Chuck Ponzi August 5th, 2008

Now that the housing bailout bill has been approved by congress and signed into law by the political pandering president, we have all agreed to accept the cold hard reality of covering someone else’s bad decisions and poor choices with our own hard work, sweat, and good choices. Indeed, it seems that excelling or even being of a marginally higher intellect than say, a brain slug is fit to be yoked and saddled with someone else’s mediocrity in this new era of America. It is the future of “no child left behind”, or as Brett Arends of the Wall Street Journal puts it, the Condo Flippers Do Over Act.

I remember a story that I read in grade school, Anthem by Ayn Rand. It was the first Ayn Rand book I ever read, and the only one I enjoyed. But, even in my youth, the message was chilling. The story was one of a man with extraordinary talent and physical prowess who lived in a society that believed in equality to an extreme. This society would place handicaps on those who could could see well, think better, or even walk better to the point that noone was better than anyone else in any way. Ironically, the main character I never in my life imagined that this kind of society would exist, much less under a republican president. However, it seems we have become this society:

Our name is Equality 7-2521, as it is written on the iron bracelet which all men wear on their left wrists with their names upon it. We are twenty-one years old. We are six feet tall, and this is a burden, for there are not many men who are six feet tall. Ever have the Teachers and the Leaders pointed to us and frowned and said: “There is evil in your bones, Equality 7-2521, for your body has grown beyond the bodies of your brothers.” But we cannot change our bones nor our body.

I have no flair for the dramatic, but I fear that we as a nation have allowed ourselves to become enslaved by our own political masters. We are therefore, destined for failure much more than if we had celebrated success AND failure as a means of building again something better. In our society, failure is only to include everyone, and everyone fails or succeeds together. It seems like only a little time ago that we were introducing “participation awards”, and now we are covering everyone’s losses. Except it seems that there is a conspiracy afoot.

I’m a died in the wool libertarian, but there is only so much nepotism that I can stand. I am disgusted beyond belief at what I see. What I see is that the only time that people are bailed out is when it affects big business. When the banks collectively went and did the stupidest stuff in the history of the world in the name of “financial innovation”, they get bailed out. When little investors went and did stupid stuff by buying dot coms… not a chance.

I’m mad as hell, but I don’t know what to do. In elections, I get to choose between a giant douche and a shit sandwich. Equally, everyone around me is too busy getting raped by the government to give a rat’s ass. The only thoughts that come to mind are treasonous and illegal, so I won’t write them down, but, I have to ask, at what point do politicians become responsible for their actions? Is it only when we get invaded and conquered do crimes against humanity get punished?

Unfortunately, with all of the absolutely stupid shite that happens in this country, I can’t think of a country where even more stupid shite happens, so there’s no escape. Maybe this is just what being middle class is all about. I’m too lucky to have the government wipe my butt for me, and I’m not lucky enough to not give a rip or find a way around paying for it. So, I’m stuck working for the government 50% of my income going to taxes and no say in the political process. Makes me want to stop paying taxes altogether. If I thought I could get away with it, I would.

I have to say, this housing bill, what a crock of absolute rubbish, and I’m ashamed to live in a country where politicians pander to everyone but their constituency. Everyone would be much better off if housing were cheap. Everyone complains when the prices of things rise… we call that inflation, but when it’s houses, it’s call an ownership society.

From the WSJ:

Anyone who invests in housing already gets a number of political subsidies. Your mortgage interest can be deducted from your income tax. Your capital gains, up to certain limits, can also be tax free. Taxpayers maintain the roads to and from your home. The new rescue package is just one more subsidy for the asset class of housing.

There was no rescue package for all those honest people who lost their savings in the dotcom crash. And there was no suggestion of any rescue package.

Meanwhile the majority Democratic party is agitating, with plenty of popular support, for a “windfall profits tax” on energy companies.

Such a tax, if it should pass, would by definition lower the returns from investment in oil and gas exploration. Inevitable consequence: Less investment in oil and gas exploration. But this is apparently an acceptable price to pay to ensure that…well, that investors in big energy companies don’t make too much money.

So, where does this all leave us?

Among the many ironies: The current economic crisis is largely the result of too much investment in housing, which led to a bubble and then a collapse, and too little investment in energy, leading to fuel shortages and skyrocketing prices. Yet the political class is acting, as far as I can see, to increase investment still further in housing and reduce investment in energy.

Where do our douche and shit sandwich stand on this?

• Free Speech , Housing Costs , Inflation , Rants , Unintended Consequences
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Chuck Ponzi March 11th, 2008

Despite all that you hear and see in the headlines about rising oil and gold prices, we are about to experience the worst deflation in the history of the United States, or at least the 2nd worst after the Great Depression.

I have to write this entry because of the amount of absolute rubbish that I see printed throughout the media and repeated ad nauseum in the blogosphere regarding the money supply and how the recent fed actions are inflationary.

Even with the dramatic action today in the stock market (the last time we saw a 400 point day in the dow was mid 2002, near the depth of the last bear market), the general trend is that the market is quickly siphoning off the dollars put out via the central bank the past 8 years.

Noone now doubts that Greenspan made 2 fatal mistakes that caused the largest bubble in history. First, he brought interest rates too low and held them too long, and secondly and more importantly oversaw the most complete and utter breakdown of lending standards in history. Put together, it pumped too much debt into the system.

This debt became non-servicable from income during a time when debt should have been waning, not peaking since the largest demographic baby boomer bulge is passing into its retirement age. The sad state of affairs of most baby boomers is only a testament to the incredibly poor management of their finances until this point. Several decades of declining interest rates and ever-increasing credit has created a new age of debt serfdom where most can only hope to ever service the debt and hope it never gets called, the serf ever sickens, or misfortune visits a single household.

Put succinctly, increasing the money supply is inflation, deflation is decreasing the money supply. The accomplished blogger Mike Shedlock has made this case quite well, and the facts speak for themselves.

In the deluded minds of those pumping housing, they are hoping that actions by the FED will rescue housing. It won’t. Housing was in a bubble that was reinforced by the increase in money supply, and as long as the money supply is contracting and remaining contracted, we not see a return to the insane days of lending we have seen the past 7 years. This is deflation. Assets going down in value. Housing, stocks… even commodities should be declining. Which brings us to the next bubble… commodities. It was only a matter of time; and frankly I haven’t a clue as to how long it will last. But it’s not ready to pop yet. We are just now getting the first whiff of a bubble; and there will be plenty of time for commodities apologists to scoff it off and disprove recent price action, but let’s not forget the fundamentals… commodities are priced between the cost of production plus normal profits and the cost of alternatives. Gold, corn, rice, sugar, even oil has alternatives, and let’s be honest… we have departed from these fundamentals. It costs approximately $400 to produce an ounce of gold. It costs approximately $4 to produce an ounce of silver. We have all gone mad in the search for the next place to put our dollars. We are living in an inflated world where stocks and housing are no longer considered safe havens after the last 2 bubbles have popped, yet commodities are just warming up.

But, let’s not forget that even with the bubble forming in commodities, it does not yet have a complicit Federal Reserve bank… borrowing for precious metals is much more difficult than leveraging equity in a house or margining stocks; and there are few takers to lend the money in that kind of speculation.

I predict this next commodities bubble will be much shorter than the last 2 and more violent to the participants.

Disagree below.

• Bubble , Deflation , Inflation
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Chuck Ponzi October 28th, 2007

I have to admit, one of my guilty pleasures is both listening to Peter Schiff and following his advice. His theories have given my portfolio a great push forward. This is a great example of taking on the domestic bull in relationship to our declining dollar. There will be a time to buy USD again, but that time is not now.

I believe a lot of that timing will come from Bernanke’s will to crush the housing bubble. If he doesn’t, it’ll be a long time before we can get well again. We need to take the tough medicine.

• Credit Bubble , Debt , Housing Crash , Inflation , Mean Reversion
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Chuck Ponzi October 8th, 2007

Some longer time readers will remember a post that I made back in April of this year titled “Chuck Ponzi’s Law of Unintended Consequences“.  That post detailed the bail-out idea du jour… foreclosure moratoriums.

I always enjoy a discussion of how the mortgage mess that we find ourselves in can be “fixed” by using nontraditional methods.  For each of the parties arguing the solution, it often involves directly benefitting them, while the cost is to be borne by another group… “the marks”.

Mike Shedlock’s analysis of the CRL (Center for Responsible Lending) and FDIC’s proposed solutions is particluarly interesting.  His post is properly titled “The Debt Slave Act of 2005 Revisted“, which makes perfect sense considering how consumers have effectively been cut off from the one chance to make a clean break after devastating financial problems.  Instead, the newer law attempts to weed out deadbeat habitual spendthrifts from performing frequent and repeated filings to wipe the board clean every few years.  Instead, it has made it difficult enough to file bankruptcy that there is little to no possible way out.  In addition, with pledges to repay, many become debt slaves to past problems, unable to leave them in the past.

Don’t get me wrong, I’m definitely for personal responsibility in life, perhaps even too much; but the law as it currently stands puts a burden on already destitute people.  It has served to benefit lenders most of all.  So, it is with some twisted satisfaction that I read what Mish has to say on the matter… all of with which I agree.

First, he quotes a CNN Money article (shortened excerpt)

One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code.

The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities.
CRL’s proposal - reflected in a House bill recently introduced - would make changes to the regulations for Chapter 13 bankruptcies, which don’t wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person’s primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner’s property is worth less than what he owes. The judge could reduce the principal to match the home’s current market value as well as reduce the loan’s interest rate.

Mish also quotes the FDIC’s proposal:

The heat on U.S. mortgage lenders and servicers was turned up a few degrees this week when the country’s chief bank regulator publicly proposed that they permanently freeze interest rates on subprime adjustable-rate mortgages (ARMs) for many homeowners.

“Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it,” Federal Deposit Insurance Corp. Chairman Sheila Bair said in prepared remarks at an investor’s conference.

That solution is nearly as bizarre.

Now, before too many of my readers go off on rants considering how this is supremely unfair… consider 2 things:  first, if balances on loans can be decided in a court and lowered as a judge feels inclined, how many banks will want to loan money, and secondly consider what Mish has to say regarding “fixing” the ARMs:

It should not take a genius to figure out that if ARMs rates are “frozen” at a point where the market does not think rates should be, there simply will be no more ARMs offered. Furthermore, to cover the cost of existing ARMS, prices would rise on new fixed rate mortgages. Oddly enough, price fixing ARMs would not even help the person most at risk because that person cannot afford the teaser rate, let alone the cost of a current ARMS rate. Thus price fixing ARMs is a sure fired guaranteed way to cause a continued weakness in home prices, if not an actual out and out crash.

Which reminds me of the original Chuck Ponzi Law of Unintended Consequences:

If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.

Now, I’m considering that I have to add that while you may need to pay for it, anything other than letting the market deal with it efficiently will likely crash it anyway.  In the end, it is the same thing that my first Econ professor in college always said was the #1 rule of economics:  TNSTAAFL “There’s No Such Thing As A Free Lunch”.  No such thing.

I am willing to bet that any artificial means of attempting to “solve” the problem will only make it worse, both for the person they are trying to help, and the overall group of people.  The only people helped by the above solutions are those who have ALL of the following:

1. Long histories of repayment
2. Excellent credit scores
3. Lots of cash for a down payment, maybe up to 30 or 40% to prevent bankruptcy write-downs
4. Enough income to support purchases on fixed rates with lengthy work history.

This way, only the most qualified can purchase.  At current prices, there are likely only 1 to 2% of the people in the entire Southern California region who could fit this bill for an average home.  And, frankly, there is no way these people will live in an “average” SoCal home.  Imposing the suggested “solutions” will only serve to do three things:

• Depeen the credit crunch
• Crash the housing market
• induce a consumer-led recession, if not depression

The deeper the credit crunch, the harder and farther housing prices will have to fall to meet demand.  The harder and further prices fall, the more likely that good paying homeowners will walk away from an underwater mortgage.  More foreclosures dropping prices and deeper credit crunch will turn off MEW (Mortgage Equity Withdrawals) which is what has been keeping the consumer (along with their credit cards) in clothes, vacations, and Plasma TV’s.  A crumbled consumer is a crumbled economy.

When the service on debt becomes more than the income, defaults are certain.  Since US wages have been in real decline (against inflation), and the US dollar in severe decline, the loss of purchasing power has become an unbelievable crush.  Anyone who has not felt and seen the substantial inflation over the past 2 years has either been asleep or dead.  Even high-end wage earners have felt the sting of higher prices.

All of this leaves me very pessimistic about the local economy that has been so built on the fortunes of real estate.  I fear we may have much, much worse things ahead of us compared with the past few months.

• Credit Bubble , Debt , Housing Crash , Inflation , Mean Reversion
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Chuck Ponzi October 2nd, 2007

If you do any amount of reading in financial publications or blogs lately, the word inflation has been thrown around quite a bit. However, few words seem so clear in economics yet are shrouded in half-truths. What is inflation? If you ask 10 different people, you’ll get 10 different answers. Even academics differ on what inflation is, even the definition of the word. While one might suppose it is monetary expansion, another only sees its effect on prices. Others argue it is the relative growth of the first in relation to the economy that drives the second. Still others argue that “it’s different this time” and the old rules don’t apply; in a way they are correct.

It is no secret that in the past few years, we have seen substantial monetary expansion. Such is not necessarily the case today. A fellow blogger, Mike Shedlock, notes that we are in a very slow monetary growth period compared to years past in his post: “Is the Fed Deflating?”

It is very easy to prove the statement “the Fed is not massively printing” but people believe what they want to believe. However, Fed policies have been such to enable super easy credit transactions to take place by holding interest rates too low too long. When interest rates are held too low, asset bubbles build and credit/debt transactions soar. So does the velocity of money. But the Fed ignores these bubble (in fact even embraces them) as long as consumer prices are held in check.

Mish hit upon some very important points:

1. Inflation is time-lagged.

2. Bubbles are not inflation.

3. People believe what they want to believe regardless of the facts.

Inflation is Time Lagged

Inflation has a place in any money. Yes, even vaunted and irreproachable monies like gold can and have experienced periods of strong inflation when the purchasing ability of gold declined significantly. One such gold inflation periods happened with the California Gold rush in 1849, and later after the discover of dissolving ore in potassium cyanide in 1887.

Indeed, money produces nothing, it is merely a confidence play, though some have industrial uses (gold as an electrical conductor, or paper money as a combustible material to name a couple). Money is a confidence game… nothing more, nothing less. Only barter economies approach removing the “confidence” value. These tend to be terribly inefficient, and are not likely to return, regardless of what happens to our monetary supply. In fact, in today’s global liquid markets, many other assets have taken the place of money as a hedge to traditional fiat currency systems systematic devaluation.

Monetary inflation is valuable to prevent price deflation. In fast-growing economies, where gross domestic output is increasing as well as a growing population, if money were to become scarce, prices would need to drop to reflect that scarcity. To the counterpoint, monetary deflation is also valuable to prevent price inflation. If money is plentiful, removing that money from the market keeps prices from spiraling higher and higher. These facts are accepted in economics textbooks covering basic supply and demand relative to the money supply, and is well understood in all economics circles. So, if the answer is so simple, why don’t we simply measure one and react with the other?

You shouldn’t be surprised that our Federal Reserve has tried just that.

Unfortunately, other factors keep popping up that throw the next administration for a loop.

First, it was productivity as a deflationary force.

Then, it was a credit orgy as an inflationary force.

Then, it was a “savings glut”, reserve currency, or some other reason as a deflationary force (stockpiling dollars, removing them from spending).

As you can see, managing supply and demand is not as simple when poor information is available about who is holding the currency, and what they intend to do with it. Especially since there is a time-lag.

Basically, introducing currency into a system does not provide an immediate change in prices. This works in excellent principle in economics textbooks in perfect countries with names like “utopiaville” and “Gilligan’s Island” where perfect information abounds and prices immediately reflect available money. In addition, money is instantly used on whatever provides the most utility.

Unfortuately, humans are irrational, greedy, and inefficient. Prices are sticky. Expectations vary wildly and change in an instant. In this environment, a steady, stable central bank that moves slowly and ignores short-term glances while focusing on the long-term is likely to be the most successful. There are no heroes in this arena. Middle of the road beaurocracts are the name of the game. However, when forced by the situation, herculean pushes against inflation and short-term fixes such as the time when Paul Volker crushed the inflation of the 1970’s in the US with double-digit Fed fund rates.

Unfortunately, this is not the 1970’s.

Bubbles are not Inflation

This is the era of financial bubbles. These are extremely irrational price moves of assets where fundamental values detach from the current values. Increasing investment and overdependence on a specific asset class produce outsized gains, and more pile on, creating a self-fulfilling prophecy of higher prices and greater inflation.

Then it happens.

The bubble pops. It becomes self evident that the prices moves were irrational, and it painfully returns to it’s longer-term trend. Bubbles are not price inflation, they are driven by inflation. The only way that bubbles can form is by a single enabling forces: monetary inflation. Instead of the money chasing a fixed set of goods and inflating their prices, humans instead choose to purchase assets. That’s not inflation. It may look like it, but it’s only temporary, not systemic.

Before you begin to think that I am a current FED apologist, consider what I believe to be the root of financial bubbles… monetary inflation. That is controlled by the Federal Reserve.

People Believe What They Want

Regardless of the facts. Much like the crush of public opinion when the housing bubble was in full-blown effect, there is now a crush of opinion beginning to build about systemic inflation. Indeed, there is a growing believe in the infallibility of precious metals as a store of wealth. This has all the seeds of a future bubble in precious metals. If asked where I believe the next bubble will be, I’d put my money on precious metals. (and have put some)

Getting back to inflation, however, inflation is much like anything in the financial world… it acts like virus, and once it has infected enough, it spreads on its own, creating a self-fulfilling expectation of increasing prices. Expectations (or confidence) is the name of the game.

Unfortunately, like a virus, the only way to kill it or severely wound it is to remove its source of food… money. If people expect things to cost more in the future, they will stockpile that thing now, increasing demand for it and consequently prices. It is possible that much of the inflation of the 1970’s was a reaction to many Americans stockpiling food, water, and other resources in the shadow of the cold war. The same way that people fearing being priced out forever, they purchase more than they need now in the chance that they might need it in the future. Many people bought houses much larger, and in much greater quantity than their needs or abilities dictated in an attempt to remove that fear of running out.

Summing it up

Are we experiencing inflation? It depends on what you consider to be inflation. Prices are rising of many consumer goods. Conversely, a massive bubble is violently deflating. People’s incomes are not growing as quick as prices.

However, I can be confident about making one prediction. If housing prices in bubble areas do not come down fast enough, wages will need to increase faster than they have been. And, the Fed will allow the first while fighting the latter. As they say… don’t fight the FED.

• Credit Bubble , Inflation
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