Housing Bubble Angst

Last night on Ben Jones' excellent Housing Bubble Blog, a very interesting series of posts were made. While the commentary was lively, there was a very clear and recurring sense of angst - just what type of person would be feeling anxious, or uncomfortable in any way, while in the midst of unprecedented increases in personal wealth, largely as result of rising real estate prices?

Some people may feel this way because they have never owned a home and are currently renting - they now find themselves priced out of their desired market, and deem this to be unfair. Had they been born a few years earlier or married sooner, they would have been able to purchase a home at a reasonable price and would be well on their way to amassing a great fortune - maybe they would have been able to "trade up" by now, and instead of being on the outside looking in, they'd be enjoying truly spectacular digs. It seems timing has become increasingly important to every individual's financial success in life - much more so than a few generations ago.

Or, perhaps they are renters who some time ago sold their home with the intention of buying again "after the crash", and they are now perplexed by both the continued price escalation and general insanity of it all - growing impatient with the pace at which real estate prices make their inevitable return toward long established trendlines. They feel that they understood things that others did not and due to this superior reasoning ability, they took action - but they are now restless, waiting for their shrewd wager to pay off.

Perhaps they are homeowners who have dramatically improved their standard of living as a result of the equity "built up" in their home over the last few years - never has it been so easy to "build" anything before ... truly a "lazy man's way to riches". They wonder if maybe they have "tapped" too much of this equity - if maybe they have been fooled in some way ... duped into spending money which they shouldn't have. The thrill of the purchases having long since passed, the debt remains, and it becomes more costly to service as the months go by.

Perhaps they are homeowners who have acted responsibly over the last few years - they have resisted the temptation to spend their home equity to purchase things that their grandparents would surely consider foolish. But, somehow they feel left out - there is an apparent "standard of living gap" between they and others of similar means. They look around and wonder what exactly is going on with home prices, and they search for explanations for why people are behaving as they are.

A common thread for all these people is an underlying sense that something is wrong - something is very wrong with the way homes are bought and sold today. It didn't used to be this way - what has happened in the five years since the Nasdaq bubble burst? How can things go on like this and what happens if they stop going on like this?

In the coming months and years, more people will take notice, and more people will search for explanations for what they see happening around them - and there will be a lot more angst.

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Another Interpretation

One of the mainstream financial websites interpreted the statement from last week's Fed policy meeting. Here's a less politically correct interpretation from the point of view of the author:

Release Date: March 22, 2005

For immediate release

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 2-3/4 percent.

A surprise move of 50 basis points might bring down the whole house of cards - as long as the house is still standing, there's no need to do anything rash. We're hoping we can get far enough into the rate raising cycle so that we can make a surprise move or two back down (hopefully, after I retire).

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.

Yes, after several years of negative real interest rates, we're still calling it "accommodative" - others might call it "reckless", "irresponsible", or "running out the clock until I retire", but we'll keep calling it "accommodative". As for productivity, you know, we've gotten so much mileage out of this "productivity" angle, there really is no reason to stop using it now - it's like, we can use "productivity" to explain just about anything.

Output evidently continues to grow at a solid pace despite the rise in energy prices, and labor market conditions continue to improve gradually.

We're going to use the word "evidently" here because we don't really know - none of our models seem to work anymore. We hear good things we hear bad things ... we think it's growing.

Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident. The rise in energy prices, however, has not notably fed through to core consumer prices.

Of course these are MY expectations of longer-term inflation - I'm 79 and I'm retiring in less than a year - your time horizon may be different ... good luck with that. Now, we have to be very careful with this next part - this $55 oil has kind of forced my hand. We have to acknowledge rising prices somehow - I don't think people are buying our 2-3% CPI numbers with what they see in house prices, gas prices, and such. We don't want to get everyone too excited - even just mentioning the "I" word, everyone's going to be saying "The Fed's worried about inflation, the Fed's worried about inflation", and the currency and bond markets are going to go crazy, and who knows what else ... I know ... I'll get the "I" word out on the table, then talk about "pricing power" (good for business, good for the bottom line), then kind of dismiss it by saying that you, as the consumer, do not have to be concerned because it will not be fed through to you - it will have no affect on your life - just keep on doing what you were doing, secure in the knowledge that long-term inflation expectations are well contained.

The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal.

Now when we say "sustainable growth", keep in mind, I'm retiring in less than a year. We've had to print lots of money and create lots of credit just to get this far, and millions of people are in debt way over their heads, but it has produced growth. And, as for price stability, it is entirely possible that we will have to find new, creative ways to calculate consumer prices, so that we can ensure that prices remain stable - maybe if the housing bubble bursts, millions get foreclosed on, and have to rent homes, thus forcing rental prices up - then we'll start using actual house prices in the CPI calculation instead of imputed rent, and this will offset $5 per gallon gas ... well hopefully, this will be Bernanke's problem.

With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.

Yes, inflation is contained, long-term inflation, underlying inflation, it's all contained - no problems here, go on about your business. Measured? Measured? That blasted word - why did I ever use that word? How am I ever going to get rid of it? Let's see, how many more Fed meetings? Can I just keep using that word at every meeting until I retire? I keep getting the feeling that if I stop saying "measured", life as we know it will come to an abrupt end.

Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

What this means is that if things start falling apart between now and when I retire, I can call Cheney and ask him to start bombing somebody - he owes me BIG time. Then I can yell "deflation" and cut rates to zero - this should allow everyone to refinance again, and this should get us through to next January.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.

It's unanimous!

In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 3-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, and San Francisco.

Who cares?

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Two Very Different Views

Say what you will about the New York Times and Los Angeles Times, but they certainly seem to be a lot more concerned about the rapidly approaching iceberg, than is a mainstream financial publication such as BusinessWeek. After a weekend full of hair raising real estate stories in the L.A. Times (Putting Stock in Property, More Than Miles Apart, Doubt is Cast on Loan Papers) and a terrifying piece about hedge funds from the N.Y. Times (If I Only Had a Hedge Fund), it was quite comforting to pick up the latest BusinessWeek and have Cooper and Madigan soothe some rattled nerves once again regarding the state of the US economy (Inflation is Back on the Radar - if you can't get to this article, just read anything by either one of these two - it all sounds the same.

The L.A.Times articles raise some real concerns, what with native Chris Boone selling his mutual funds to buy land he's never seen in far away Nevada, and Erik Mellquist's parents calling him 'stupid' for paying $284,000 for a rundown, 1,000-square-foot condo with no garage. Then we find that Ameriquest is once again accused of duping their sub-prime clientele - this time accused by Linda Hubbard and others, of forging financial statements and rigging appraisals to assist these people in going into debt way over their heads while refinancing. And, to top it all off, just when we thought we might hear some comforting words from the hedge fund community, Seth Klarman, founder of the Baupost Group, which manages $5 billion, makes this prediction "It is completely obvious that this will end badly -- for the firms, investors, everyone".

Well, thank goodness there's BusinessWeek with it's team of James C. Cooper and Kathleen Madigan and their take on the U.S. Economy - just listen ... in fact, after those Times articles, you should read this out loud ... several times:

Right now financial conditions are extremely accommodative. Not surprisingly, the U.S. economy is simmering along nicely, as consumers and businesses boost their spending.

Yes! The sky is clearing ... feeling better already ... continue please ...

But one result of solid growth is that inflationary pressures are building as businesses face rising costs ... For the first time in years, inflation is officially back on the Fed's radar ... Unless financial conditions are cooled off soon, strong demand will continue to use up whatever slack is left in both the labor markets and production capacity.

"On the radar", "using up slack" ... feeling has returned to all extremeties ... a wonderful recovery, but there is still the question of real estate ... Jim? Kathy? ... drive it home ...

Because mortgage rates are hovering near 6%, buyers still have leeway to bid up home prices. Rising real estate values have pumped up household wealth, leading to more consumer spending. Plus, cheap mortgages enable homeowners to tap into housing wealth through refinancings and home-equity loans. Mortgage rates would have to rise by a substantial amount, probably hitting close to 7%, before consumers stop using their homes to finance current spending.

Ah ... now it is all clear ... Greenspan and the Federal Reserve have help in shaping the perceptions of the world in which we live. While some see rampant speculation and wreckless lending, others see "leeway to bid up home prices". Hmm... I wonder if there any other publications out there that see the world like Jim and Kathy do ... or better yet, TV shows!

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Tangier Punch

Ah ... memories of the Nasdaq bubble. A great article from the Telegraph in the U.K. from a couple weeks ago - Greenspan Should Have Removed the Punch Bowl. It is interesting in many ways - first, the author should be given credit for having written this article at all, and in so doing, connecting a whole bunch of dots. Many of the 2000/2005 parallels seem obvious, but one look at today's real estate market would lead you to believe that not enough people are paying attention. What is most interesting about the article is that when talking about the Nasdaq bubble, Mr. Siklos uses words like "alarm", "bubble", and "sell-off", then cites comparisons to the South Sea Bubble era regarding the VA Linux IPO:

"The warning language I've just read is at least an improvement in disclosure compared to the classic prospectus of the South Sea Bubble era, in which someone offered shares in 'a company for carrying on an undertaking of great advantage, but nobody to know what it is'. But, I wonder whether the spirit of the times isn't becoming similar to that of the earlier period."

But, when talking about today's odd happenings in the world of real estate and international trade, he opts for the more demure "curious", "strange", and "fret":

A couple of the after-effects of the bubble's end remain curious. One is that it did not lead to any significant or lasting economic malaise in the US - even after the double-whammy of the September 2001 terrorist attacks. Rather, there was a slight recession and a slow recovery.

Although some economists now fret about the declining dollar the way they used to about soaring dotcoms, America's mood remains strangely upbeat.

It's as if, just for a moment, he was thinking about shouting something at the top of his lungs, then thought better of it, and instead simply pointed to poor Bernie Ebbers as a sign that maybe it really is different this time.

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It Didn't Have To Be This Way

An appropriate first post - Stephen Roach hits another home run with his latest missive The Test. The last paragraph serves as an excellent premise for this blog:

"It didn’t have to be this way. The big mistake, in my view, came when the Fed condoned the equity bubble in the late 1990s. It has been playing post-bubble defense ever since, fostering an unusually low real interest rate climate that has led to one bubble after another. And that has given rise to the real monster -- the asset-dependent American consumer and a co-dependent global economy that can’t live without excess US consumption. The real test was always the exit strategy."

Yes, it's easy on the way up. Ever increasing liquidity to meet every emerging problem and everyone gets rich - not rich in the old sense, of course, with higher real income and savings, but through higher asset prices for stocks and homes.

"Asset markets around the world are now quivering at just the hint of an unwinding of this house of cards. And they quiver with the real federal funds rate barely above zero. What happens to these markets and to an asset-dependent US economy should the Fed actually complete its nasty task of taking its policy rate into the restrictive zone? "

All aquiver, that's right. Paul Volker must be so proud of his successor ... about to bring down the whole house of cards with quarter point increases to the Fed Funds rate in the low single digits.

"I still don’t think America’s central bank is up to the task at hand. In the face of disruptive markets or growth disappointments, this Fed has repeatedly opted to err on the side of accommodation. I suspect that deep in its heart, the Federal Reserve knows what’s at stake for the US -- and for the world -- if the asset-dependent American consumer were to throw in the towel. "

This is my central belief on this issue, and the motivation for this blog - that given the choice of some economic pain and a long slow death by inflation, the Fed will opt for the latter. It will never be able to raise interest rates like Paul Volker did, in order to put this fiat currency system back on a track that is sustainable for another generation or two - instead, we will continue to swim out to the deep water and hope for the best.

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