The Housing Bubble

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Bloomberg reports on California. “As the key spring U.S. homeselling season approaches, buyers are finding deals on new houses as builders focus on boosting revenue. Dwayne Saunders purchased a house in Eastvale, California, in December, paying $450,000 after builder D.R. Horton Inc. cut the price by 4.5 percent, threw in a washer-dryer and covered his closing costs. This month, the house next door sold for $404,000. ‘It was bigger too,’ Saunders said. ‘I think D.R. Horton just wanted to finish this phase and move onto the next one.’”

From New York Magazine. “Today, in an economically transformed New York, speculators seek profit where others fear to venture. They are rushing toward the margins ahead of an economic upheaval that people in Brooklyn real estate call ‘the wave.’ East New York runs south from Atlantic Avenue to the saltwater of Jamaica Bay. ‘It’s the last frontier,’ a Corcoran broker said as he showed me an Ocean Hill brownstone, purchased for $600,000 in August and flipping for $900,000 in November. ‘Until the next frontier—Brownsville and East New York.’”

“Who are all these investors? In Bushwick and Bed-Stuy, there are a few high-profile players, like Dixon Advisory, an Australian retirement fund that has recently been buying up dozens of properties. But most investors are locally based and stealthy. Several told me off the record that firms like Dixon are latecomers. ‘There are not any deals in Bed-Stuy,’ said one. ‘I think suckers are buying at $1.2 million thinking they will get $2 million.’”

The Houston Chronicle in Texas. “In the last two years, the multifamily market in Houston has boomed with sky-high occupancy rates and rents, hordes of new people moving to the city and thousands of units under construction. But the forecast for 2015 - in light of tumbling oil prices - is far less rosy, industry leaders said Tuesday at separate events on the local real estate market. Rent growth will drop off and job growth will shrink even as construction crews bring more units online, panelists said at the annual meeting of the Houston Apartment Association.”

“Kirk Tate, CEO of apartment builder Orion, said Houston has been ‘red-lighted’ by lenders. Brandt Bowden with the Hanover Co. agreed that capital for new construction has dried up in Houston. He said the drop could be a positive, as things heated up very fast in the last few years and construction costs became inflated. ‘Ultimately, there was a fever in Houston,’ Bowden said. ‘The drop in oil broke that fever. We are getting cautious.’”

The Okotoks Western Wheel in Canada. “Despite plummeting oil prices, Alberta’s real estate market is expected to remain strong, with only a slight decrease in sales expected from last year’s record numbers. For any first time buyers hoping to find a great deal, the CREB report actually forecasts a slight 1.58 per cent increase in prices, something Okotoks realtor Brad Pond said is simply due to constant demand. Home buyers will have a definite advantage this year, as the pressure won’t be as intense as last year, he added. ‘Buyers are walking into a more balanced market now, so it’s not going to be as high pressure for buyers,’ he said. ‘It’s a major, major purchase and people were having to make a snap decision in 2014 they were having to make that decision in literally minutes.’”

“Pond said it was tough watching buyers have to jump on a purchase as large as a house, and is hopeful that 2015 will provide more opportunity for a fair deal. ‘It’s the biggest decision of your life I always feel awful for people after a boom, especially people moving to Okotoks, they’re making this decision in a day and some people are encouraged to write an offer in order to win the purchase,’ he said. ‘They’re encouraged to write without conditions of financing or a home inspection and I just don’t think that’s right for a purchaser.’”

“The business of bundling riskier U.S. mortgages into bonds without government backing is gearing up for a comeback. Just don’t call it subprime. Hedge fund Seer Capital Management, money manager Angel Oak Capital and Sydney-based bank Macquarie Group Ltd. are among firms buying up loans to borrowers who can’t qualify for conventional mortgages because of issues such as low credit scores, foreclosures or hard-to-document income. They each plan to pool the mortgages into securities of varying risk and sell some to investors this year.”

“Reopening this corner of the bond market may lower consumer costs and expand riskier lending, aiding the housing recovery. The most dangerous slices created from the securitization of loans are also the highest-yielding, offering companies from private-equity firms to real estate investment trusts a way to increase returns as global central banks suppress interest rates to foster economic growth. ‘I go to conferences and no less than a dozen investors are saying they want these assets,’ said Michael Kime, chief operating officer of W.J. Bradley Mortgage Capital, a lender that started making some of the loans last year.”

The Washington Post. “On a cold Sunday afternoon 10 years ago, Comfort and Kofi Boateng stood with Comfort’s mother and their three children before a quarter-acre parcel in a brand-new subdivision in the center of Prince George’s County. The place was called Fairwood. Today, they struggle under nearly $1 million in debt that they will never be able to repay on the 3,292-square-foot, six-bedroom, red-brick Colonial they bought for $617,055 in 2005. The Boatengs have not made a mortgage payment in 2,322 days — more than six years — according to their most recent mortgage statement.”

“They came from a Ghanaian culture where credit is scarce and people built their houses with cash and lived in them for generations. Deeply religious, they found their real estate agent and mortgage broker at their church in Laurel. When their money got tight, they borrowed more and refinanced to take on more debt. Caught up in the mind-set of the time, they said, they thought they would be able to continue to refinance.”

“This was more house than they were expecting to buy, but they believed it would be a good investment. They said they thought it would go up in value, like their Germantown house, and they could use that equity to finance their children’s college educations. ‘The purpose of getting the house was to get our kids through college,’ Comfort said. ‘It wasn’t that we didn’t manage our money. We know in America, everyone owes something. We couldn’t get things done the way we expected. It happens to everybody.’”

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The Sylva Herald reports from North Carolina. “Modern safety features; extra beds Western Carolina University can’t afford; investor money flowing into the local economy – there’s a punch list of benefits from the student-housing boom that added half again as many beds in a three-year frenzy. Some fear another real estate bubble, however, as developers – many new to the student-housing niche – make decisions that seem based on the amount of capital they can secure, not on market needs. The specter of urban blight in rural Jackson County grows as fields and forests give way to apartment complexes that look more like Charlotte than Cullowhee. ‘It is too much,’ said Rick Bennett, a longtime Cullowhee real estate agent who rents to WCU students. ‘At some point, the law of supply and demand will weigh out. I don’t know when. But it will happen.’”

From Lehigh Valley Business in Pennsylvania. “Residential home sales in 2014 rose by 4.4 percent throughout the Greater Lehigh Valley. Carbon County saw a 10.5 percent increase in homes sold, jumping to 621 last year. At the same time, average sales prices fell 4 percent to $97,167. ‘When I looked at these numbers [closed sales], … a lot of this was foreclosed sales,’ said Cass Chies, broker with Diamond 1st Realty, Palmerton. ‘That’s what really spiked these numbers. There have been a lot of foreclosures that have sold, which is a good thing because the banks are moving their inventory.’”

The Washington Post. “Half the loans on newly constructed homes in Fairwood during the housing boom in 2006 and 2007 wound up in foreclosure — 723 of 1,441 so far, according to a Washington Post analysis. In Fairwood, one of the nation’s most aspirational black communities, houses once valued at $700,000 are going for $350,000. Legions of homeowners who bought high have seen their equity evaporate, and still labor under hundreds of thousands of dollars in debt.”

“In August 2006, Edith Garner, who taught special education at Benjamin Tasker Middle School in Bowie, was one of those who fell in love with Fairwood. She bought a townhouse for $427,213. She signed an agreement for an adjustable-rate mortgage with an interest rate of 8.875 percent. She was counting on a rising house market. ‘Everything was going up and up and higher,’ Garner, 58, said of the housing market. ‘I wanted to make money, too.’”

From Vegas Inc in Nevada. “Builders sold 611 new homes in Southern Nevada last month, ending 2014 with a tally of 6,007 sales, down 18 percent from 2013, according to Home Builders Research. The median sales price of last month’s closings was $291,785, down 2 percent from a year earlier. Overall, the results ‘are less than anyone projected,’ Home Builders Research President Dennis Smith said in the report. ‘The annual totals leave us disappointed but with an ‘it could have been worse’ feeling,’ he wrote.”

“Perhaps in a sign of weak finances and tougher lending requirements, buyers at one point were increasingly canceling purchases. In October, they backed out of 21 percent of new-home sales contracts in Henderson, up from 12 percent in April, according to Home Builders Research. In North Las Vegas, cancellation rates jumped to 34 percent from 25 percent in that period.”

The Miami Herald in Florida. “Miami’s housing market continues to outperform the nation, but its growth still lags behind the faster pace of recent years. Developers and market analysts said the slowdown was expected, and healthy. The growth in prices began to lessen last spring, and home sales have also slowed in Miami-Dade recently as the number of units on the market returns to pre-recession levels. ‘The party can’t go on forever,’ said Kwame Donaldson, an economist at Moody’s Analytics.”

“Demand for houses over the past two years has largely been driven by investors with a nose for a deal and Latin American buyers looking to purchase second homes, according to Donaldson. ‘But as prices go up, the bargains aren’t there like they used to be,’ he said.”

Bloomberg on New York. “Lower Manhattan’s Trump Soho, the five-year-old tower that was seized in a foreclosure amid slow sales of its condominiums, may drop its focus on part-time residences and operate most of the property solely as a hotel. The building’s new owner, Los Angeles-based CIM Group, is ’stepping away’ from marketing the roughly two-thirds of condos that remain unsold, said Gary Schweikert, the building’s managing director. The company is considering converting the unsold units at the tower permanently into hotel rooms, he said.”

“Seventeen condo units at Trump Soho are currently listed for sale, with prices ranging from $825,000 for a studio to $50 million for a 10,000-square-foot (930-square-meter) presidential suite, according to property-listings website StreetEasy.”

From China Daily USA. “A Chinese real estate developer plans to put up a 95-story residential tower but not in the city. It will be across the Hudson River in New Jersey’s waterfront. China Overseas Inc is building the tower at 99 Hudson Street. It will have 760 condominium units and be the ‘most significant condo project ever’ in New Jersey, according to the Jersey City mayor’s office. At 950 feet, it will be the tallest building in New Jersey when it is completed. An apartment in the 104-unit building starts at $16.95 million.”

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A report from the South China Morning Post. “Offshore bond sales by mainland property developers have stalled in January as rising investor fears of a flurry of debt defaults have junked one of the usually busiest months of the year for real estate issuance. With an estimated US$10 billion in offshore debt falling due for repayment this year and next, a bad January bodes ill for the ability of developers to refinance huge foreign borrowings. ‘Offshore refinancing will become more difficult and expensive for mainland developers this year and weaker players will suffer even more,’ Christopher Yip, a director of corporate ratings at S&P in Hong Kong, told the South China Morning Post.”

“Defaults by Kaisa Group Holdings are the main reason why investors are spooked. It was then that offshore investors realised that they ranked behind everyone else in the queue for repayment after onshore creditors asked for court protection to freeze Kaisa’s assets on the mainland. Specialist onshore financing vehicles had already launched a total of more than 10 products that extended 2.5 billion yuan in credit to Kaisa. Some of those products are due for repayment later this month and analysts expect the firm to struggle to make good on its obligations.”

“‘Trust defaults will blow up in the future given the sluggish property market,’ said specialist trust financing consulting firm Use-Trust Studio in a report.”

From Bloomberg on China. “After more than a decade of curbing the currency’s gains to help turn the nation into a manufacturing colossus, there are signs the People’s Bank of China is now propping up the yuan to stem an exodus of capital that’s threatening the economy. A key barometer of foreign-exchange flows on the central bank’s balance sheet, known as its yuan positions, fell 128.9 billion yuan ($21 billion) in December from a month earlier, the most since 2003, PBOC data show. China’s foreign-exchange reserves dropped to $3.84 trillion as of December, from an all-time high of $3.99 trillion in June.”

“Goldman Sachs Group Inc. says China’s official errors and omissions data point to a record $63 billion leaving the country in the third quarter of 2014. Bank of America Corp. estimates $120 billion of capital flowed out of China in the final quarter of last year. ‘Everyone thought the movie would never end, and suddenly it ended, so everyone is hurrying to leave,’ Kevin Lai, an economist at Daiwa Capital Markets in Hong Kong, said by phone. ‘The authorities need to think of a way to keep the audience in the theater’ as the economy slows, he said.”

“City Developments Ltd., Singapore’s second-biggest developer, warned last year that the local housing market may face ‘fire sales’ and mortgage defaults due to falling rents, especially for high-end homes. Rental prices of residential properties fell by 3 percent last year, URA data show. After five years of price gains, values are falling and defaults are rising. ‘Some of the properties in the auction are those where the owner has multiple properties and he can’t rent them,’ said Grace Ng, deputy managing director at broker Colliers International in Singapore.”

From Tribune India. “Karnal is among the cities in Haryana that have been in the grip of a severe slowdown in the realty sector for over two years now. There has been a significant drop in demand here and according to market watchers there has virtually been no sale-purchase in the city and its vicinity in one of the worst slowdowns so far. End users as well as investors have remained reluctant to enter the real estate market because of the paucity of funds, say local property experts.”

“Property prices have fallen by almost 30 to 40 per cent in most of the areas of the district. ‘I had purchased a plot in CHD City for Rs20,000 per sq yd in 2011. But now the price of the same has dropped and is between Rs13000 and Rs15000 per sq yard,’ says Vir Vikram Kumar, former president of Karnal Property Dealers’ Association. ‘But even this significant correction in the market has not brought back buyers here.’”

The Calgary Herald in Canada. “Unstable oil prices have created an unclear picture for what the city’s housing market will bring in 2015, say industry members. On the resale side, the Calgary Real Estate Board expects sales to ease by four per cent in 2015 and price growth of 1.5 per cent. Industry veteran Wendy Jabusch says she expects a slower stretch in 2015, adding the pull-back makes sense.”

“‘I think we are going to see the industry take a little bit of a pause, level off a bit and that’s perfectly fine,’ says Jabusch, Brookfield Residential’s VP of Calgary Homes. ‘What was happening over the course of these last couple of years is not sustainable. The run-up on prices, you just can’t keep increasing like that.’”

The Herald Scotland. “North Sea oil may be in decline but it is still central to the economic projections of the Scottish and UK governments. in conversation with those not employed in the oil industry, I note a surprising schadenfreude towards the current situation. While such a reaction is probably misguided, it is understandable. The presence of the oil industry has made Aberdeen an almost impossibly expensive place to live for those without oil-sector salaries. The cost of living, housing in particular, has been a major cause of the recruitment crisis in the health and education sectors.”

“The industry-wide inflated salaries are the principal cause of sky-high living costs. An acquaintance working as a contractor recently bemoaned a reduction in his day rate. It was hard to avoid responding, ‘welcome to my world.’ particularly as it wasn’t so long ago that he let me know that the rate was more than a £1,000.”

“The downturn in the price is an opportunity for the industry to take a close look at its costs. Some companies have already started the process with interesting side effects. The attendance at one company’s Christmas bash was way down on previous years. It wasn’t hard to find the reason: employees had to pay for their tickets and the bar was no longer free. Welcome to the real world.”

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The Detroit Free Press reports from Michigan. “Recently disclosed e-mails and documents give the clearest evidence yet that high-level banking officials pushed subprime mortgage loans knowing some Detroiters couldn’t pay them. The new documents were revealed in a potential class action by African-American Detroit homeowners against Morgan Stanley, one of the nation’s largest Wall Street investment firms. In e-mails in the 2004-07 period, Morgan Stanley staffers referred to the mortgages as ‘a bunch of scaaaarrryyyy loans!!!!!!,’ ‘crap,’ and ‘like a trash novel.’ In an internal memo dated April 14, 2006, Steven Shapiro, head of the firm’s trading desk, predicted a growing problem with mortgage foreclosures: ‘We should expect … a good percentage of the borrowers going into extended delinquency/liquidation.’”

“The following January, Shapiro e-mailed officials at New Century, asking, ‘What is going on with these loans??????????’ A New Century executive e-mailed back, ‘You mean besides borrowers who apparently don’t have the money to make their mortgage payments? (Sorry to be flip …)’”

The Washington Post. “African Americans for decades flocked to Prince George’s County to be part of a phenomenon that has been rare in American history: a community that grew more upscale as it became more black. In the early 2000s, home prices soared — some well beyond $1 million — allowing many African Americans to build the kind of wealth their elders could only imagine. But today, the nation’s highest-income majority-black county stands out for a different reason — its residents have lost far more wealth than families in neighboring, majority-white suburbs. And while every one of these surrounding counties is enjoying a strong rebound in housing prices and their economies, Prince George’s is lagging far behind, and local economists say a full recovery appears unlikely anytime soon.”

“Denise Watson bought a two-bedroom townhome in the Villages of Marlborough in 2005. She saw the home, which cost $315,000, as a good first step to building some equity as the years wound down on her 24-year Air Force career. But now the investment she thought would help her build wealth has left her nearly $100,000 in the hole. The dizzying downturn and weak recovery have caused many of her neighbors to simply walk away even as Watson and her husband have made every mortgage payment. ‘I feel stuck, which hurts after you have worked so hard and done everything that society says you are supposed to do to grab your piece of the American Dream,’ she said. ‘I would never have thought that in all my years this would happen.’”

The Advertiser in Louisiana. “Oil service giants Schlumberger, Halliburton and Baker Hughes — they all have a significant presence in Louisiana — recently announced layoffs. Although oil prices have plunged aplenty over the past six months, today’s oil business problems are light years away from what they were in Lafayette in the 1980s. Tom Hebert, who chairs the Young Professionals of LAGCOE, recalled those rough days as a young child. ‘As a kid in the early ’80s, everyone had a Cadillac in the driveway and a brand new house. It was similar to the time of the last few years,’ he said.”

The Dallas Morning News in Texas. “The big run-up in apartment building may run out of steam this year. Apartment construction across the country has more than tripled since 2009. Last year developers started more than 350,000 multifamily housing units nationwide. Analysts say that apartment construction increases should dwindle in the next two years. And a slowdown in Texas’ economy could play a part. In North Texas at the end of the year, more than 30,000 apartments were being built in the Dallas-Fort Worth area compared with about 26,000 single-family home starts in the area in 2014.”

“In Houston the dramatic fall in oil prices and layoffs by energy firms are reducing development. Houston-based apartment architect Sanford Steinberg said he’s already seeing the impact of the energy sector pullback. ‘Projects are being put on hold,’ Steinberg said. ‘They are not killing the project but putting them on hold. In the last few years we have been going crazy building multifamily housing, not just in Houston but all over the country,’ he said. ‘I worry about the multifamily sector overbuilding. It’s the one residential sector that has the greatest access to credit. There is a history of builders building more because they can get credit than because they can fill up the units.’”

The Bend Bulletin in Oregon. “Foreclosure filings dropped 58 percent in Deschutes County last year, according to figures from the county. Oregon’s foreclosure process has delayed a full recovery in the housing market, John Helmick, Gorilla Capital CEO, said in a news release earlier this month. He expects about 600 new foreclosures to be filed monthly in the first half of this year in the counties tracked by Gorilla, which buys foreclosed homes, redevelops and sells them. Changes made to state foreclosure laws over two legislative sessions led to the delayed recovery, he said.”

“Each change, however, brought the foreclosure process to a crawl. As the housing industry adapted to the new rules, the process ramped up again, Helmick said in the interview. ‘It’s like resetting the ceiling fan,’ he said. ‘Turn it off. Wait for it to stop. Then start it on again.’”

“In Deschutes County, nonjudicial foreclosure filings — called notices of default — doubled year over year, from 67 in 2013 to 134 last year. Lynne McConnell, associate director of HomeSource at NeighborImpact, said her agency continues to see homeowners seeking foreclosure counseling. ‘I believe there were eight new cases the week of New Year’s alone,’ she said. She attributed the decline in Deschutes County filings overall to rising home values in Bend, where homeowners behind on their mortgages may now sell their homes at a price that allows them to satisfy that debt. That advantage, she said, has yet to reach beyond the city. ‘That’s very localized to Bend,’ she said. ‘It hasn’t reached the outlying areas, which are still under water. The banks are still catching up on their filings, I think.’”

From Westside Today in California. “As we began 2015, the number of homes available for sale in Brentwood was not as low as it was a year ago. However, there are only 50 homes on the market, which is the same supply as at the beginning of 2013. Due to the high demand for Brentwood houses especially under $2 million, the median $3.7 million list price is almost unbelievably 70 percent higher than it was two years ago, and 23 percent higher than one year ago.”

“A number of factors have contributed to this continuing lower supply. One is that some owners who have been leasing their home rather than selling in the down market have not yet made them available for purchase. Another factor is that the level of purchasing by investors has continued to increase through 2014, putting pressure on the market in many Brentwood and other Westside neighborhoods. Additionally, banks own only a few Brentwood homes, which have not yet been listed for sale. Also, 20 local homes are either in pre-foreclosure stages or already have had bank auction dates scheduled.”

The Sun Sentinel in Florida. “Home prices in Broward and Palm Beach counties leveled out in 2014 but still finished the year on an upswing. Prices surged following the downturn but have cooled since then. Marisa DiLenge, a Broward agent with Better Homes & Gardens, said the market remains steady, but it’s nowhere near the frenzy of 2013 and early 2014. ‘The values are still there, the phone is still ringing, buyers are still coming out, but I’m not getting the offers I normally get,’ she said.”

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This is a weekend topic on the effects of Fannie Mae, Freddie Mac, the Federal Reserve’s bond ownership and deflation. From the CBO’s report, WARNING PDF. “Outlays increased for several major categories of spending: Outlays rose for the each of the three largest mandatory programs: Medicare,by $18 billion (or 15 percent), primarily because ofa large payment made to prescription drug plans in November 2014 to account for unanticipated spending increases in calendar year 2014; Medicaid, by $16 billion (or 23 percent), largely because some of the provisions of the Affordable Care Act did not take effect until January 2014; and Social Security benefits,by $9 billion (or 4 percent).”

“Much of the increase in spending occurred because payments to the Treasury from the
government-sponsored enterprises Fannie Mae and Freddie Macwere $32 billion less in December 2014 than they were in December 2013, when Freddie Mac made a one time payment of about $24 billion after a revaluation of certain tax assets significantly increased its net worth. (Those payments are recorded in the budget as offsetting receipts—that is, as negative outlays.)”

“Net Outlays for GSEs: Actual, FY 2014 -39 billions.”

The American Enterprise Institute. “The Fed’s $3.5T QE purchases have generated almost half a trillion dollars for the US Treasury since 2009. On its $4+ trillion portfolio of fixed-income securities, the Fed earned an average interest rate of about 3%, which generated the $116 billion of interest income last year for the Fed. To provide context for that amount of interest income, consider that all nearly 7,000 FDIC-insured US banks together earned only $116 billion in net income during the first three quarters of 2014, and will probably end up with about $155 billion in net income for the whole year.”

“After accounting for operating expenses and other costs (currency issue, interest expenses, dividends, etc.), the Fed paid ‘residual earnings’ to the US Treasury last year of $98.7 billion. That annual Fed distribution to the Treasury was the largest ever, and brings the total amount distributed since QE started in 2008 to almost half a trillion dollars — $469 billion in the six years from 2009 to 2014.”

“That was a point made today by the WSJ in its staff editorial ‘The Fed Cash Machine,’ which pointed out that QE has made the Fed’s annual distribution of ‘residual earnings’ a significant revenue source for the US Treasury: ‘For perspective, the entire federal budget deficit for fiscal 2014, which ended in September, was $483 billion. Without the Fed’s windfall, it would have been nearly $100 billion more. Corporate income tax revenue in 2014 was $321 billion, so the Fed turned over nearly 30% of the amount provided by every American corporation.’”

“Treasury is spending the Fed’s windfall, naturally, which means that when the QE boom ends the country will have to spend that much less or find the revenue somewhere else. The danger is that politicians are getting used to the money, which is one more reason for the Fed to begin winding down its balance sheet sooner rather than later.”

“Bottom Line: While the record transfer of almost $100 billion from the Fed to Treasury last year has gotten some media attention, what hasn’t been reported, except by the WSJ today is this: The monetary expansions known as QE1, QE2, and QE3 ended up being a gigantic transfer of wealth from the private sector to the public sector. By ‘acquiring’ almost $3.5 trillion in assets with a ‘magic checkbook’ that were previously held largely by private investors and the private sector, those trillions of dollars in Treasury and MBS securities, along with the billions of dollars in interest income those securities generate, got transferred to the Fed, which has then transferred almost half a trillion dollars in residual interest earnings to the US Treasury in the last six years.”

“Q: Is that fair/accurate to describe QE1, QE2 and QE3 — as monetary policies that ultimately transferred billions of dollars in private wealth to the US Treasury via the Fed? Or is it more accurate to describe it as printing money to finance the government’s budget deficit disguised to look like monetary policy, since the bond holders got paid for their securities? (Thanks to Jeff Dorfman for help with that second description.)’

“Update 1: Or here’s how Jon Murphy describes it in an email: ‘The Fed is just printing money and giving it to the Treasury but ‘laundering’ it through bonds.’ Update 2: Another way to think of the Fed’s $3.5 trillion acquisition of assets through QE1, QE2 and QE3 is to view the Fed as the ‘world’s largest hedge fund’ — see posts by Scott Grannis here and here for details.”

From Money Week. “Merryn Somerset Webb interviews Paul Hodges about the global economy’s ‘Great Unwinding’, and how Britain’s house prices could halve. Merryn: ‘Paul, when we last spoke you predicted a fall in oil price –you said that you thought the oil price would fall from $80 to $50 by the end of last year, and at the end of last year you were saying you thought it would be down at $50 in the first half of this year, so you’ve already been proven very, very right. Can we just talk briefly about what the basis was for that forecast?’”

“Paul Hodges: ‘Yes, it’s what we call the ‘great unwinding’ of policymaker stimulus that if you look at where we’ve been since our last interview here two years ago, central banks have pumped more and more money into the economy. As a result, we’ve had a sugar high, really, where financial markets just go up in a straight line. In China, people got the idea that somehow suddenly China had become middle class, and so there was this enormous demand and there was free money from the Fed and the Bank of England, so everything looked wonderful.’”

“‘It was a complete and utter charade from beginning to end. There has never been, since 2009, a single moment anywhere in the world where there was a supply shortage, a customer didn’t get the oil, the petrol, or anything else that they wanted, but it was all built on wishful thinking from the central banks. They were saying, ‘We can create demand by printing money.’ The problem is, if you look at the markets, the futures market, where the financial players took the money from the central banks and they went into the… They wanted a store of value, because every pension fund in the world knew that Ben Bernanke and Janet Yellen wanted to devalue the dollar. As a result of wanting to devalue the dollar, pension funds looked for a store of value. That, of course, was oil, because everybody uses it, very large market, and it’s priced in dollars.’”

“‘What you saw, instead of financial players and physical players – the oil companies, people like us who buy to use for transport and for heating and so on – instead of a balance of one-to-one, you’ve suddenly got six times as many financial players going into the market. What happens? Of course, the price rises and goes from $30 at the end of 2008 up to $120, because you can’t print oil in the way that you print money.’”

“Once you start deflating a bubble, it doesn’t go slowly, it bursts. This is what you saw happening in July and August. That was why we made the call in the middle of August, we said, ‘The oil price is now going to collapse, and the obvious logical corollary of that is the dollar is going to go very high indeed,’ and we’ve seen that – the oil price down 50%, the dollar up over 10%. The dollar going up 10% may not immediately, if you’re thinking in pounds and so on, become very important, but it’s absolutely critical because you’ve got $6trn or $7trn of debt in the emerging economies all tied to the dollar, all thinking, ‘We borrowed at 1%. Aren’t we clever?’”

“It was 1% then, but now it’s 1% plus 12% increased value of the dollar, so you’re going to see bankruptcies all over the emerging economies – and, of course, you’re going to see bankruptcies all over the States because people have spent $1trn.”

“It’s terrible, this word ‘trillion’. Before 2009 I didn’t know what the word ‘trillion’ was. I used to think billions were rather a lot.”

“Merryn: ‘So, bankruptcies in the US connected to the huge infrastructure spending in the energy sector?’ Paul Hodges: ‘Yes. The US economy is now riding for a fall. We don’t know how big it is, but if you look at jobs growth since 2009, it’s all – and I mean ALL, with capital letters – being tied into the oil and gas exploration bubble, so all the rest has not moved at all. If you look at the housing recovery, such as it’s been – it’s been 600,000 to one million, which sounds good, but when you’re coming down from two million it’s not so good – that 400,000, most of that new house building has been in Texas in the oil belt, because I was in Houston summer last year; 10,000 people a month were coming into Houston, so you’re building a lot of houses.’”

“Merryn: ‘So, the USA economic recovery has been very heavily leveraged to the shale boom, which in turn was caused by very low interest rates in QE.’ Paul Hodges: ‘Yes.’”

“Merryn: ‘So, as that reverses, we can only expect the US economic recovery to just disappear?’ Paul Hodges: ‘My view of it all is the Fed is actually irrelevant here, that the real action is over in China, that the Fed could do maybe a $10trn final blast, but would the new Congress actually allow that to happen? It’s an interesting question. I don’t know the answer, I just raise the question, but if you look at what’s happening in China, you see that the property market taxes… Property taxes paid last year in China fell 30%. That’s a pretty big downturn in one year.’”

“Merryn: ‘Final question: is it possible for a deflationary environment to persist when central banks can print as much money as they like and shovel it into the economy in a variety of different ways?’ Paul Hodges: ‘People have to want to spend, and if you don’t need to buy anything and if you are fairly cautious about knowing exactly how long you might live, then it’s quite difficult, I think, to encourage people to spend. The central banks, the economists, work on this theory, which was fine at the time – Modigliani’s theory – which said that we all know how long we’re going to live and therefore we consciously make a decision to hold back on consumption today so that we have something left for the future.’”

“‘That was fine if we were all dying at 50 because you weren’t holding back very much, you were just getting more money as you got… But if you’re living to 80 or 90, say, how long are we – you and I – going to live? We don’t know, so probably, if we’re sensible, we’re going to err on the side of caution.’”

“Merryn: ‘This is our worry – that they could. They have the ability to do so; anyone can create inflation if they really want to.’ Paul Hodges: ‘Yes, but what I hope is that common sense prevails and that we abandon these out-dated economic theories. Milton Friedman came along and he said that inflation was ‘Always and everywhere’ – and monetary – but he’s wrong, of course; he’s completely wrong. He was working during the baby boom in the States. The States had a 50% increase in the number of babies being born over an 18-year period. Of course there was massive demand, of course there was no supply…Friedman confused cause and effect.’”

“We’ve had six years, let’s face it, six years of central banks believing that Friedman was right and saying, ‘If we put out enough money, then we will end up with inflation. Sorry about that.’ Could we have some common sense on this which says, ‘If you’ve got an older population, you’re not going to want to spend,’ and could we please, instead of being negative about all these older people, could we not celebrate this and say, ‘Isn’t it wonderful that our society has achieved this?’ Does it really matter if we have GDP? Let’s face it, before 1929, which isn’t very long ago, nobody measured GDP, so for thousands of years people were pretty happy and getting by without thinking about…’”

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