|How can individual property owners make sense of an economic situation of such global scope and economy-shattering depth that financial experts like Dr. Alan Greenspan, Chairman of the US Federal Reserve System from 1987 to2006, are even driven to say, "I don't know"?
In many ways, determining what is relevant to one property, in one community, in one province, at one point in time is easier than dealing with a sea of generalities and trying to be right in hundreds directions at once.
According to Greenspan, it boils down to this: "It is important to ask ourselves, 'Where is the bottom and when will it stabilize?' I look to two prices which I think are critical for determining when the private sector by itself will stabilize. The first is the price of homes in the United States, and the second is world stock prices. The home price issue is a very critical one in the sense that...the amount of equity in homes in the United States, that equity, is the ultimate collateral which backs up the whole international structure of mortgage backed securities ... ."
Early in November, Greenspan visited Toronto and answered a series of questions put to him by a representative of the local banking community. Approximately 2300 financial "suits" sat in almost complete silence -- virtually no coughing or blackberry checking -- as they listened to Greenspan's views on what was going on and what would be going on next. The following excerpts present an interesting perspective for Canadians intent on deciding whether Canada will or will not weather the economic storm without going down with the "ship" -- its neighbour to the south.
The Problem: Home Equity Glut
Greenspan: "The sale of vacant for-sale [US] property, which is picking up rather aggressively -- it is that which will stabilize prices, but not in an easy way, sometime in the first half of next year. When that happens, then, instead of having this extraordinary uncertainty with respect to the value of assets on all banks' or intermediaries' books, we will know what they are really worth. When we get to that point, and banks truly know whether they are solvent or not, then I think we begin to see the very major problems constricting private equity... . There are early signs and until we get to a stability, we are interdependent on the sovereign credit, which is basically the only really important mechanism which will bring us through this crisis. This is a once in a century event. "
Greenspan warns us to expect a further drop of 5 to 10 percentage points, but the rate of decline is slowing. This makes it possible to project a bottom for evaluation of assets, even before prices fully stabilize.
Where to Start: In analyzing large-scale problems, Greenspan presented an interesting approach to analyzing financial alternatives.
Greenspan: "First define what the problem is, and I feel what the problem is fairly clear. What its solution is is less so." If stress is building, write down exactly what your problem is. Be specific and definite. Not just "I'm worried about my investments," but a list of what you dread specifically this week, this month, over the next two months, over the next six months. Once the problem is clear, you can concentrate on solutions. While global uncertainty reigns, finalizing solutions may be a challenge, but at least this is constructive, forward thinking, not "what if" whining about pending doom.
Numerator or Denominator:
"For equilibrium in the financial system and, therefore, in the banking system, you have to get even more capital into the banks, or failing that, the banks are forced to sell assets -- you either have to work on the numerator or the denominator. What the whole action on the part of banks and central treasuries is, is to, at the moment, put significant amounts of new capital into the banking system. It is beginning to bring down these risk premiums significantly, but there is more work to be done, and it is not 'cost-less'...". Following Greenspan's reasoning, will solutions to your problems focus on increasing income, cutting expenses or liquidating assets? This is a time to reduce debt even if the most you can do is not use credit cards and live within your cash means.
Greenspan: "That is a critical question and I don't know the answer, but what is certainly the case is, as US home prices decline, we are still creating new toxic assets. Not because we are issuing [sub prime mortgages] -- they are effectively zero, most markets are dead -- but we still have US1.5 trillion dollars outstanding in mortgage-backed securities, backed by pools of US [subprime mortgages], and, therefore, the price decline is very critical in that respect. Essentially what we have to do here is stabilize the prices and get that part of problem solved. Whether that spills over to the other problems -- there's the commercial paper market, basically different types of consumer lending and the like -- I am not sure, but if you clean up part of the balance sheet, it is very likely you may get the reverse effect of what we get now, at least I think that is a reasonable expectation... . We know we are going down and there is very little we can do about that but what history tells us is that one can start to stabilize... . What we really need is a stabilization, and then it will begin to feed on itself." Don't make matters worse by acting rashly.
Greenspan: "... there is a general belief that fundamentally the American economy is not inflation prone. One way or the other we'll pull back, and a lot of us believe that, and that's not true in a lot of the emerging economies, as you know ... . We have demonstrated a degree of resilience which I am not sure we have really understood but it is not a bottomless pit in that regard. We must be very careful ... ."
Greenspan: "There are some very fundamental roots in the United States that create this stability and number one is the Constitution of the United States which to protects the rights, not only of individual citizens and property rights, but equally of those foreigners who invest in the United States. We saw a most interesting phenomenon when the crisis arose. Where was the safe haven? With all of our problems, the [US] dollar strengthened significantly, because people saw that as a safe haven. If we lose that, we will be in trouble."
Greenspan: "There is an extraordinary desire to recognize that we all live in the world and that we all rise and fall together." This statement about international relations makes sense on a community level, on each street, in each apartment and condominium tower.
Timing is All
Greenspan: "Canada is an unusual case where you have done everything right, but the degree of exposure to the rest of the world, especially your neighbor to the south, means if we don't get it right, you've got a problem."