U.S. Markets open in 9 hrs 8 mins

Are Silver, Oil, Housing Suffering From the Pain of Paying?

Daniel Gross
Fin - Daniel Gross - US

Macroeconomic data and sentiment may lie behind the recent slump in the market prices of silver, oil, and the continuing debacle that is the housing market. But mind games may be at work as well.

Behavioral economists like Dan Ariely, author of Predictably Irrational, call it the "pain of paying."

It's the psychological barrier that pops up when you have to part with your own hard-earned cash in order to obtain a product or service. I know some skinflints who seem to feel the pain as a physical stimulus. Of course, using other people's money — i.e. debt — tends to reduce the pain and put consumers in a more expansive mood. That makes sense. Debt is leverage, and leverage is the force that helps you lift more than you could — or would dare to — under your own power. Buy something with borrowed money — a house, a stock, a futures contract, a company — and you're more likely to pay the asking price because, at some level, you're not really treating that cash as your own. Thanks to limited liability corporations and the bankruptcy code, borrowers don't always feel the full pain of not paying back loans.

But just as the greater availability of credit tends to push prices upward, it stands to reason that a sudden lack of availability of credit would tend to push them down. Put another way, when you tell people that today they must pay a higher portion of the purchase price in cash than they had to yesterday, they may be less likely to bid aggressively.

That certainly seems to be playing out in the silver market. The price of silver has been soaring in recent months. But in the past several trading days, silver has fallen sharply off its peak. Why? Investors may have realized, en masse, that the recent rise wasn't sustainable. But it could also be because silver speculators have been forced to use more of their own money to play in the market. As Reuters reported on May 10:

"CME Group Inc raised margin requirements for the 5,000-ounce silver futures five times over a two-week period by a total of about 84 percent. The margin hikes, cited as one of the triggers for the broad-based rout in the commodities complex last week, sparked a slide in silver prices since touching a record high of $49.51 an ounce on April 28."

Before April 25, investors had to plunk down $8,700 to maintain a single contract. By May 9, the sum had risen to $16,000. As the cost of maintaining a bet on silver nearly doubled over a two-week period, the air came out of the market. Coincidence?

A similar dynamic has been seen in the oil market. Now, there are very good real-world reasons for the price of oil to be both high and volatile, ranging from tensions in the Middle East to the rapid increase in car ownership in China. But speculation also plays a role. And as in the silver market, the CME has tried to remove some froth by forcing those who wish to trade futures to, in effect, use less debt and more cash. On Monday, as Reuters reported, CME raised "the margin call for crude futures for the fourth time since February as price volatility soars." Since February, "the cumulative increase in margins on U.S. crude benchmark West Texas Intermediate CLc1 positions since February is 67 percent from $3,750 to $6,250 per contract." Could the requirements that oil speculators experience more pain of paying be one of the factors that has pushed oil from a recent high of $114 down to the high $98 today?

The housing market is similarly feeling the pain of paying. Housing was a market and asset class more dependent on margin buying than any other market or asset class. A typical stock investor doesn't use much margin debt. But a typical homeowner uses plenty of other people's money to make his housing investments. At the height of the boom you could easily borrow the entire purchase cost plus closing costs. But as anybody who has refinanced or tried to buy a home in the past few years knows, lenders are demanding significant down payments. In a shocking turn of events, it turns out banks want to lend against equity in the here and now, not against promised equity in the future. The upshot: compared with several years ago, homebuyers are much more likely to experience the pain of paying.

Take a look at Freddie Mac's first quarter results. Freddie Mac is really two companies: a reasonably decent, prudent mortgage-lending company founded in 2009 bolted on to the diabolically atrocious, reckless one that operated before 2009. A chart on page 7 shows the original loan-to-value ratios at which loans were extended in different years. In 2006 and 2007, the figures came in at 75 percent and 77 percent, respectively, much higher than the pre-2004 norm of 71 percent. After the bust, however, Freddie Mac began to demand that its borrowers put more of their own skin in the game. The original LTV ratio fell to 68 percent in 2009, and ticked up to 70 percent in 2010. Put another way, this giant lender is demanding that 10 percent more equity stand behind its loans than it did in 2007. That means homeowners and homebuyers must make more-sober decisions about refinancing and purchasing. The proof is in the numbers. It's in the early days, of course, but the serious delinquency rate for loans extended by Freddie Mac in the pain-of-paying era are quite low: .31 percent for 2009 and .07 percent for 2010.

As with oil and silver, higher margin requirements for establishing and maintaining positions is one of many factors weighing on the housing market.

Daniel Gross is economics editor at Yahoo! Finance

Subscribe to Daniel Gross's RSS feed here.

Follow him on Twitter: @grossdm. Email him at grossdaniel11@yahoo

You can find his columns here.