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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