Talking (Fed) Heads

Watch out, You might get what you’re after
Cool babies, Strange but not a stranger

Hold tight wait till the party’s over
Hold tight we’re in for nasty weather
There has got to be a way
Burning down the house

No visible means of support and you have not seen nuthin’ yet
Everything’s stuck together
I don’t know what you expect staring into the tv set
Fighting fire with fire

From The Talking Heads - Burning Down the House - 1983

It's hard to imagine the Talking Heads being so prescient regarding Fed policy.

***

As all the world's financial markets await Thursday's appearance by Alan Greenspan before the Joint Economic Committee to discuss the outlook for the economy, let's review some recent Fed Head talk.

Last Wednesday, Dallas Fed Head Richard Fisher likened the current state of the rate raising cycle to the eighth inning of a baseball game.

"We're clearly in the eighth inning of a tightening cycle ... We have the ninth inning coming up at the end of June. I think there's room to tighten a little bit further, and then we'll see. We may have to go into extra innings in the contest against inflation."

Another Fed Bubble?

Shortly thereafter, clear signs could be seen of a new bubble forming - another bubble inadvertently created by the Federal Reserve. Since the baseball analogy was first used to describe monetary policy, there is now a speculative fever sweeping across all of the financial media. A mania where writers have taken advantage of the easy terms offered by the Dallas Fed chief, only to overextend themselves in leveraging this analogy.

Of all the risky bets made, this may be the most tortured - let's hope this bubble bursts quickly ... but not immediately.

Gramlich Catches Fisher Foul Ball

On Friday, Fed Governor Edward Gramlich refuted conclusions that the Fed would stop tightening, saying:

"I don't know what inning we're in, period. "

The Fed governor, who may get even more testy and say even more interesting things before he retires in August, also said he felt the United States had won price stability and would work to keep it.

"To me, that is the ultimate test of price stability -- do you think that $10,000 goes farther this year than it did five years ago? I would argue in that sense we have achieved price stability."

Well, you can certainly buy lots more DVD players with that $10,000 (actually 345 DVD players at $29 each), but you'll be disappointed how much less $10,000 gets you in tuition, medical bills, gasoline, or housing.

Greenspan Still Baffled by the Knuckleball

In China yesterday, Alan Greenspan once again admitted to being baffled by the long term interest rate "conundrum".

"The pronounced decline in U.S. Treasury long-term interest rates over the past year despite a 200-basis-point increase in our federal funds rate is clearly without recent precedent. The yield on ten-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago."

Unable to explain this unusual behavior, four possible causes of the conundrum were cited:

• Markets signaling economic weakness
• Pension fund buying
• Foreign purchase of U.S. Treasuries
• Excess global savings
  

Somehow, it doesn't seem that the low long term rates are really such a bad thing, at least for the next eight months, until Easy Al retires. Imagine what would happen to the real estate bubble if the ten-year note would have gone to over 6% instead of back down to 4%. With 30-year mortgages headed toward 8%, either home loans would have to get much more creative, or the entire economy would have a distinctly different feel right about now.

Before being praised, the nine thousand hedge funds currently competing for better return were identified as being susceptible to losses or worse:

"Consequently, after its recent very rapid advance, the hedge fund industry could temporarily shrink, and many wealthy fund managers and investors could become less wealthy. But so long as banks and other lenders to these ventures are managing their credit risks effectively, this necessary adjustment should not pose a threat to financial stability.

I trust such an episode would not induce us to lose sight of the very important contributions hedge funds and new financial products have made to financial stability by increasing market liquidity and spreading financial risk, and thereby enhancing economic flexibility and resilience."

Yes, all the spreading of risk and enhanced flexibility will work ... up to the point that it stops working. This offers little assurance:

"The economic and financial world is changing in ways that we still do not fully comprehend.

Policymakers need to be able to rely more on the markets' self-adjusting process and less on officials' uncertain forecasting capabilities. ... In this regard, the recent emergence of protectionism and the continued structural rigidities in many parts of the world are truly worrisome. In the end, I trust that we will all recognize our common interest in fostering global and domestic arrangements that promote the prosperity of our citizens."

So, if Asian currencies successfully unpeg from the dollar, and no trade wars break out, things should be OK. That is, the U.S. consumer and the rest of the world should be able to somehow handle the monstrous amount of U.S. dollar denominated debt that was created when the stock market went bust five years ago and a healthy recession was prevented from happening. When the biggest boom in history was followed by the shallowest recession in history, thanks to the creation of an even bigger boom based on more credit and debt ... and people’s homes.

Fighting fire with fire
Burning down the house

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An Appeal to Septuagenarians

As portions of the mainstream media continue to hammer away at unsound lending practices and other factors driving the speculative frenzy in today’s real estate market, senior citizens must look on in amazement at what young people are doing these days.

ABC World News Tonight ran two pieces in the past week about interest-only loans - one a South Park style commentary by Robert Krulwich, and another on Saturday night's broadcast by Gigi Stone and Mellody Hobson. Both segments were stern warnings about the perils that interest-only loans present to those who choose them - most strikingly, the danger of what happens if home prices go down as monthly payments rise.

A Look at the ABC News Reports

While the Krulwich piece was excellent - a dumbed down, very entertaining cartoon which really should have made the issues comprehensible to just about anyone - a search on the ABC News website was unsuccessful and Tivo obediently followed prior instructions to jettison this program to make room for new ones. So, unfortunately, this segment is now just a memory.

The Saturday night piece was aired in two segments, with the first segment Home-Ownership Boom Fuels Risky Loans available online. During the second segment, anchor Dan Harris interviewed ABC News Financial Contributor Mellody Hobson - it is provided here:

Harris: Let me ask you your take. Are these ever a good idea, these loans?

Hobson: I actually don't think they are a good idea. One of the things to keep in mind is you're not building up any equity during the interest only period, which isn't great. It's like having a credit card where you only pay the minimum balance, but in this situation, none of the money goes to principle. More importantly, I'm really concerned that people are stretching, buying way more house than they can afford. In the beginning the payments are very small, they look very affordable and attractive, but within three to five years, those payments jump dramatically, in many cases doubling. And it scares me, because I think in a few years, people are going to be looking at foreclosures.

Harris: Do you think lenders are being irresponsible pushing these products on people?

Hobson: I think lenders are giving customers what they want. But I think they're doing it in a very aggressive way.

Harris: So, for customers who want to buy a house and don't have that much money are there alternative loans that they should be looking at?

Hobson: The best alternative is a traditional 30-year fixed rate mortgage. Right now you can get it for 5.62%. A year ago that number was 6.28%. If you can't afford a house at this interest rate, you can’t afford a house. But before you get discouraged, keep in mind that renting, in many parts of this country, is the more compelling value because housing sales have been so red-hot.

Harris: In other words, buy what you can afford.

Hobson: That's right.

Well, it seems that Mellody has hit the nail squarely on the head - "payments jump dramatically", "looking at foreclosures", "renting ... is a more compelling value". And we can only hope that, in the first segment, the exhilaration of the calculated risk made by Emily and Marc Duffy doesn't turn out to be just an ill-advised gamble at the peak of a speculative bubble, where, in a few years they find themselves upside down in their dream condo, as their monthly payment ratchets upward.

They may look back and wish they had been content to rent, as Mellody advises.

Then again, their $300,000 condo may be worth $600,000 in a few years, and they will look back at their calculated risk and marvel at how astute they were.

We'll see.

Did the right people see these?

Looking at some of the demographic data for network news broadcasts, one finds that the median age of network news viewers is around 60. Not surprisingly, the thirtysomethings who seem to dominate anecdotal accounts of the current real estate mania seem to prefer Cable TV News to Nightly Network News by roughly a three-to-one margin. And then of course there is the internet, offering such fare as this [in defense of the Monaco Corporation, while they do claim to be a "solutions-based firm", they don't claim that these are "good solutions", just solutions].

So, the answer is probably no - the people who would most benefit from seeing these segments on ABC World News Tonight, probably did not see them.

What is ABC's Motivation?

So what's the motivation on the part of ABC News to air warnings such as these? Surely they know their own demographics. While there may be some sixty year olds taking out interest only loans, they likely make up only a tiny portion of the total.

This can be nothing other than an appeal by ABC News to septuagenarians all across the country to protect the younger generations from themselves. It is clear that the banking industry, the government, and most importantly the banking regulators, are doing little in this regard.

ABC News is kindly urging grandparents to get on the phone and call their children and grandchildren. To relate to them stories of a different era, when real estate purchases required 20% down payments and 30-year fixed loans - when prices didn’t double every three years - when homeowners didn't borrow against their home to buy boats and jet skis and granite countertops.

Perhaps, the eighty year olds will relate what it was like being a teenager during the Great Depression - when people who were lucky enough to have a job saved money, but didn't trust the banks.

Maybe the septuagenarians can do the work of the banking regulators.

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Kudlow and the Jobs Report

The May jobs report just came in at +78,000. While manufacturing had a slight decline, education/health services and construction were the big gainers. As you might expect, this was viewed as a good number by the folks at CNBC - Larry Kudlow was crowing about non-inflationary growth, a Goldilocks economy, and how the Fed has so marvelously done their job of stimulating growth and fighting inflation.

Let's go to Larry's latest articles over at the National Review for the supporting analysis of this now ever-present non-inflationary growth theme.

In More Non-Inflationary Prosperity, we learn that, despite what you may find at the grocery store, at the gas pump, or at your local housing development, there really is very little inflation:

Core inflation is still tame, rising at 1.6 percent over the past year, about the same as the second half of last year and actually slower than in 2002. The gold price, at $418, is consistent with less-than 2 percent underlying inflation.

As we all know, core inflation doesn't count food or gas - what it does count is cheap imported goods from Asia and housing rental costs that are stable, now that anyone who can fog a mirror can buy a house. So, while core inflation may be 1.6 percent, this really has very little to do with what people actually pay for things that don't come from China.


Apparently, the plan is that as long as people are "house rich", they won't notice food and gas prices - oil just doesn't seem to want to go down, does it?

The Federal Reserve has restrained inflation expectations, and as a result long rates have descended even while short rates have moved higher. That’s a nice piece of work.

Wow! Where do you start with this one? Long rates are the "conundrum", remember? So, a conundrum is now a nice piece of work? Hey Al, nice conundrum!

Actually, we are looking at non-inflationary prosperity for several more years to come. This is a good stock market scenario where the broad indices still look to be 20 to 25 percent undervalued. In policy terms the Fed has done its job by restraining inflation and President Bush’s supply-side tax cuts have reignited economic growth. The results are unmistakably positive.

Why stop at several more years? And why stop at 20 to 25 percent undervalued? Shoot for the stars! If you read this paragraph over and over, it just sounds loonier and loonier.

In Striking Out Inflation, after ogling the new Fed Head in Dallas, and falling all over himself in praising the new Fed Head's brilliant baseball analogy, Larry gets back to the non-inflationary growth theme:

Market price signals are forecasting continued economic expansion with low inflation. Exactly what Greenspan & Co. desire. In effect, the Fed has reigned in the money supply to curb inflation fears, while the supply-side tax cuts put in place two years ago continue to provide economic growth incentives.

Well, not quite - the mortgage backed securities market (whose money doesn't show up in the money supply numbers) is now completely out of control, and the populace is so drunk with home equity "wealth", that the notion of low inflation growth is really a grotesque distortion of the economy as we knew it just a few years ago. But, apparently, if you can point to a positive GDP number, a tame money supply number, and a bogus inflation number, you can declare victory.

It’s likely that Dick Fisher, who’s no gun-slinging hip-shooter, is reflecting a sub rosa buzz inside the Federal Reserve System. The buzz is that the Fed has succeeded in holding down inflation and that the tightening cycle is coming to an end.

Well, we did learn something from Larry here - sub rosa - private - it wasn't a complete waste of time.

It’s too early to expect a formal policy comment to this effect. But it’s clear there’s a considered view within the central bank that economic and inflationary conditions are far better than the predictably dour and declinist mainstream media would have us believe.

Oh no - is there another Federal Reserve victory lap coming?

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Money Magazine Does Real Estate

Despite the best efforts of the Federal Reserve in their recent campaign to sound the alarm about potential problems with today's real estate market and lending practices, it may all be just wasted breath. They are up against a force much more powerful than even they can imagine - Money Magazine.

The June "Your Home" special issue of Money Magazine is a powerful tour de force in mainstream financial media propaganda - something that everyone should study carefully then place in a baggie and store in a safe place. Many years from now, they can show their grandchildren and great grandchildren.

Fortunately for our purposes here, most of the articles in this issue are available online - today we take a closer look.

Zell: No Bubble Here

Setting the tone for what is to follow, as if to first cleanse the palate, an unabashadely bullish condo-converter clears the air about all this housing bubble nonsense.

A bubble by definition goes poof -- the way so many tech stocks did in 2000 -- and there's no value left.

OK, Zell, pick up a newspaper - the definition of "bubble" is being stretched so we don't have to call it the housing "balloon".

Worst-case scenario? A flat housing market. Look, all I can tell you is we're the largest owner of apartments in the U.S. and among the largest converters of apartments to condos. If there was a danger of a bubble, would we be in this business?

If there was a danger of a bubble would I be stupid enough to tell you? I've got overpriced condo conversions I'm trying to unload.

Sivy on Real Estate - Confessions of a Market Timer

I've read Sivy on stocks, why must Sivy also be on real estate?

"... why not sell when prices are high and invest the money ... I got such an opportunity six and a half years ago, when I decided to sell my co-op apartment because I thought Manhattan real estate prices were close to a peak."

You sold in 1998. No one should listen to anything you have to say ... ever.

Boomtown USA

This is, without a doubt, the signature article for this issue and perhaps for the entire early 21st century housing mania - the smiling Rothschilds grace the cover, and though they may not realize it, they may be immortalized for this appearance on the cover, so near the peak of the bubble. Providing excerpts from this masterpiece really does not do it justice - it must be read in its entirety, preferably with a stiff drink and some powerful sedatives.

Here is some advice for the people interviewed:

• Kelly Pearson - Yes, the possibilities in San Diego are unreal. Things that are unreal have a way of becoming real, sometimes real fast.
• Manuel and Eva Altamirano - Leave your equity alone. If it will help, convert $10,000 of your home equity into $1 bills. Whenever you get the urge to roll over your equity, get out all the $1 bills, spread them all over your bedroom, and roll around in them.
• Ryan and Laura Rothschild (pictured on the cover) - You spent $850,000 upgrading your home - someday, you may wish you had the $850,000 and the pile of dirt, instead of the ceiling beams and the lovely garden.
• Angie and Ted Carter-Donovan - Ted, you better get control of that wife of yours - now everyone thinks your last name is hyphenated.
• Michael and Cheryl Roberts - Wow! Five people in 2650 square feet - you poor things! You're only up $1.4 million and you don't like the $6 million tear down - life just isn't fair.
• Jerry and Laura Satran - There for a minute, it looked like this might end on a somber note. Well, actually ... if you consider how many condo conversion down payments you could squeeze out of that extra $100,000 they didn't get, that is kind of sad.

What's great about this article is that not only do the six success stories dwarf the single cautionary note in size, but the cautionary note is sandwiched in between them, so the reader goes away feeling good.

OK, one quote. This piece includes what has to be one of the best housing bubble rationalizations ever:

These days, everybody knows someone who has made money in real estate, and rising prices have become a national preoccupation. We are a wealthier country than we have ever been, so it makes sense that we would spend more on real estate, pushing prices to new highs.

Somebody, get me a bucket!

Are Home Prices Really So Crazy?

This argument, wholly unsound as it is, appears with greater frequency as the weeks go by. The clear message is that you've got lots of time - think how many houses you can buy and sell in three years.

After all, Federal Reserve chief Alan Greenspan complained of "irrational exuberance" in 1996, more than three years before the stock boom ended in tears.

Just when it looked like they were starting to give some good advice, out comes this subterfuge:

"We normally recommend getting as much of a line of credit as you can, but then to sit on it," says Mark Gleason, a Burbank, Calif. financial planner.

That's not to say you can't use your home's value to improve your and your children's standard of living. Most planners say using equity to help fund college is a reasonable choice.

And about 12 percent of readers in our survey said they were using cash from their equity to buy other real estate. This too can make sense -- a vacation home is something you can enjoy now and an asset that can grow in value.

You see, they may say "sit on it", "fund college", and "vacation home", but when the neighbors are driving their Hummers to Arizona to buy investment property, good intentions can quickly be forgotten - once the paperwork is signed, that $200,000 line of credit starts calling like a lonely sea maiden on a rocky coast, luring the unwitting sailor closer to shore.

The 100 Major Markets

Gee, I wonder what Money Magazine forecasters where predicting for stocks in early 2000? Perhaps a slow-down in the rate of growth?

The Miracle Mortgage

Has anyone else noticed that nearly every participant in the housing bubble is in their thirties? Except, of course Ted, with the hyphenated last name - he let his wife do all the talking.

Like the Berniers, tens of thousands of Americans have recently discovered the power of paying nothing but interest on their home loans.

Yes, that's power - when the lifestyle doesn't match the income, what do you do? The answer is obvious if you are 36 or 37 years old.

The appeal is easy to understand: When you don't pay down principal, you can save hundreds, even thousands, of dollars a month. Interest-only payments let you shoulder a bigger mortgage and buy a home you might not otherwise be able to afford. Or you can use the extra cash to pay down debts or fund a child's education.

Again with the subterfuge - this is all so sick and twisted. An entire generation of Money Magazine reading thirtysomethings now think that this is how the world really works! Not paying principal is "saving" money and it's OK to buy a home you can't afford!

By the way, who's writing the headlines for Money Magazine stories these days and just how effective is this variety of mind control? Nowhere else in this article is the word "miracle" used. In fact they provide a few sound cautionary notes, but a few glances at the bold headline and the smiling couple, and interest-only loans seem pretty harmless.

No Money Down Mania

OK folks, here it is. This is the real danger in today's real estate market - it's these get-rich-quick gurus that are the ones that everyone has to look out for. It seems all so logical (and sick and twisted), to close this special edition with this article.

Imagine your average Money Magazine reader who may have heard "housing bubble" a few times on the evening news recently. This reader can carefully study this issue, and conclude for himself that the real danger in the real estate market today is these hucksters who are charging people exorbitant amounts of money for their get-rich-quick real estate seminars, with no guarantee of results.

If a friend tips you off to some investment property in Vegas, then hooks you up with a Realtor who is a friend of a friend, and you can get a deal done, well, that's OK.

But don't pay good money to attend one of these seminars!

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The Wealth Effect on Steroids

Driving north from Los Angeles over the Memorial Day weekend, it was hard not to notice the wealth effect created by the California housing boom. Home equity "extraction", made ever easier by competing lenders via lines of credit and cash-out refinancing, has enabled an entire generation of homeowners to spend money like their parents never dreamed - all thanks to the rising value of their homes.

The phrase "wealth effect" was heard frequently in the late 1990s when companies like Cisco where flying high. Then, long time Cisco shareholders could sell some stock, pay a little tax, then go out and buy something nice. Or, maybe they would just take some money out of that boring savings account and spend it instead - better to stay "invested".

The wealth effect has been a great driver of personal consumption in the U.S. over the last ten years, and personal consumption has been a great driver of U.S. growth. In fact, consumption makes up an ever increasing share of U.S. GDP - a GDP that is closely watched by the rest of the world.

At this point, policy makers must have concluded that growth by any means is good growth - that somehow increased consumption, based on increased home equity "extraction" is a good thing.

[The term "extraction" when used with home equity has always been bothersome.
Its common usage related to a dental procedure gives it a connotation of removing something that shouldn't be there - this is precisely the opposite of the historical role of home equity, as something that should be there. ]

The Wealth Effect on Display

On the drive north, the beneficiaries of the wealth effect are very conspicuous. One after another - young men with their families in large new trucks - towing boats, all-terrain-vehicles, and jet-skis. All seemingly brand new. Some of the trailers piled so high with shiny toys that they look dangerous - better not to follow too closely.

Monstrous quad cabs with full length beds, camper shells, and huge tires - no chance of this fitting into a standard size garage - the bigger the better ... some adorned with bumper stickers saying things like "God Bless America".

How do these thirty-somethings afford all of these expensive toys?

It was hard not to notice all the new malls popping up too. Outlet stores and large outdoor malls with huge signs - a vast array of choices from which the consumer can choose. All clean and fresh. Pleasant pastel colors, in stark contrast to much of the surroundings - crumbling buildings far off in the distance and roads that seem to be in greater disrepair by the day.

In the most recently constructed malls, there seems to be a new trend - one-stop shopping for homebuyers. Lined up in consecutive suites one finds a Realtor, then a home loan company, then an escrow company - from left to right, easy to follow. This allows consumers to more easily purchase homes, which allows the existing housing stock to more easily rise in value, which facilitates more consumption due to rising home equity, which enables the building of more malls.

A virtuous circle!

And the billboards. After passing the giant IKEA distribution center, a regular pattern of billboards emerged. Billboards provide a pretty good insight into what drives the local economy. In this case it was clear - billboards for homebuilders, Realtors, home loans, and Indian casinos. Then another homebuilder, another Realtor, another home loan company, and another casino.

When you think about it, today, these go together quite well.

So what about the steroids?

The world doesn't normally work this way - people, by the millions, do not just find hundreds of thousands of dollars on the sidewalk, pick it up, and spend it.

Just like baseball players don't normally hit as many home runs as they have in recent years, homeowners don't normally spend as much money as they have in recent years - they don't improve their lifestyles in such an extreme manner without some outside assistance. Sure, federal agencies have recently issued new guidelines for home equity lending, but the horse has long since left the barn - home equity withdrawal, like steroids in baseball, has become ingrained in the culture.

People now believe that this is the way the world works - that somehow they are special - that they are deserving.

Like steroids, home equity withdrawal is part of a much bigger system that has evolved over a period of years. Most everyone involved has been increasingly delighted with the results to date, but there is a growing awareness that something is not right.

Just like the sluggers who broke all the home run records needed some help, the young men towing shiny new toys behind big new trucks have needed help too.

Let's hope that fixing the looming problems caused by home equity "extraction" goes as smoothly as fixing the problem of steroids in baseball.

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