September 17, 2016

The Way All Such Madness Ends

An Economic Letter from the Federal Reserve Bank of San Francisco. “The collapse of an asset price bubble usually creates a great deal of economic disruption. But bubbles are hard to anticipate and costly to deflate. As a result, policymakers struggle to determine how they should respond, if at all. Evaluating the economic costs of past equity and real estate bubbles—with particular attention to how much credit grew during boom phases—can provide valuable insights for this debate. A recent study finds that equity bubbles are relatively benign. More danger comes from housing bubbles in which credit grows rapidly.”

“How should a central bank respond to an asset price boom? Rudebusch (2005) provides a detailed road map. It all depends on how early one can tell that there is a bubble, and whether the costs of different policy interventions outweigh the benefits. Central banks monitor asset markets closely since they provide timely information on broader economic conditions. However, it is often difficult to tell the signal from the noise. Fluctuations in asset prices reflect a varying mix of fundamentals and speculation. Uncertainty about these mixed signals has often stayed the hand of policymakers, much like a monetary version of the Hippocratic admonition, ‘First, do no harm.’”

“Financial crises often follow credit and asset price booms that collapse abruptly. But many booms in credit and asset prices do not end up in a crisis or even in a garden-variety recession. This is the policymaker’s conundrum, to distinguish booms driven by speculation from those driven by fundamental economic forces.”

“We cannot provide a definitive answer to this debate. However, our research highlights the need to pay particular attention to conditions in housing and mortgage markets, rather than those in equity markets. The collapse of a leveraged housing market is still as dangerous today as it has always been.”

From CNBC. “Jim Bianco, president of Bianco Research, and CNBC’s Rick Santelli debated the potential repercussions from the ongoing money-printing bonanza from central banks around the world. ‘If you want to complain, you can’t complain when the stock market is at an all-time high and yields are this low, because everyone is trapped in the relative performance game,’ said Bianco. ‘This is like ‘99 with tech stocks or 2006 with real estate.’”

“Bianco believes that as long as asset prices continue going up, everybody ‘keeps rolling their eyes’ and looking the other way. ‘Today it’s a new era that central banks are running everything,’ he said.”

From MarketWatch. “U.S. Treasury bonds — backed by the full faith and credit of America — are considered the safest investment in the world. No longer. Friday’s sudden market tremor may herald the end of the bond bubble. Or it may just be the beginning of the end. But either way, this bond-market madness is going to end the way all such madness ends — with ordinary people losing money.”

“So far this year, U.S. wage inflation has averaged about 2.1%. So it would be reasonable to assume that in due course general inflation will be at least that, if not more. That means your 10-year Treasury will actually leave you poorer, in real terms. This, of course, is assuming that inflation does not gather speed — which it has usually done in the past. If inflation runs above 2.1% a year, someone buying a bond paying just 1.6% will get hosed.”

“The general principle of investing is to save $100 today in the expectation of having $110, or $150, down the road. Saving $100 today in the hope of having $90 in 10-years’ time seems an odd way of doing things.”

“There’s no great mystery to why the U.S. is in this situation: sluggish growth, low pricing power, and central bank activity around the world since the financial crisis of 2008. Plus one other factor: Few investors today can remember anything but a bull market in bonds. The Treasury market bottomed out in 1982 and has been largely on the way up since then. But bonds are called ‘fixed income’ for a reason. The coupons on your bond won’t rise. So there is a limit to how much you should pay for them.”

“Future generations may look back on this moment with amazement. They may ask, ‘What were people thinking?’”

The Dallas Morning News in Texas.”With home prices in the Dallas-Fort Worth area soaring over the last few years, local property owners are sitting on billions of dollars. Texans have some of the highest home equity rates in the country, according to CoreLogic. With so much money locked in housing, the number of consumers breaking into that piggy bank is growing. Homeowners are refinancing their properties to pull out cash or getting lines of credit tied to the equity in their homes.”

“‘Home equity lines of credit were up 36 percent in the second quarter compared to a year ago in Dallas,’ said Daren Blomquist, economist with Attom Data Solutions, formerly known as Realtytrac. ‘The increase in HELOCs in Dallas was the largest in any of the 74 metro areas we track nationwide.’”

“Currently almost 64 percent of home loans made in the U.S. are refinancings. The share of cash-out refinancings is at the highest level in eight years — about 10 percent, according to Freddie Mac. But cash out refis nationwide are still about a third of what they were before the Great Recession. In the first quarter of 2016 alone, U.S. homeowners got almost $16 billion from cash out refis and home equity lines of credit.”

“Tough credit standards should keep consumers from using their houses like a cash machine with no limits, said Jonathan Smoke, chief economist with ‘It does not look like The Big Short all over again,’ Smoke said. ‘I would expect that an increase in cash-out refinancings and more HELOCs would be a logical result of recovering home equity balances, and that would be most significant in markets like Dallas where home values are at record levels.’”

From CBS DFW in Texas. “The house-flipping craze is hot and busy in North Texas. A new report by ATTOM Data Solutions shows the number of houses being flipped and the number of flipping investors are both at a nine-year high.”

“Daren Blomquist, the senior VP of communications at ATTOM, said the numbers are easy to interpret. ‘What’s that’s telling us is that there are more people kind of jumping on the flipping bandwagon, it’s not just some of the bigger, more established investors. It’s folks who maybe saw it on TV and think, ‘Well, we can try our hand at home flipping’ and they’re getting into it as well, thanks to the vey strong housing market.’”

“Apparently the flipping frenzy start to really kick in over the last two years and there have been nationwide increases over each of the last five quarters. Blomquist said, ‘Now in the second quarter we saw more than 51,000 properties flipped across the country. That was the highest level we’ve seen going all the way back to the second quarter of 2007.’”

“‘People definitely need to be careful if they don’t have experience in flipping, because it’s inherently a very highly speculative activity,’ he said. ‘You’re betting on the market to be behaving in a certain way in six months or a year, when you’re done rehabbing that home.’”

“There are also some concerns for amateur flippers in Dallas who seem to be operating on are very low purchase margins and not leaving themselves leave themselves a very big cushion. ‘In Dallas we’re only seeing that flippers are purchasing at a 6-percent discount below the property estimated full market value. Where as nationwide flippers are buying at a 26-percent discount,’ Blomquist said. ‘The problem with that is [flipping] it is very speculative and very reliant on the market continuing to go up at the same pace that it has been. And that’s where flippers can sometimes be caught and really lose a lot of money.’”