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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About the Name ...

For those wondering about the name of this blog, it is best explained by starting with a well known analogy for the idealized role of the Federal Reserve within an economy, then going a step or two further.

The Well Known Analogy

Think of the American economy as a gathering of people where alcohol is served - the level of excitement and frivolity is directly proportional to the amount of alcohol consumed. The amount of alcohol available for consumption is controlled by the party host - when more alcohol is made available, more is consumed and the party becomes lively. With less alcohol, the party becomes subdued.

The wildest parties occur when there are no limits on alcohol consumption - we'll get to that shortly.

So, what is the role of a responsible party host/central banker? As once described by former Fed Chairman William McChesney Martin, it is the job of the central bank to "take away the punch bowl just when the party gets going". That is, to provide just enough stimulous in the form of alcohol/credit to get everyone talking to each other and feeling good - to add "lubricant".

Great care must be taken, however, to apply this stimulus in moderation.
Unpleasant things can happen when people drink too much or borrow too much money - reckless behavior and terrible accidents during the consumption phase, followed by heartache and regret later.

A single decision made while under the influence, can have a life altering impact.

The Current Party

We now find ourselves in the wee hours of the morning. This party has been going on for a long time - much longer than most people expected. The party host has provided so much top shelf liquor, fine wine, and beer, the guests have barely noticed that they have been drinking quite a bit more than usual - everyone has been having such a good time.

There was also a big party the previous night.

Usually, the host allows at least a few days between parties to tidy things up, but the current party is really just a continuation of the previous party - that party had only liquor and fine wine, tonight's party also has beer.

Most of the beer drinkers stayed away from the previous party - they don't really appreciate top shelf liquor and fine wine. Judging by the size of tonight's crowd though, it is very clear that just about everybody likes beer!

But it is quite unusual having back-to-back parties like this.

What Mess?

It looks like everyone is having a good time at this party, so, where's the mess?

Well, it's hard to see the mess when the party is still going on - hard to see because people are not looking for it and if they do see something out of place, they are apt to igore it. Everyone is having such a good time and they want the good times to continue. Why not?

But, the mess is actually everywhere - empty bottles and cans on the floor, trash overflowing, pictures askew, spilt food on coffee tables and countertops, ashtrays overflowing. Stains on the carpet from who knows what, broken patio furniture, uprooted shrubbery, and fresh tire tracks on the front lawn.

The mess is there and it is horrible. It is made even worse because no one cleaned up from the previous night's party. In fact, much of this mess is left over from the previous night and now it is all really piling up ... and it is starting to stink!

Last Call

Now it seems that the host has grown tired of his party and all the guests. He may have finally realized that things have gotten a bit out of control with all the alcohol that he has supplied - maybe it was just too much.

But now, he finds that nobody wants to leave - in fact, as late as it is, people are coming in through the front door faster than others are leaving. The free booze has drawn people from all over and they continue to arrive - everyone just loves a good party.

The party host is pictured here reviewing the guest list, considering what to do next - trying to figure out who can clean up the mess - he's going to be leaving shortly.

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