London Bombings

No post today - too much awful news from London.
Your best online news source today is probably BBC News.
Also, see Guardian Unlimited and TimesOnline.
General Glut has some comments here.

Sorry there's nothing here - I haven't yet figured out how to selectively turn on and off the "Continue reading" thingy.

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We'll Need Helmets, not Hairshirts

The mainstream financial media is increasingly questioning Federal Reserve monetary policy in light of the now almost universally acknowledged housing bubble, mammoth trade deficit, and various other related imbalances in the global economy.

The developing pattern of discussion about monetary policy is eerily reminiscent of the early stages of the discussion about the housing bubble, which seemed to progress through three stages:

1. Lots of talk about whether or not a problem exists
2. General acceptance that there really is a problem
3. Predicting how unpleasant things might get
   

While the housing bubble discussion is now clearly entering stage three, discussion of monetary policy seems to have entered phase one.

Wall Street Journal

A few weeks back Greg Ip of the Wall Street Journal noted that since the stock bubble burst in 2000, and after three years of super-low interest rates and lending standards, Americans have borrowed and spent like never before, creating a self-reinforcing housing boom which has added nicely to both growth and employment statistics. With the debt and current account statistics even more impressive than either growth or employment, Greg wonders how things will ever get back to normal:

"How that will happen puts the nation in uncharted territory: After treating a bubble, how does the Fed manage the side effects of its medicine?"

The phrase "uncharted territory" seems to be popping up all over the place these days - Mr. Greenspan has used this term during recent congressional testimony and Fed Governor Kohn also seems to be fond of it.

In this same article, in what is destined to be a classic analogy for this era, a former Fed governor expands on the uncharted territory theme:

"We have done what no other economy has done before, faced with an asset bubble," Lawrence Lindsey, a former Fed governor and Bush adviser, said at a recent panel discussion. Praising both the Fed's rate cuts and Mr. Bush's tax cuts, he said, "This is the first time in history the textbook economic policy... was used, and worked. The problem is, once you finish that chapter of the economic texts, you turn the page and the page is blank -- because no one has gone through the process before."

The textbook that Mr. Lindsey is of course referring to is the one that was written after the Great Depression. The one that says, if we are ever dumb enough to create another asset bubble like the one that preceded the Great Depression, let's inject enough money and credit into the system to make the magnitude of the bust much smaller than the magnitude of the boom.

That's where the textbook ends ... that's where we are today.

BusinessWeek

Then last week, Chris Farrell at BusinessWeek penned Alan Greenspan: Wizard or Villian?, in which he apparently decided that the best defense was a good offense - that "hairshirt" economics, responsible for the extended pain and suffering of the Great Depression, should be acknowledged then again discredited, lest this thinking work its way back into mainstream economics.

[Now, admittedly, "villain" is a hard word to spell correctly, but you'd think that someone would have hit the spell check button at some point in the process of publishing this article. Newsflash - 8/19/05 - the spelling has been corrected]

Greenspan-bashing is now a popular sport among the Masters of the Universe. One reason is that the 10-year economic expansion came to an end with the dot-com bust and subsequent recession. Another is that Greenspan's standing as the Monetary Maestro was overhyped during the halcyon days of the 1990s. And the third is that his fallibility as a central banker was overemphasized during the difficult economy of the early 2000s. Indeed, the chairman has never recovered his lost luster.

Still, Greenspan's most vehement critics go a lot further than this. They're convinced he has made a fundamental error as a monetary economist. Call it the hairshirt economists vs. the cheerleaders for growth-is-good. The hairshirts believe that for the health of the economy to be restored, the inevitable bust that follows a boom must be at least as great as the boom. Growth proponents -- and there's none greater than Greenspan -- believe that it's better to limit the fallout of a bust and get the economy growing again as quickly as possible.

So, here's one of the many people in the world who think that the biggest stock market boom in history is logically followed by the shallowest recession in recent history - that more easy money is the solution to all problems, even if these problems were caused by easy money.

Lunches really can be free and perpetual motion machines do exist.

While it seems to have worked this way for a while, it is not likely to work this way forever. When this theory was adopted, the U.S. was an emerging economy on the gold standard. Today we are an aging economy with a fiat currency - with a government that has made promises that it can't keep, while at the same time engaging in wars it can't pay for and assuring its populace that its standard of living will endure.

In fact, the real possibility that this is a fundamentally flawed theory that is looking more fundamentally flawed every day, is quite possibly why more and more economists seem to doubting the chief economist, Mr. Greenspan.

Look, Greenspan is no economic wizard, and this isn't a brief to defend him. He has made his share of mistakes, although fewer than many of his predecessors. But what should be defended is the economics of growth. Remember, not all price increases are bubbles, booms are better than busts, and growth is not only good -- it's vital.

So, a growth-is-good cheerleader, knowing full well that the head cheerleader is perplexed by the situation in which he finds himself, pleads for more growth - to just pump more money into the system.

It's always worked before - anything but hairshirts.

Like the housing bubble a year or two ago, the monetary policy problem is now being talked about a lot - clearly we are in stage one of the process outlined earlier. When monetary policy becomes generally accepted as being a problem, we will have progressed to stage two, at which time a few people may begin speculating about how unpleasant things might get.

Then many will realize that ... we'll need helmets, not hairshirts.

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From Boston to Baltimore

If you live in Baltimore, Maryland and are considering purchasing real estate in that area, and if you happened to catch last Thursday's ABCNews Nightline about the real estate boom, how might that influence your real estate purchase decision making process?

The Nightline piece began:

Tonight on Nightline, the red-hot real estate market goes worldwide. From Baltimore to the Balkans, it seems everyone is playing, but not everyone is winning. Is it a bubble that's beginning to leak?

This may have come as a shock to people living in Baltimore - maybe the first time that "Baltimore" and "bubble" were heard in the same sentence.

There were a total of four segments in all. First the New Hampshire real estate market, then another excellent animation about mortgage lending by Robert Krulwich, a look at how the British are buying Bulgarian real estate, and finally this segment about the Baltimore real estate market:

Chris Bury: We once thought of buying a home as a long-term investment. Now many see it as a short-term gold mine. But can this housing craze lead to real economic revival in some of our toughest neighborhoods? We found an example very close to here, less than forty miles up the road, in Baltimore, Maryland.

[Voice of auctioneer]

Chris Bury: In Baltimore, the bidding at real estate auctions has been this fast and furious for nearly a year. On this day, auctioneer Paul Cooper sells 25 properties in less than three hours. Prices from $50,000 to $450,000. Many of the buyers come from out of town. They're smelling bargains and sensing a revival in the city on the rebound.

Bostoner #1: I'm from Boston and I came to Baltimore because I heard so much about the properties.

Bostoner #2: I went there looking for another investment property, and we found it. We ended up paying below our expectations.

Auctioneer: A lot of the out-of-towners have an insatiable appetite. They're just coming down here, they're buying, they're doing renovations ...

That's right, Baltimore is a new real estate hot spot. New Englanders are coming south to help revitalize neighborhoods in Baltimore - investing in the future of a once great city that has had some hard times lately. The city officials see the goodness in all of this - homes in blighted areas being passed into the hands of American investors only to be repaired and restored to improve the neighborhood. The segment concludes:

Chris Bury: For now city officials and investors alike seem unafraid that the Baltimore market, like so many others could be a bubble waiting to burst.

Investor #1: I don't see a bubble. I see prices continuing to climb at a steady rate.

Investor #2: I would say it's a bubble in cities like San Francisco, L.A., New York. I think Baltimore is a little bit of a forgotten gem.

So, You're Living in Baltimore

So, you're living in Baltimore and thinking about buying real estate in Baltimore. It sounds like a safe thing to do based on this piece - the auctioneer is happy, the mayor is happy, the Boston investors are happy. There's been lots of talk about housing bubbles - in places like California and New York, but this is Baltimore.

Does the local paper have anything to say about the recent popularity of the Baltimore real estate market? Well, as a matter of fact, this Baltimore Sun article provides an in depth look at the many pros and cons associated with the issue. It breaks down as roughly two parts caution and one part cautious optimism and includes these notes:

Two out of three houses sold in Baltimore this year have been snapped up by people who don't intend to live in them, an unusually high amount of investor activity that is adding fuel to the city's efforts to revive itself - but could endanger housing values down the road.

There have also never been so many out-of-town investors, Baltimoreans say. Buyers from high-price areas such as Washington, New York and California are plunking down their dollars here because prices are appreciating quickly but are still comparatively cheap. Many area residents are jumping into the fray, too.

And some are selling to each other - dozens of houses have turned over more than once this year, generally from investor to investor.

It looks like the real estate bubble might be coming to Baltimore, but it's not there yet. So, if you live in Baltimore, and were considering a home purchase, what do you do?

Look North

Maybe it would be wise to check out some real estate stories in the newspapers where the out-of-town investors are coming from - just to get a better understanding of the big picture. Let's see, in New Hampshire, the experts are no longer questioning the existence of a bubble, but rather trying to predict it's timing and impact:

New Hampshire's red-hot real estate market is expected to enter a painful price-correction period starting in late 2006 that economists say will result in a 5 percent to 25 percent drop in home prices.

Many economists believe house prices will continue to rise until then. But, New Hampshire economist Russell Thibeault of Applied Economic Research in Laconia said most recent home sales figures for New Hampshire over the past five months indicate prices have stopped increasing. Prices have leveled off, he said.

Same thing in Boston:

Experts say the first signs of a bursting housing bubble include falling sales volume, but prices that don't immediately drop - exactly what the latest Massachusetts real estate figures show.

The Massachusetts Association of Realtors reported yesterday that single-family house sales fell 11.1 percent in May - the worst decline in almost three years. But median house-sale prices actually rose 6.2 percent, hitting $359,900.

Look Around You

So, what does all this mean to Baltimoreans and why are Bostoners investing here?

According to National Association of Realtors, the year-over-year increase in home prices, as of the end of the first quarter of 2005, was 14.8% in Boston but only 6.9% in Baltimore. The Boston area has experienced year-over-year increases of over 20% for the last several years and has been designated a bubble area by everyone except the local realtors - everyone pretty much accepts that the boom is over.

This helps to explain why the guys from Boston are investing in Baltimore real estate and not Boston real estate. In Boston, real estate prices are now very high and there is little hope of additional significant appreciation.

Is that a good thing? Investors leaving mature bubbles in their home states to invest in other parts of the country? If the Boston to Baltimore connection is anything like the California to Arizona connection or the California to Nevada connection, prices in Baltimore are going up!

Just think of the potential gains between now and the time that Baltimore is called a bubble. Just think of what might come after that.

So what does it all mean if you live in Baltimore?

If your business is real estate speculation, it sounds like now is the time to act. There may be another year or so of price increases before they start talking about a bubble bursting in Baltimore - just think how far prices could rise!

If, on the other hand, you are looking for a place to call home for the next ten years or so, you should realize that you are competing with wild-eyed speculators who are most likely going to drive up prices in your area, then move on to some other area as soon as prices moderate in Baltimore.

If you are buying for the long term, you may feel good about your purchase a year from now - you may think of yourself as having made a shrewd investment decision as your home equity rises. But, how about in two years or five years - will there be any speculators around to support price levels then?

Will real estate stories in the Baltimore newspapers next year sound like the real estate stories in the New England newspapers today?

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The Stink Test

Pulling up next to a red, jacked up Hummer2 yesterday, it was hard not to think that there is a fundamental disconnect between the thought processes of common people, such as the gentleman driving this vehicle, and those of today's economists.

After having just waded through a number of EconoBlogs in an ongoing attempt to further enlighten my engineering mind, the sight of many bold decals plastered over all sides of this monstrous vehicle, advertising the driver's home loan business, momentarily overloaded my sensory system. There quickly ensued a failed attempt to capture this spectacle using a powered off camera phone as the light turned green.

It was quite a spectacle and spoke volumes about today's economy.

Macroeconomics

As an engineer whose parents were educators in the public school system, who stressed the liberal arts and humanities as their son gravitated toward the cold and calculated field of science and engineering, macroeconomics has become a great fascination in recent years.

Fascinating because of the charts and numbers as well as for the human behavior driving the charts and numbers.

Just the absurdity of it all since the late 1990s - trying to explain what just happened, and what might happen next in a financial world that seems to spin faster and faster - much more interesting than engineering.

After quickly learning that CNBC economists are not to be trusted, a few macroeconomics programs on PBS were found, and these have been helpful. But when graphs about aggregate global demand are shown, thoughts of empty shipping containers on their way back to China quickly come to mind, followed by images of newly unemployed textile workers in the Carolinas.

The PBS economist seemed to be so fascinated by the charts and the numbers that maybe he was missing things that are equally important. Things that don't lend themselves to charts and numbers - people. Maybe he should watch this PBS documentary, or look into the eyes of an unemployed Carolina textile worker who just wants to have what their parents had - a decent job, an uncomplicated life, and the hope of a brighter future for their children.

Despite the charts and numbers used by today's economists, and conclusions which are drawn from them, there appears to be something that is not quite right about the guy in the Hummer and the Carolina textile worker. Things just don't add up.

Despite what many economists say, this economy just doesn't pass the stink test.

More Discussion

It is nice to see more discussion about the state of today's economy - beyond the headline numbers and the combined spin from the financial media and the government. Blogs are helpful in this regard. On Wednesday, first quarter final GDP came in at 3.8% - tops in the western world. But, Barry Rithholtz over at The Big Picture questions that number.

He thinks something smells funny.

And, yesterday the Fed Policy statement said, "Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually." But, really, how firm can this expansion or labor market be when so much of it is based on the real estate madness now infesting almost every burgh in the country - when almost half of all new jobs nationwide are real estate related, and when home-equity financed consumer spending drives domestic growth.

That's got a bit of a smell to it, doesn't it?

At least more interesting questions are being asked these days. In Backstopping the Economy Too Well, Nell Henderson wonders if risky overconfidence is the result of having too much faith in Alan Greenspan:

For many home buyers, it's the sense that house prices will keep going higher in a U.S. economy blessed with healthy growth, low interest rates and tame inflation -- thanks in part to Fed policies under Chairman Alan Greenspan.

For many lenders, it's the assumption that borrowers in the stable, vibrant Greenspan Economy will have no trouble repaying increasingly risky home mortgage and home-equity loans.

But according to some Fed observers, this confidence is a worrisome legacy after Greenspan's nearly 18 years helping to steer the economy through a variety of storms. As Greenspan prepares to step down early next year, they say, he leaves behind a widespread perception that people can take bigger financial risks because the chairman can and will save them if their bets go sour.

But to this economist, it's all Phillip's curves and Taylor rules. There are people in this story - people buying overpriced homes and borrowing against these overpriced homes to buy more overpriced homes. And these people believe that nothing bad will happen because of the faith they have in the world's chief economist, Alan Greenspan.

In Alan Greenspan, Wizard or Villain?, BusinessWeek economics editor Christopher Farrell questions monetary policy under the Greenspan Fed:

Still, Greenspan's most vehement critics go a lot further than this. They're convinced he has made a fundamental error as a monetary economist. Call it the hairshirt economists vs. the cheerleaders for growth-is-good. The hairshirts believe that for the health of the economy to be restored, the inevitable bust that follows a boom must be at least as great as the boom. Growth proponents -- and there's none greater than Greenspan -- believe that it's better to limit the fallout of a bust and get the economy growing again as quickly as possible.

Shortly after its publication, there quickly ensued an EconoBlog Ph.D. free-for-all here, here, and here.

While it's not clear if anything was resolved, it is indicative of how economists view the world. A world full of charts and numbers and theories - but very few people. To common people the economy might smell foul, but economists apparently have an entirely different sense of smell. And, policy decisions are made based on what economists smell, not what ordinary people smell.

That stinks.

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