This article is kinda funny.... how could things like this have kept unnoticed for as long as a year!
Lots of comments and some are very good. One comment says: Charge her rent, or marry her? A tough decision... LOL!
Worriers are spoilt for choice at present. But there is probably nothing investors should worry about more than the future for US house prices. This applies even for those who live nowhere near the US.
The US housing market is wildly out of whack, with a huge overhang of 4.55m unsold houses. Data on Friday showed this backlog at a record level, which would take more than 11 months to clear if sold at a normal pace.
The median house price, according to government figures, is down 8 per cent from a year ago. The S&P Case-Shiller index, based on 20 large cities, suggests the problem is worse than this, with prices down 15 per cent in nominal terms since the peak in 2006.
There are various ways in which the market could return into balance. But what is most important is how prices adjust.
This may seem debatable. After all, lower prices should mean that more people can afford their own home. Another way to bring the market into balance, a slowdown in construction, would have nasty economic consequences of its own.
But prices are more important. This is firstly because of their impact on the economy. There is a debate over what economists call the “wealth effect” – the tendency of homeowners to spend more when they feel wealthier due to their extra wealth on paper. But when prices were going up, this effect looked substantial.
The dramatic rise in real house prices coincided with an epic collapse in US savings, as shown in the graphic. It reached the point where the savings rate became negative, so that Americans spent more than they earned.
It follows that the risk of a negative wealth effect is now quite severe. Consumer confidence surveys, showing sharp falls in recent months, confirm this.
Second, there is the impact on markets. Last year’s credit crisis was sparked by fears about defaults on subprime mortgages. As it dawned that many people had been given mortgages who could not afford them, the question arose of how many would eventually default. The ultimate damage that the financial sector will suffer, with all its knock-on effects for the global economy, appears to depend on US house prices.
According to Janet Yellen, governor of the San Francisco Federal Reserve, “the single most important determinant of the level and change in subprime delinquency rates has been the pace of house price changes”. The problem arose as prices stopped accelerating upwards and grew worse as prices fell.
Lower house prices tend to diminish the incentive for owners to attempt to hold on to their houses.
They become more likely to abandon the keys or to acquiesce to a foreclosure. This is most true if they have fallen into “negative equity”, where the value of the equity left in the house is less than the loan. And Americans’ percentage of equity in their homes has fallen below 50 per cent for the first time since 1945.
So it is reasonable to suggest that the ultimate default rate on the “toxic” debt instruments that have caused the problems in the credit market also depends on house prices.
This leads markets to a final, profound problem: unpredictability. Nobody has modelled the historical experience of default rates in response to negative equity, because there is no historical experience of it.
Similarly, there is no experience of national house prices falling so sharply in nominal terms.
Such evidence as there is suggests prices could fall further. If houses are valued as a multiple of the rent they would fetch (a version of a price/earnings multiple), they appear overvalued by 90 per cent compared with historic norms.
Much of the house price boom was based on buyers’ belief that such a fall was impossible. Ben Bernanke, Fed chairman, said in 2005 that the US had “never had a decline in housing prices on a nationwide basis”. Such a fall is under way.
Hence a national fall in nominal house prices is a perfect example of a “black swan” – an exceptional event that has not been covered in historically based models. Such events, widely discussed in recent months, can lead to extreme and unpredictable responses in financial markets.
The policy response adds a further dimension of uncertainty. There is a case for the US government to intervene to keep prices from falling too far. This would limit harm to society and to capital markets.
But any government intervention in a market’s natural clearing mechanism opens the risk of unpredictable distortions.
With no experience to fall back on, there are many ways in which the US might intervene. And, of course, the identity of the US president a year from now is uncertain.
Candidates have not even made up their own minds. John McCain, for example, ruled out any help for people who had “made bad decisions”, only to say just weeks later that his first priority was to keep “well-meaning, deserving homeowners who are facing foreclosure in their homes”.
It all adds up to parabolic uncertainty – the kind that markets find most difficult and that investors should find most worrying.
In nature, all kinds of phenomena – from the height of humans to the number of peas in a pod – follow this distribution. And the assumption that investment returns also follow a bell curve is the building block for a system which is central to the way fund managers approach risk. Known as "Value at Risk" or "VaR", all MBA students learn about it early on at business school. 