Friday, January 18, 2008

A Crisis of Value

Although the U.S. economy sinking towards recession like a McMansion built on a bog is no laughing matter for the millions of Americans whose quality of life will be negatively affected, I couldn't help but laugh at Bush's recently announced "special package of measures worth billions of dollars to avoid a downturn in the world's biggest economy."

It's dark comedy indeed that "US shares turned sharply lower following the announcement" of a "stimulus package worth perhaps $140bn dollars [that] will have little real impact on a total US economy worth a gargantuan $14,000bn a year," according to the BBC correspondent. A more poignant evaluation of the tax cut is to question how much good it will do to stave off a recession that has little to do with tax levels in the first place.

It only takes one look at the BBC's "latest news" sidebar next to the article, which, at the time I read it, displayed these headlines:
Sub-prime woes spread worldwide

  • Merrill Lynch posts $7.8bn loss
  • JP Morgan's $1.3bn sub-prime hit
  • Citigroup's $9.8bn sub-prime loss
  • Fed boss says 2008 outlook worse
  • Sub-prime woes continue for UBS
  • Bear Stearns boss Cayne resigns
  • Morgan Stanley takes $9.4bn hit
  • Fed tightens sub-prime rules
  • ECB lends $500bn to lower rates
  • And these headlines, further down under the "US SUB-PRIME PROBLEMS" header:
  • Bush details housing rescue plan
  • Political deadlock on aid
  • Carnage on Wall Street
  • Foreclosure wave sweeps US
  • US housing market crash
  • Credit woes 'need private action'
  • Nor will Bush's "housing rescue plan," which allows some distressed sub-prime borrowers to refinance their mortgage loans at a lower rate or freeze interest payments, guarantee a significant leg up for the economy.
    "Something other than lower interest rates is needed to fix the sub-prime crisis and a freeze on mortgage interest payments is a big step in the right direction, if it works," said Cary Leahey, managing director of Decision Economics. [BBC]
    It won't work for many people, according to Forbes.
    The Bush Administration's plan to rescue the housing market and keep the economy from slipping into recession took flak yesterday for freezing interest rate hikes for a mere fraction of subprime, adjustable-rate borrowers. But there's a bigger risk: It could deepen and lengthen the credit crisis.

    According to analysis by Barclays Capital, the "freezer-teaser" plan applies to just 240,000 subprime loans. The Mortgage Bankers Association reports the number of subprime adjustable rate mortgages at 2.9 million.

    It also won't help the 16% of subprime borrowers who are already delinquent or in default, and it won't help millions of other homeowners who either will be deemed able to pay the higher rates when they adjust, starting in January, or who have the unhappy circumstance of having a house worth less than their mortgage or a loan that has already reset to the higher rates.
    From the perspective of a financial layman like me, the federal government's branch-hacking strategies fail to get at the root of the U.S. economic crisis. It is a crisis of value.

    Home "buyers" took out sub-prime mortgage loans that seemed irresistible due to their initial low interest rates. When the interest rates reset to much higher levels (sometimes double), many borrowers could not pay them back. Many had poor credit histories and-or income levels that were not prepared for the higher rates.

    These homes, of course, were primarily in the suburbs. According to an excellent BBC guide on the crisis, "it was difficult [for lower-income or first-time buyers] to become an owner-occupier without moving to the very edge of the metropolitan area." The guide contains a telling graphic of the locations of the Cleveland metropolitan area's foreclosures: primarily in the suburban areas. The City of Cleveland has since filed a lawsuit against 21 banks who engaged in sub-prime lending in the area.

    The hard evidence points to the deception of the banks in offering sub-prime loans without clearly explaining the adjustable rate structure. But the crisis is about the more abstract but fundamental deception of the American dream. In an important sense, cookie-cutter suburban homes are overvalued. They incur higher transportation costs on their inhabitants, who have to drive to do any errand. Many potential buyers probably also overestimated the size of the house they could afford. The initial "teaser" rates could have made these homes seem affordable. If so, they also could be facing higher heating or cooling costs.

    In any case, it was naive to believe that the expected value of these homes would materialize. A U.S. Conference of Mayors report (PDF) chronicles the housing bubble growing and bursting:
    The U.S. economy this decade experienced a dramatic real estate bubble – the inflation of both home values far in excess of historic norms and of reasonable estimates of the growth of fundamental determinants of home value. One salient feature of the bubble psychology was the expectation on the part of home-buyers of a continuation of this supra-normal trend in home price appreciation.


    ...then the perfect storm occurred. Home price appreciation ground to a halt, and home sales plummeted. This happened just as the ARM rate resets were beginning in large numbers, dooming the finances of millions of buyers. Delinquencies and foreclosures began to mount. At the same time, the inventory of new and existing homes for sale escalated, putting further downward pressure on prices, and limiting the ability of those who needed to


    [In 2008,] [h]omeowners will...see property values decline by $1.2 trillion in 2008. The initial adjustment of over-heated home prices to the combination of weaker market demand and large inventories of homes for sale would have reduced values by $676 billion in 2008. Now, due to the foreclosure and mortgage crisis, home values will decline further, by an additional $519 billion. Foreclosures in 2008 will increase by at least 1.4 million. These homes represent a market value of $316 billion. [emphasis added]
    The mortgage crisis is primarily a metropolitan crisis. It is the first shock reality has sent us that our suburban fantasy is unsustainable. (The second shock might come with the 2008 summer driving season.) The libertarian, hyper-individualist strand in our society has pushed us to think that there is only value in individual homes. The larger the house, the larger the lot, the better, even if we are isolated from everyone else, even if we have to spend a lot more for our daily lives. In short, we have forgotten the value of community. We have forgotten that living in urban settings can decrease our cost of living, primarily through lower transportation costs. Transportation costs are significant, sometimes higher for households than housing costs, but they are not something homeowners generally think about when deciding the affordability of a place. A 2006 report by the Center for Housing Policy (PDF) found that
    On average...working families in the 28 metropolitan areas spend about 57 percent of their incomes on the combined costs of housing and transportation, with roughly 28 percent of income going for housing and 29 percent going for transportation. While the share of income devoted to housing or transportation varies from area to area, the combined costs of the two expenses are surprisingly constant. In areas where families spend more on housing, they tend to spend less on transportation, and vice-versa. However, in all the metropolitan areas there are neighborhoods where working families are saddled with both high housing and high transportation cost burdens.

    In their search for lower cost housing, working families often locate far from their place of work, dramatically increasing their transportation costs and commute times. Indeed, for many such families, their transportation costs exceed their housing costs. Recent census data suggest this trend may be accelerating. Of the 20 fastest growing counties in the United States, 15 are located 30 miles or more from the closest central business district.
    It follows that if families spend less on transportation, they can spend more on housing. That is to say, perhaps they could better bear ratcheted-up interest rates and save their property from foreclosure, or, better yet, afford a conventional loan with prime rates.

    What would help our current economic woes much more than offering up minute tax breaks or suing sub-prime lenders would be to halt the suburban growth in this country. It actually would have paid off 15 years ago when we were starting to come out of the early 1990s recession and the housing market started booming, or 60 years ago when we converted the hubris of World War II victory into paving the first interstate highways and machining the first suburban tract homes on a large-scale. We could have done this through comprehensive, regional planning that directed growth towards existing built-up centers where utilities were already provided. We could have done this through urban growth boundaries or urban services boundaries. In short, we could have done this through smart growth.

    Now reality has started to halt suburban growth for us. And since we were relatively unprepared due to our previous collective fantasizing, it is being halted the hard way, and we will endure losses to the tune of $166 billion less GDP, half a million fewer jobs, and the aforementioned $1.2 trillion drop in property values, according to the U.S. Conference of Mayors report.

    This, I have long thought, is an example that gets at the heart of what sustainability really means to me. If nothing is constant but change, then, technically, nothing is sustainable. We can only be sustainable in direct proportion to our ability to adapt to change. Even a country totally powered by renewable energy cannot escape the law of entropy. Wind turbines and solar panels eventually deteriorate.

    The central question of sustainability then becomes, "Do we want to avoid massive hardship or suffer it?" This question is intimately tied to ethical first principles based on happiness, on eudaimonia. Its necessary corollary is, "Do we want to plan for change or let it overtake us when we are unprepared?" Clearly, the housing crisis and slumping economy fall under the latter result. We should learn from this hardship and accelerate planning for quality of life after all the cheap oil is gone. This involves rediscovering the value of community.

    Tuesday, January 15, 2008

    Europe Beginning to Realize Not All Biofuels are Created Equally

    From the New York Times:
    Europe May Ban Imports of Some Biofuel Crops

    PARIS — In a sign of growing concern about the impact of supposedly “green” policies, European Union officials will propose a ban on imports of certain biofuels, according to a draft law to be unveiled next week.

    If approved by European governments, the law would prohibit the importation of fuels derived from crops grown on certain kinds of land — including forests, wetlands or grasslands — into the 27-nation bloc.

    The draft law would also require that biofuels used in Europe deliver “a minimum level of greenhouse gas savings.” That level is still under discussion.

    Monday, January 07, 2008

    Brasil's New Black-Gold

    In mid November, Petroleo Brasileiro announced the discovery of a super-giant oil field. It contains 5-8 billion BOE and like most of Brasil's oil, is located off-shore and is an ultra deep water field. The largest discovery in the last 7 years (since Kashagan) brought out the peak oil deniers as usual:
    Peak oil advocates claim that the world is running out of oil unless the West gives up its energy-consuming lifestyle. Like global warming and population-bomb Malthusianism, it's essentially junk science because it operates on a static model. Crucially, it leaves out the politics of whether oil companies are allowed to discover
    Recent news suggests that Brazil may be sitting on even bigger oil deposits than the recently discovered (and huge) Tupi field
    Besides Brazil, China has made 10 major new discoveries this year alone
    They go on to include India, Mexico and Russia in their list of countries making oil discoveries. Never mind that the first sentence isn't quite correct, but from what I gather they are trying to equate moderate oil discoveries in a few countries as proof that oil is not peaking. A reminder then: even though it is technically correct that we are "running out" of oil (once you begin to consume a finite resource, you start running out) peak oil activists do not necessarily claim that the primary problem of peak oil is that we are running out. The main point is that current and projected rates of production are neither sustainable nor possible. In a world of diminishing resources where supply cannot keep up with demand, serious problems will begin to plague our economic system upon which growth (of money and energy) is quintessential.

    What about Tupi? We've been using technology for a long time now, why was this just discovered? What does the find mean for Brasil's and global production? Via Reuters we find that Tupi was hidden from previous scans. Only once new technology was developed specifically for surveying through layers of salt was the possibility of an oil field detected. We are now developing technology to locate oil in more extreme environments, but do we also have the technology and physical capacity to commercially extract oil in these same places? A short answer would be yes, but not without costs and delays. Nearly all types of oil or equivalents being developed to replace and supplement on-shore conventional crude production are running into barriers, including but not limited to rig shortages (Gulf of Mexico and the North Sea), engineer/technician shortages, financing problems (Kashagan), cost overruns (Alberta oil sands) harsh climates (Sakhalin) and limits to drilling technology.

    An article I read at the time of the discovery that had some cost information is now archived, so no link. I recall that the initial test well alone cost millions to drill. This field is under miles of water and sea bed, including over a mile of rock hard salt (layers of salt are difficult to drill through). As with the other projects above, the Tupi field will also have its high costs and a long development timeline to bring commercial production online. Pilot production won't begin until 2013, assuming there is an "investment of $35 per barrel before financing costs," and the deeper Brasil must go for more oil, the cost to produce a barrel of oil will rise. The Middle East cost per barrel is about $5.

    The media jumped on the reserves and possible production amounts and ecstatically reported that the field may well produce 1mbbl/day. What most failed to mention is that such a level of production could take until 2022 to be brought on stream. This article by Dave Cohen is an excellent analysis of not only Tupi but the short and mid-term future of Brasilian oil production. In it he describes the huge problems Brasil is currently facing, such as the 10-15% decline from its existing production base of off-shore and deep water fields, the fact that these fields are known to peak faster than on-shore fields and do not plateau and that bringing these massive fields on stream can take years. This is not soon enough to cover Petrobras' projected production shortfall through 2013. Tupi will not make up for the declines and delays over the next five years.

    I do also agree with the other conclusions reached: that Petrobras is most likely to succeed in producing this oil. The bulk of its production lies off-shore and so there lies its area of expertise. And it certainly is a boon for the country as a whole and should do much to provide the government with new revenues if the oil can be exported. If Petrobras does indeed eventually export oil, could they become our new Mexico? Mexican production is crashing and net exports could be nothing by the time Tupi is just starting to produce 100k bbl/d. Perhaps the US has a reason to begin mending relations with Brasil and its new found growing oil wealth (discoveries will continue to be made in the Santos basin).

    Tupi and Kashagan provide two clear pieces of evidence that the easy-to-discover oil is gone. We now dig deeper, search in harsher environments and spend more money to find new sources of oil. In regards to climate change, this raises the question: Should we really be looking for more oil? If our options were mutually exclusive between choosing new oil (and natural gas) discoveries or, say, coal, then I would opt for the former. Today we have more climate friendly options such as conservation (simply eliminating waste would be a giant first step) and alternative energy development (wind, solar, tidal, geothermal, hydro). Is it moral to continue on our teleopathic quest of finding and exploiting the last drop of recoverable oil reserves, blindly ignoring the hazards of climate change that creep in from the sides? At times it may be, but we ought to generally choose a cleaner path.