frightening -- when we desperately want to change it.

anthropomorphism is what lies behind ancient rituals of sacrifice. early humans thought that their local volcano erupted because it was "angry," and so concluded that a gift would calm it down.

now, let's tie this all together, with a little help from our friend, math. for the sake of argument, we’ll assume the worst-case temperature reconstruction (the infamous “hockey stick”).

what you have to remember is that whenever someone makes a claim about atmospheric cause-and-effect, it is supported only by their model of how the atmosphere works.

the problem is that our atmosphere is what is called a "nonlinear, dynamical system." this is a fancy way of saying that its features -- temperature, humidity, cloud cover, etc. -- do not follow neat lines and curves, and they are subject to wild fluctuations, putting it in the same class of systems as the stock market. both are breathtakingly complex and have thousands or millions of influences (variables, in mathspeak).

these systems can barely be captured by today's greatest mathematicians and our most powerful supercomputers, much less by al gore.

in closing, i’d like to address one last point and remind everyone that government funding does not put research on the moral high ground. nazi-era eugenics arose without any sort of governmental directive. german scientists simply knew that they could get easy money if their research was in line with popular opinion. how popular? so much so that its supporters included theodore roosevelt, woodrow wilson, winston churchill, oliver wendell holmes, louis brandeis, alexander graham bell, leland stanford, h. g. wells, george bernard shaw, the carnegie and rockefeller foundations, the cold springs harbor institute, and researchers at harvard, yale, princeton, stanford and johns hopkins. even some nobel prize-winners lent their support.

now, all of this is not to say that humans should be definitively ruled out as global warming's root cause. we could very well be exactly that. the point is that we should take it all with a grain of salt and not rely on anecdotal evidence (another nasty human tendency). we should be focus our efforts on saving the world from more definite threats, like war, death, near-earth objects, and supervolcanoes.

let’s not lose our heads just because it's easiest to blame ourselves.