From Volume 4, Issue Number 52 of EIR Online, Published Dec. 27, 2005

World Economic News

PIMCO: U.S. Housing Bubble Will Deflate in 2006

U.S. housing bubble will deflate next year, according to PIMCO, the world's largest bond-trading fund, headquartered in California, in its December 2005 outlook on interest rates. A piece by PIMCO managing director Paul McCulley is entitled "MEW drag." He explains: "MEW is Mortgage Equity Withdrawal, which is Americans taking equity out of their homes by putting more debt on them. Or what I dubbed several years ago, turning the house into an ATM. Rightly or wrongly, most Americans look at MEW as the closest thing there is to a free lunch: home prices magically go up, generating unrealized capital gains, which can be magically monetized, if not realized, by borrowing against them."

Unfortunately, "MEW is very likely to decline, as the huge run-up in property prices of recent years" is coming to an end. Ever fewer people have "sufficient incomes to support the debt necessary to pay asking prices, particularly when mortgage interest rates rise." Therefore, "both volumes in total home sales, and MEW are set to fall sharply in the year ahead."

"That's what we expect in the year ahead. I would suggest that the downside for home price appreciation ... is particularly acute right here in California, where over 80% of new mortgages over the last year have been exotic creatures—interest only, pay option, and negative amortization concoctions."

Of course, "when the American property market comes off the boil, maybe turning tepid, the world will feel the impact, not just American homeowners," McCulley cautioned.

EU Budget Problems Remain After Late-Night Compromise

A late-night compromise Dec. 17-18 on the European Union budget will not solve its big economic and fiscal problems. The compromise implies that Britain's "special rebate" will be cut by 10.5 billion euros, over the 2007-2013 budget period, so that Britain will end up paying that much more into the budget.

The major continental countries, the biggest contributors to the EU budget, will also pay more, because the entire 2007-2013 budget will be 862 billion euros, instead of the 840-850 billion level at which they wanted it frozen. The original projection for a budget to fund all expenses, especially those for the 10 new Eastern members that joined in 2004, was 875 billion euros.

Further, Germany, the biggest single contributor (24.5%), agreed to a cut in EU funds for eastern Germany, in the range of EU100 million from 2006 on. Those funds will instead be paid to Poland.

None of this will solve the problem of the Maastricht system, namely that none of the bigger EU member-states will be able to meet the budget criteria in 2006 or 2007. Nor will they be able to easily pay their share of the budget, because their tax revenue base will continue to shrink, unless they launch a real economic recovery program—in defiance of Maastricht.

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