Chuck Ponzi August 28th, 2006

If there was any doubt about the creditworthiness of the housing bubble belief, you need to look no further than the credit expansion that created it. In the end, our housing bubble, like all financial manias of the past, rested on a great willingness expand credit at a rate greater than the growth of the economy.

Our credit bubble likely popped last week.

The growth rate of the economy, that’s like what, 5-6% or so for the past few years?

Well, more or less (although primarily less).

Credit (Monetary) expansion does several things for an economy. The most important is that it allows more dollars (or euros, or whatever) in circulation to buy more stuff. (and stuff is the scientific term for plasmas, Hummers, and granite countertops with obligatory stainless steel appliances). All joking aside, this allows companies to buy more machines to manufacture more stuff, people to buy more houses, and companies to build more buildings to work in. This is generally good for an economy. Imagine an economy with a restricted supply of money that had very little to lend. Banks could not offer reasonable rates on borrowed money due to it being pledged to deposits, jobs could not be created because companies could only buy machinery to be operated in the amount of its earnings, and growth in the economy would be limited in the short run.

So, who controls the amount of money available? Well, the easy answer is… he who prints it!

Of course, it’s not that simple. In fact, if you ask some of the most brilliant people you know, most would not be able to tell you how we create more money in the US.

In the olden days, (when we had a standard set by Gold), money could only be expanded to equal as much as the available gold supply. Each dollar was tied to a specific fraction of an ounce of gold. Ideally, this didn’t change in relation to the amount of gold, so the only way to expand money supply was to mine more of the stuff. This was a barbaric way to live. Mining was a way to grow rich… or so it seemed. The government decided it would rather allow productive enterprise as a means to grow rich, rather than digging stuff out of the ground. So, the dollar was decoupled from gold. (this is intentionally simplified)

It has remained that way in the US since. Gold has gone up and down in relation to the value of the dollar, and the swings have been quite mighty! Still, gold is a “barbarous relic” and its greatest value is that it’s in limited supply. However, many cultures still cling to this funny yellow metal; it’s still used in jewelry, and as a backup currency in times of severe economic uncertainty.

Under the new model, more money could simply be “printed” and a fresh batch of capital could be whipped up in no time flat.

Now, some astute readers may be asking…

What about electronic funds, or money that is deposited? That’s not printed!

Well, that’ s the beauty of the system. Under a standard banking system, banks would be required to hold entire customer deposits, available upon demand to the owner. This is why bank robbing used to be such a great gig… mounds of money sitting in one single place. Now, customer balances are little more than a number on a screen.

Of course, now we have another invention called the Fractional Reserve System. A fractional reserve system means that banks only have to hold a fraction, or a portion of the money, and the remainder can be lent out to businesses or people needing money. This fractional reserve process would allow deposits to be reused, and make them lesser targets for bank robbers… yes, today, robbing a bank might yield only a very, very, very small fraction of their entire deposits. However, that fractional amount still needed to be held as “a reserve” in case depositors required immediate funds.

The “fractional” portion of the banking system allows monetary growth. Fred at Itulip describes it well:

(T)he gist is that banks are required to keep a fraction of their assets on hand, deposited safely at the Fed, to act as a “cash cushion” at times when depositors demand their money from the bank as cash. This cash reserve is in proportion to the amount of depositors’ money that is loaned out. The proportion of this cash reserve to the total amount loaned out is intended to provide just enough of a buffer to keep the bank solvent and keep things running smoothly in the event a lot of depositors make demands for cash at once, such as during a run on the bank. This fraction, called the reserve fraction (or ratio), is typically from 5% to 20% of the amount of money the bank has loaned out. This may seem low, but holding any more cash in reserve than is needed except for outlier cases is considered an uneconomical use of capital by a bank. The cash in reserve is not making money for either the bank or its depositors as loans, so from a day-to-day operations persective, the less reserves the better. From a longer term risk management perspective, the more the better. Statistically, 5% to 20% reserves is the “right” amount, except in those outlier cases where these levels are either too high because reserves at those levels are at some times constraining the economy’s access to credit or, conversely, too low at other times because too many depositors are making a rush to liquidity and demanding their cash.

The reserve fraction, considered as a number that is mutable as a matter of policy, is also one of the most powerful tools a central bank can use to adjust the amount of money available to the economy. It is easy to see why: a reserve requirement of 10% means that banks can lend out ten times the actual money on deposit with the fed. Even a seemingly small change from, say, 2% to 8% means that 12.5 times the money on deposit can be lent out. For example, $10bln initially on deposit with a 10%, reserve requirement results in approximately $100bln of money available as loans. If the reserve fraction is reduced from 10% to 8%, the for the same $10bln cash on deposit there can be approximately $125bln of money available as loans in the economy. This is an increase in the money supply of around 25% from a reduction of the reserve ratio by 2%.

This is where our story gets interesting. If the Federal reserve can increase money so easily as to change reserve requirements, isn’t the flipside to out-of-control increase in monetary supply that reducing money supply in times of inflation as simple as increasing the reserve requirements?

If you guessed yes, you would be right.

So, getting on to the meat of the issue: Would you believe me if I said that an article titled Sub-Prime Lenders’ Shares Fall has nothing to do with the Fractional Lending system, and yet has everything to do with the impending housing bubble bust?

Many, too many if you ask me, have blamed the Federal Reserve for the credit expansion. I only partially agree with that statement. You see, the FED has lost control of the money supply.

Lost control of the very thing they are supposed to control?

Yes, and very badly. The problem arises with the reduction of the fractional reserve to 10%. I recommend reading Fred’s entire treatise (takes about 20 minutes, but is chock full of facts and great figures). For me to write an entire basis for these assumptions would mean I would be recreating his work, which is a great read.

What about lending outside of the “reserve banks”?

Good question! The next pin to be pulled in the financial markets was subprime lending, which has caused some of the worst type of lending. These are some of the bizarre outcomes of expansion of the subprime lending markets:

1. A great deal of subprime is now concentrated in Stated Income Loans (aka liar loans) which have been estimated to contain 60% liars. Question is… if you lie on your application or on your taxes, which one is worse? The answer… does it matter? Lying leads to more lying, which can lead to overstretching financially and failure when difficulties arise.

2. The greatly expanded access to credit allowed borrowers with a diminished ability to pay and questionable personal financial responsibility. This is evidenced by the increasing number of “never-paid a single payment” loans being floated. So much that investors have balked and required these bad dealers to repurchase their own junk.

3. Other banks that needed to compete, needed to lower their lending standards. This introduced more systemic risk into our banking system.

4. Expanded credit markets depressed risk premiums overall, and “chasing returns” meant a flight to risk, in the form of subprime lending.

So, what caused the shift to subprime lending? Would it surprise you if I told you the FED did it to themselves?

By lowering the cost of money, creditworthy people could borrow money and lend it to other at a higher rate. This is nothing new, it’s called rate arbitrage, and is practiced all over the world; between countries, and in subprime lending.

In addition, pension funds and insurance companies based future values of their portfolios on a certain return rate. To accept the abysmal rate that the FED was offering would have mean big losses or underfunded liabilities. What do you really think caused the big pension funds to fail? Hint: It wasn’t that companies didn’t put enough into them, it was that the returns failed to match historical returns, and defined benefit (as opposed to defined contribution plans) require that the company come up with the shortfall. In a higher-rate, higher-return environment, we likely wouldn’t have heard a peep out of defined-benefit pension funds.

Essentially, because interest rates went down with restricted reserve requirements and expanded competition, banks could only take on more and more risk to preserve their income. The easy solution? Sell the risk to someone else through MBS (Mortgage Backed Security) agreements! Yes, through this handy-dandy little feature, banks and loan brokers can just make money on the transaction and take none of the risk to the toxic loan you just made. Because investors had not yet figured out just how much risk there is in those loans, rates remained low, creating very low risk premiums.

Which brings us back to Greenspan’s words a little over a year ago:

Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.

Cryptic? Yes. Prescient? Yes.

But, these are the words of a desperate man, not of an in-control central banker who wields magnificent financial power. He is in one sentence lamenting his loss of control over the credit environment, and warning of risk in the system. However, he feels there is nothing that he can do at this time. Raising interest rates creates an inverted yield curve, and the FED can no longer push the yield curve in any direction. Raising reserve requirements only puts banks at a disadvantage. It seems, investors have an insatiable desire for more risk because HE put them there. The fabled “Greenspan Put” is exactly that; a fable. He would be pushing on a string to try to solve any problems at this point.

I think we just heard the pop last week that makes this house of cards come down.

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Chuck Ponzi August 15th, 2006

http://www.newyorkfed.org/markets/statistics/dlyrates/fedrate.html

Recent chatter on various news articles are that the FED’s pause is helping to stabilize housing prices.

Not a chance. In Orange county, the inventory numbers speak for themselves. Despite calls by local Realtors that the inventory is ‘waning“, OCrenter at Bubble Market Tracking has shown that the numbers are steadily climbing and have already reached nosebleed levels. We are likely going to see a pull-back in inventory numbers late this fall, only to go to new historical records next year. We are already at over 7 months inventory in OC, and over 9 months in San Diego. Could we go to 14, 15, or 16 months by the end of the year with slipping sales? I think so.

More importantly, history does not support this claim.

Fed Funds rates dropped from 9 3/4 in Feb 89 to 3% in September 92, and California still had one of the worst housing-busts in recorded history in the US. A total drop of 6 3/4%! We currently stand at 5.25%. Not possible to even drop that much this time.

While in the late 80s, housing prices was 3 standard devaiations above the mean, we are now 4 standard deviations above the mean, and our Fed Funds rate stands at 5 1/4%. Even dropping to Zero (like Japanese-stype ZIRP), we will not be able to save housing if you believe that history can repeat itself.

Mike Shedlock believes strongly in a deflationary scenario. If you believe in history repeating, or at least rhyming, housing is toast, as is pretty much everything else. I highly recommend following his blog daily.

OK, before anyone goes and ruins the bear party… remember this will take some time to run out. The Fed will do everything in its power to run down the clock on the coming recession by fiddling with sentiment by talking tough with interest rate policy and meanwhile fiddling with the interest rate here and there. We are likely to see much more disinformation coming from the FED in the future.

***Interesting note, as I was writing this, I came across this article on the OCR (Jon Lansner’s) Blog only confirming the FED’s wish to sweet talk the public with bizarro psychology.***

—Never mind the man behind the curtain… 40% of housing sales to speculation, or 4X the historical norm means nothing…Forget about land prices going up 10X over 5 years…Negative savings rates are irrelevant…cash-out refi’s are a healthy portion of the economy… all is well, now go away and sip your cares away with your $5, er.. I mean $6 Latte—

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Chuck Ponzi August 14th, 2006

A recent review of Gary Watt’s new predictions brings to light a few issues that sadden and disappoint anyone who works for the real estate industry; and should at least disappoint or engender feelings of distrust in those who buy and sell real estate with a Realtor.

Frankly said, aside from Gary’s predictions (I am confident he will be soundly trounced this year), he is advocating a lack of morality that is breathtaking at least. And perhaps even legally actionable in its intent.

If you want to review his mid-year analysis, it is here.

Here are a few choice quote, backlit by the corresponding points of the Realtor Code of Ethics it rubs or breaches:

Listing Cycle:
a. Our listing inventory usually “peaks” in September/October and declines through January, February, March and into the April/mid May time period.
b. The buyers normally begin entering the market in February and stay strong through June.
c. However, this year is . . . INVERTED! The latter half will be more active.

There is currently no historical precedent for an “inverted year”… never happened before, so without any sound discussion of what has fundamentally changed about 30 years of documented history, we are left believeing that he is just hoping.

A brother-in-law of mine told me you can wish in one hand and poop in the other and see which one gets full faster. Although I don’t claim to understand this logic, I am certain that wishing into the one hand will never get it full.

From Article 11:

REALTORS® shall not undertake to provide specialized professional services concerning a type of property or service that is outside their field of competence unless they engage the assistance of one who is competent on such types of property or service, or unless the facts are fully disclosed to the client. Any persons engaged to provide such assistance shall be so identified to the client and their contribution to the assignment should be set forth.

You know where I’m going here… Watts’ competence to issue economic analysis has to be questioned. When those who defend his track record speak, they are referring to his “forecasts” which are fortunately for him issued mid-year (or later). Uh… with mid-year forecasts allowed, I am confident that most people with high-school algebra could do as good or better than Mr. Watts. That’s a fact.

Also from his mid-year outlook

Listing Agent Advice
1. Price Reductions:
Please do not put a “price reduced” banner on your listings, and if you have one up, please take it down. It “falsely” advertises to the neighborhood that prices in the area are going down. What is more true is that sellers are lowering their expectations and becoming realistic. Plus: For we who show property, it does not instill confidence in our potential buyers.

From the Code of Ethics (COE)

Article 15 REALTORS® shall not knowingly or recklessly make false or misleading statements about competitors, their businesses, or their business practices.

At the very minimum, this is a conflict of interest to clients. If a buyer is not properly informed of the past status of pricing on the property, he/she is unable to assess the willingness of a seller to negotiate on the property’s sale. Besides being counterproductive, I am confident that the ‘ol boys monitoring the cartel status and anticompetitive information-mongering tendencies of the NAR would be happy to know if those who control the information contained in the MLS are withholding from consumers in a concerted attempt to put buyers at a disadvantage. Not a good position to be in considering the open lawsuit to that effect from the Department of Justice.

Besides, is he really that naiive to believe that other agents will actually heed his suggestion? If so, they are truly unsavvy businesspeople. Watts does not hold any position of administration in the local real estate community, so his remarks can only be seen as asking listing agents to be uncompetitive. Certainly not an ethical solution for those they are representing! Following Watts’ advice makes you less likely to sell a home from a willing (and perhaps even desperate seller), and perhaps even subject to administrative oversight that you did not properly represent your client. You could be in hot water for following his advice!

From Watts’ document:

Sold Signs: When the listing goes into escrow, please put an “in escrow” or “sold” banner on the sign! The days of a panicked buyer, desperately looking on their own for a home, are long gone. Once again, we are advertising to the neighborhood the wrong information.
Plus: Imagine how potential buyers feel seeing all those for sale signs. Do you really think you’re helping them enter the market?
Signs: If you have a listing where there are other (or many) for sale signs nearby, I would recommend that you call the other agents and see how many of them will remove their signs from their listings. At the very worst, rotate your signs until one (or more) of the listings sell, then make sure it has a sold sign on it!

He is advocating collusion, plain and simple. Any realtors who actually follow this advice could be at risk for a legal fight.

Article 12 REALTORS® shall be careful at all times to present a true picture in their advertising and representations to the public.

Ooh, that’s gotta hurt.

From his document:

Affordability Index: The numbers state that so few can afford a home - Factual
A seriously flawed index using archaic methods that are no longer relevant – Accurate

His discussion of “factual” and accurate should actually prompt someone to open a dictionary and check out the meaning of the words:

Factual:
1. Of the nature of fact; real.
2. Of or containing facts.
Accurate:
1. Conforming exactly to fact; errorless.
2. Deviating only slightly or within acceptable limits from a standard.

Well, those actually look pretty similar to me, can someone else who is perhaps a linguist or semanticist explain to us if Mr. Watts has any foundation in…well… fact? (Besides, Accurate actually allows for a deviation within “acceptable limits… wouldn’t that make factual actually more accurate than… accurate?)

Besides that, I distinctly remember some stock analysts representing stocks and mutual funds saying that the old methods of valuing companies where outdated and archaic. Something about a New Economy or something like that?

Anywho, who is Mr. Watts to tell us about this fundamental shift in human psychology? Has he been professionally trained, published any demonstrable works? As far as we can tell, he’s a salesman plain and simple. I hope those reading his “outlook” realize that he has everything to gain by you believing it.

Perhaps we should also reflect on the first article of the COE:

Article 1When representing a buyer, seller, landlord, tenant, or other client as an agent, REALTORS® pledge themselves to protect and promote the interests of their client. This obligation to the client is primary, but it does not relieve REALTORS® of their obligation to treat all parties honestly. When serving a buyer, seller, landlord, tenant or other party in a non-agency capacity, REALTORS® remain obligated to treat all parties honestly.

The Document as a Whole
There are also a number of seriously flawed arguments in his document:

June marks the Federal Reserve’s 17^th straight rate increase and yet they still cannot slow this economy down! This should be the end of rate hikes for the rest of the year.

First off, dead wrong. If the FED fails to slow the economy down, it will hike more! Not less. That is simply idiocy.

Secondly, irrelevant. FED rates do not directly impact mortgage rates, and less the speculative nature of SoCal real estate. They do not change psychology like rates; that changes on its own! Credit spreads are some of the smallest in recent times! With that kind of imbalance, we pretty much only have 2 options; higher rates in the future, or recession!

The Federal Reserve reports that consumers have $5 trillion dollars in liquid cash sitting in banks or savings and loans. By April of 2006, they had $53.83 trillion dollars of household Net Worth.

Irrelevant. First off, average homeowners (which makes up about 95% of Orange County) have very little liquid net worth. There is even a joke about the SoCal Two-thousandaires. Secondly, that household networth that he is so concerned about is primarily Housing, and secondarily retirement/pension savings. Not the kind that can be tapped to buy more houses!

Personal income has been growing at twice the rate predicted by economists. So with consumers making up 70% of the economy and business spending growing, these forces are propelling the economy upward with a “one-two punch”. The economy should continue to grow at a rate between 3% and 3.5% for the rest of the year.

Besides being incredibly irrelevant, wouldn’t the economics growth of 3 to 3.5% mean that housing should follow a similar path? He also fails to put it in context for those readers who know nothing about economics (mostly realtors) that this is somewhat anemic growth, and could be argued that it is lower than inflation (he is not quoting inflation-adjusted numbers), and therefore we are actually already shrinking, not growing). His misuse of the numbers just shows you can torture the numbers long enough to tell you anything. Or, as Mark Twain said, “there are lies, damn lies, and then there are statistics.”

Besides, the vast majority of the liquid net worth is held by the top 1%. And, believe me, they are not buying multiple stucco boxes in Mission Viejo!

As of June, we have employed 1.8 million new workers over the past year. We have averaged over 2 million for the last two years – all adding tax receipts to the Treasury. If you add in the self-employed, we added another 1 million workers last year!

Once again, out of context! (and not using “accurate” figures). Economists have hypothesized that we need to have 250K new jobs per month JUST TO STAY IN PLACE! I’m no bear on America, but please get your facts straight man! Each of the BLS numbers have had downward revisions, and many have argued offer little insight into the quality of work being created. I’m no expert, but this topic has been handled many times by Mike Shedlock and Calculated Risk. The information is readily available, although I doubt that Gary is seeking it out. He is optimistically filtering and modifying information to suit his own objective.

In the U.S, incomes exceeding $100,000 (+) are growing 6 times faster than the population. For the first time, there are over 1 million people living in $1 million dollar homes and 1/3 of them own a 2nd home!

This one is easy… inflation, and overleveraging. There is little to no equity in many of these homes, and the 2nd home is an “investment” property. Warren Buffet has been known to say that it is only when the tide goes out that you discover who is swimming naked. The tide is going out.

[California’s] employment growth is at 1.5%, adding 223,000 jobs last year. However, our self-employment growth rate is 11.1% which added another 218,000 jobs.

This screams for an answer. When 98% of your new jobs were “self employed”, that means there is a problem with your economy. Considering that there were about 60K new real estate agents in California last year, you can see how real-estate dependent we really are! That’ not even including the other real-estate jobs we created.

Finally, if demographics and migration were putting pressure on sales, we should see a shrinking supply of homes, not a growing supply. As of this morning, www.ocrealestatefinder.com shows 19,199 homes for sale. For the sake of the clients of those reading his outlook, I hope that none of them actually believe that artificially restricting exposure of their listings will help them (or their clients) in any way. Volume is bad and it is going to get worse before it gets better.

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Chuck Ponzi August 11th, 2006

Due to the infrequency of my posts, I don’t always get to recap some of the big stories that are happening in the world of the Housing Bubble. However, there are some things that happen that prompt an immediate reply.

First, for many who follow news in the world of housing bubble blogging, you may already know that Ben Jones’ blog (www.thehousingbubbleblog.com) was featured in the Newsweek section of MSNBC.com. While housing bubble bloggers have largely been seen as anti-american fascist ne’er-do-wells in the polls of public (homebuilders, sellers, and realtors) opinion, they have not received the accolades due their persistence and foresight during a time of easily-lost sensibilities. Two true originators of bubble blogs, Rich Toscano and Ben Jones have now both been features in mainstream media and are no longer unlikely prognosticators of doom, but rather pioneers into discovering, documenting, and explaining the largest financial mania that has gripped the world to date.

How do we know that this is as mainstream as I say it is… Don’t trust me, I captured a screenshot of the article about Ben’s Blog as the #2 spot of most viewed articles on Newsweek’s business site:

You can visit the site to read about his blog here.

I was actually visiting the site about an entirely different topic that is near and dear to any bubble blogger. That is the proliferation of debt in America, and the harm it is about to do to people everywhere.

The other article I was reading is titled “Why Consumer Debt is Rising: Spend Cycle”

It prominently features a picture of set of large men moving furniture out of a foreclosed home in Ohio.

The article is a Q&A session with Christian Weller who recently authored a report titled ‘Drowning in Debt’ by the Center for American Progress. I have seen similar reports commissioned by Countrywide and Fannie Mae, so this is not just a one-off event. Americans are literally drowning in a sea of debt many will likely never be able to pay off legitimately.

While his assessment of the why leaves a little to be desired:

The data shows that people are borrowing more money not because of over-consumption, but because they’re caught in a bind,” says Weller, a senior economist at the CAP. “In that bind, the only escape valve for middle class families is to borrow more money.”

(Hint, I don’t believe that borrowing is a legitimate form of paying one’s bills) There is a wonderful lesson here to be learned; if you can’t afford a middle-class lifestyle without borrowing to get it, you aren’t middle class. Yes, as taboo as that may be, people should not buy stuff they cannot afford. (A Saturday Night Live classic clip with Steve Martin comes to mind)

Yet, his message is on-topic and makes it clear to others that debt is not your friend. (Note to all, debt is not wealth, despite what someone who wants to sell you a book says)

Some of the choice questions and answers bear out a systemic risk to our country due to the risks people are taking on with debt.

Is credit more available to more people now?
The expansion of the credit industry has given people more access to credit, no doubt about it. [But] I would argue that people are borrowing more money now than in the past [not because of more access to credit] but because prices have risen in the face of a very weak labor market. As for housing, the home equity cash out equaled $431 billion in 2005 [for spending other than home improvements]. That’s a substantial contribution to households’ resources that they can then spend on all kinds of things: sending their kids to college, buying a new car, paying for health care and other things. We know home equity cash outs are extremely sensitive to interest rates, they’re also very sensitive to home-price depreciation. So you don’t even need to have a crash in the housing markets to really see severe economic consequences.

A mere mention of “crash” in housing markets would have been laughed at in MSM a mere 12 months ago. The unwashed prophets of doom spreading their sickly story of gloom were all but laughed at in the open a mere 1 year ago. Oh, how the story changes when the prophets’ predictions come to fruition. Here is what always happens (and you don’t have to live through one to read enough about it to be an expert, just an aptitude and a willingness to see things from another perspective than what someone who is trying to sell you something wants you to see)
1. Prices rise due to intrinsic demand
2. Price history establishes belief of future growth where tress grow to the sky
3. Prices exceed all rational ability to be supported by fundamentals established in #1
4. Sales volume slows due to priced out participants or wary newcomers
5. Inventory spikes due to a rush to the exits.
6. Carrying costs exceed participants’ ability to maintain
7. Credit becomes increasingly harder to obtain due to elevated risk to lenders
8. Declines come slow at first, and then a torrent later.
9. Abject capitulation, participants renounce participation
10. Fundamental underpinnings return

The explanation:

Why are so many Americans falling into debt?
The labor market has been rather weak, employment growth has barely kept pace with population growth, wages have been flat, income has fallen for five years in a row, and at the same time, prices for critical big ticket items-items such as health care, housing, college education—have gone through the roof. In that bind, the only escape valve for middle class families is to borrow more money.

This one is easy. Global wage arbitration through increased globalization and reduced trade barriers creates downward pressure in “premium” labor markets. Our wages are not increasing as fast as the prices of products we buy. With little restraint, and a willing Federal reserve to prevent short-term deflationary pressures, we inflate constrained assets. It’s only a matter of time before these price increases trickle through to other items, or wholesale asset deflation occurs when credit is tightened. It would take the greatest the minds of all time to thread
the needle with our current imbalances.

The next 2 points should be taken together:

The chairman of the Federal Reserve Board, Ben Bernanke, recently expressed concern over the increasing availability of credit to U.S. families, including the extension of non-traditional mortgages. How significant is this?
The realization by the Federal Reserve that there is a housing bubble, that this is beyond what can be justified, is certainly noteworthy. The question is, where does that leave us? The Federal Reserve, under both Bernanke and [Alan] Greenspan, has done two things: they’ve talked about it more than they did with the stock market, and they’ve also continued to raise [interest] rates for basically two years now. It’s unclear now whether the efforts by the Fed to raise interest rates were meant to slow the housing market or to have a tool at their disposal to stimulate the economy again when the market slows down. It’s really unclear what their thinking was, whether it was meant to burst the bubble or to have a tool to recover when the bubble bursts. I think most people would believe the latter.

and…

Your report shows that household debt has now reached 108.4 percent of household income. Can you put those numbers into context?
In 1952, the average debt to income (disposable income) ratio was less than 40 percent. Now, it’s 126 percent. Debt has really risen much faster than our income. [And] I don’t want to say that all debt is bad, but the growth we’ve seen in the last few years is unsustainable. And it’s not sustainable because of the reasons for which people borrow. People borrow because they’re caught in this bind of a weak [labor] market and rapidly rising prices. What that means is that eventually, unless income rises or prices slow down, people will have a really hard time making payments. And if they have a hard time making payments, there are two responses: there’s going to be less debt taken out to fuel consumption and a lot more people will default.

This is where the whole thing comes together. First, many believe that the FED was raising rates to be prepared to bail us out when deflation does come. They are likely correct in their thinking. The Fed cares little for asset bubbles except the harm they do to the economy. On the other hand, because of the relative size of this consumption-crazed bubble, the FED is having to bring out the big guns of walking loudly and carrying a small stick. If people are not scared about taking on too much risk, sometimes they need an authority figure to scare them back to their senses. I dont’ believe it worked as well as Greenie and Ben hoped it would. However, Greenspan clearly saw the unwinding as a credit bubble.

“This vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent… But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.”

There is no other explanation for Greenspan’s comments than that we are in a housing bubble.

The real problem is that the problems become self-reinforcing, and Mr. Weller explains how that happens:

What could the outcome of something like that be?
If default rates go up, banks then become more worried about lending money, and the first people hurt by that are small businesses … The outcome is slower economic growth, which means a slower labor market [and] less wage growth.

This is exactly why we can have pressure on deflation from the housing bubble. Not just in the asset markets, but in the labor markets as well.

Until recently, I was convinced that Mike Shedlock might be wrong in his conviction of generalized deflation in our economy. I am definitely not convinced any more, and am daily leaning more and more towards deflation; not only in the Austrian Economics sense of restricted money supply, but also in consumer prices. Note: I’m still not sure about consumer prices with the bull market in commodities, but convinced entirely about reduced money supply. There is no other way out of risky lending practices. Japan followed exactly the same path that we are taking nearly 16 years later.
However, I must protest strongly to Mr. Weller’s suggestion of action:

What can we do? What can the government do?
We need faster income growth. Can companies afford [to pay higher salaries]? Yes. It’s a question of policies to step in and make sure that people are making more money. You can do this through a number of mechanisms in the short term: raise the minimum wage, expand the earned income tax credit, strengthen labor law to make it easier for people to join a union. Will we see these things? I think so. Whether it will happen on a federal level is another question. But it will happen on a state and local level.

I would personally strongly oppose any policies to force companies to pay more through legislation or policies. These types of restrictions actually create more problems than they solve through reduced global competitiveness. It may be a race to the bottom, but for now at least we’re still in the running, something that cannot be said about other, more labor protective economies such as France. If we become more protective, our bleeding of jobs overseas will worsen, not improve the fortunes of those here.

The goal; spend less than you actually make and borrow only for those things that can produce greater income later (education). Our quality of life is much better than it was 10 or 20 years ago. Just because others take on debt to fund a champagne and caviar lifestyle does not mean that it makes them happier, and I am confident that it makes many very unhappy.

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Chuck Ponzi August 6th, 2006

Another write weighs in on the subject of whether there is a housing bubble.

Jerry Bowyer from Renew America tells us:

A few weeks ago, BuzzCharts came across this headline: “80% Believe Housing Bubble.” Now, we don’t claim to know everything about the housing market, but we do know this: If 80 percent of people believe that an asset is grossly overvalued, it’s not. By definition, there’s no way the crowd can believe the crowd is wrong and be right in believing it.

His “fuzzy logic” is about as backwards as can be. If anything, if 80% of people believe something, it is most assuredly a self-fulfilling prophecy at the very least.

If I can, I will try to conjure up an image in your mind a more complex model of life than to simply state fabricated absolutes as Mr Bowyer with his concocted excel graphs that tell the lies of a million data points tortured beyond imagination.

Imagine housing as a gigantic cruise ship with the FED captain at the helm. It’s only known source of power is a gigantic lever labeled “thrust”. Unfortunately, there are no markings, no indicators as to the actual speed this thrust lever creates. While the captain is able to modify the speed by pushing or pulling this lever, he is in fact, unaware of exactly how much thrust he is putting into the ship. He also realizes that if he pushes it too much, he can run the risk of overheating the engines and burning up all of the fuel. On the other hand, if he pulls it too much, they won’t reach land in time to keep passengers satisfied. In fact, it might well be that the elusive “sweet spot” does not exist, or that it is constantly changing based on the output the engines exert.

Just the same, when the ship is buffeted by large waves, the captain must push the lever as much as possible to keep from capsizing. On the other hand, with a strong current from behind, the captain must ensure he pulls the lever back sufficiently or the boat could as well capsize from excessive speed.

The truly tricky spots are when the captain realizes that his speed is getting too high. If he eases up on the lever and if he pulls back too hard, the engines slow the ship too quickly. If he does not ease up enough, the ship’s speed could cause a catastrophe. On either side of these scenarios lies a perilous outcome.

This model, too, is too simple for reality.

Psychology, Sentiment, or whatever
Imagine if you will something from science fiction… the passengers also had control of the power in this cruise ship. Imagine that through their collective consciousness, they can affect the exertion on the ship, both in forward and reverse motion. This is also a component of our economy that Mr. Bowyer is either unaware of or simply fancies it “noise” in his graphs.

Believe me, if 80% feel that something will fail in the economy, it would take a miracle for it to not happen. That collective belief will keep people from buying; not wishing, not hoping, but FEARFUL of the unknown. And, as time goes by, that fear grows, gnawing at their insides. They hear of downsizings in the auto markets, outsourcing to China and India, increased inflation, higher prices in everything, and worst of all, housing is the most expensive anyone can remember; even after they account for their paycheck, which has not kept up with the cost of everything else. And, they have saved nothing for a rainy day.

This is the fear that grips America at the present time. This is the fear that will bring down housing in the United States. No, not fast at first, remember we are on an enormous ship with a great deal of forward momentum, but nothing, and I mean nothing can compare to the power of consumer fear. Stuffing dollar bills in their pockets cannot change their minds when they do not believe it will be there in 5 or 10 years. Irrational as some may believe it to be, it is real nonetheless because they BELIEVE it to be real.

So, Mr. Bonyer, you can continue to preach your non-bubble apologism, but for the rest of the US, we will continue to be concerned. As we well should be, many people will get hurt from this, and many, many more will be owing for the rest of their lives.

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