Can The Fed Reflate The Housing Bubble ‘Monster’?
One reader is interested in Fed policy. “Ok; the housing market is rolling over. I’d like to hear from the minds on this blog if it will continue to do so, and why, if Ben Bernanke stops raising interest rates soon?”
“What if he starts cutting rates towards the end of this year like some are suggesting? Could this MONSTER re-inflate ??”
Others ask about the yield curve. “I’d like to hear some more analysis of the yield curve. People here predicted it would invert, and eventually it did, but it didn’t stay inverted for long. What do people make of the short time it was inverted and its current state?”
And, “It would be interesting to see if the current prolonged flat period was matched by points in earlier cycles when the curve inverted.”
Reuters looks at the issue. “Federal Reserve Chairman Ben Bernanke leads his first policy meeting this week, one all but certain to end with another U.S. interest-rate increase and perhaps a suggestion a 21-month run of credit-tightening is almost over. U.S. economic growth is on track for a thumping performance in the quarter of the year. But softer-than-expected new-home sales in February point to weakness in the second half.”
“‘The Fed definitely wants the economy to slow. What’s going on in the housing market now suggests that close to enough may have been done so that the Fed really doesn’t have to pound the economy over the head,’ said former Fed Governor Lyle Gramley.”
“Unfortunately, the Fed’s policy statement is about as obfuscatory as the English language will allow. Unless Chairman Ben Bernanke takes the unusual step of spelling out his intentions in clear prose, Wall Street’s uncertainty will continue. There are few market-moving economic reports due in the coming week, but there are a few that could prompt investors to change their strategies.”
“Home builder Lennar Corp. reports earnings Tuesday morning. After a strong 2005, Lennar’s stock has fluctuated widely as investors questioned whether the housing boom is over or not. The stock closed Friday at $59.92, down 13 percent from its 52-week high of $68.86 July 28.”
A reader sent in this tip. “Standard & Poor’s Ratings Services today revised its outlook on New Century Financial Corp. to negative from stable. ‘The outlook revision reflects Standard & Poor’s concerns regarding deterioration in profitability metrics that began to emerge in the last two quarters of 2005 as a result of industry-wide developments,” said Standard & Poor’s credit analyst Anne Cosgrove.”
“Like many other subprime mortgage lenders, New Century has seen profit margins erode during late 2004 and 2005, as a flattening yield curve pushed up funding costs while intensifying competition limited New Century’s ability to increase interest rates charged on loans originated.”
“Standard & Poor’s remains concerned about the prospect of asset quality deterioration in 2006, which combined with unpredictable subprime market conditions could further erode profit margins. Standard & Poor’s is especially sensitive to the adverse effect rising interest rates might have for the debt service burden of New Century’s subprime customers.”
“As a result, Standard & Poor’s can envision a scenario in which credit costs could rise at the same time the company is struggling to maintain production volumes, preventing any recovery in profitability metrics. If profitability metrics fail to improve and asset quality metrics materially deteriorate, the rating could be lowered.”
once the expectation of future returns diminish the amount of risk home buyers are willing to take on also diminishes, which in this case means even if interest rates stabilize i think less people will use the alternative mortgage products like I/O’s and option arms which have had a significant effect in driving outsize price gains.
I think speculation and I/O mortgages will not come back; that will probably lead to a mild downturn in some ‘hot’ areas. But easy money is still everywhere and as long as the credit spigots are wide open nothing has changed; I don’t see any sign that the FED is wanting to change this.
Can the fed re-inflate? Of course they can. They are almost entirely responsible for the bubble in the first place. They created the monster. The question is what do they do with it, NOW? Can they engineer this utopian “soft landing”? In my opinion the housing market is unstable because of all the leveraging. The fine tuning to keep it in check to the up or downside isn’t there and to a great extent it’s up to foriegn $$$$ and what’s done with it. If MBS start seeing losses the fuel dries up and there’s a chain reaction that the Fed will have a tough time wrestling with.
The real question is how motivated are they to see this keep running in the world make-believe finances? They don’t like an overheated RE sector. It diverts too much $$$$$$$ from the more productive sectors of the economy. They also have the dollar to protect…
I wouldn’t want Bernanke’s job. Kill the residential RE sector now or have it come back and kill you later are the choices he’s facing.
I have a question. I’m probably a financial dummy but the average worker has been experiencing std 3-4% raises/year which does not keep up w/inflation. (Back when I worked I got 6-7.5%) If this situation changed and suppposedly many companies are now flush with profits, could this reinflate?
As-Reported inflation numbers are total BS. Upward wage pressures are becoming apparent already. Add Chinese unfair trade practices and any remedies being proposed and, the prospect for illegal alien employment crackdowns and a major run in inflation is the clear path of least resistance.
Either interest rates go up or the dollar gets crushed (or both) - IMO.
“What if he starts cutting rates towards the end of this year like some are suggesting? Could this MONSTER re-inflate ??”
I don’t think so. The yield on the 10 year note has not moved much in response the campaign of interest rate hikes so far. So, there is no guarantee that cutting the Fed Funds rate will lower long term interest rates. In fact, inflation fears may cause long-term rates to push higher.
Also, the last housing bubble in the late 80’s early 90’s collapsed in an environment of falling rates. Cutting rates did not help that bubble stay afloat, but it could have mitigated the fall. During that time, interest rates were much higher so the Fed had more room to cut.
The housing craze may have started due to low rates, but it is being sustained by irrational bubble thinking. Even with low rates, affordability is dismal in many markets. This ship is going to sink and nothing is going to stop it.
“The yield on the 10 year note has not moved much in response the campaign of interest rate hikes so far.”
Is this due to market forces or govt manipulation of the curve, and how can you tell? The curve has been flatter than Kansas for a long time, and Kansas is flatter than a pancake, in contrast with the normal behavior of an efficient market driven by the decisions of many individuals on both the buyer and seller side of the market…
Some have suggested that the Fed could intervene at all points of the duration spectrum in order to get the curve to do whatever they chose, and I would like to hear evidence to the contrary if there is such…
if there is one man who has argued for FED intervention at all points of the duration spectrum it is Ben Bernanke. Proof enough to me for what is happening …
“Some have suggested that the Fed could intervene at all points of the duration spectrum in order to get the curve to do whatever they chose, and I would like to hear evidence to the contrary if there is such…”
Well, this would mean that the Fed WANTED the yield inversion, which seems extremely unlikely to me. I think they didn’t want it but couldn’t control it.
Don’t forget, interest rates are only one part of the affordability equation. Sooner or later HIGH prices stop sales. We are at that point now. Most people have aleady brought (not counting divorce sales, moving for a job, etc) for investment purposes. These investment, second house sales are about dried out IMHO.
Doesn’t matter what the interest rate is. If you can’t buy you can’t buy!
The reflation will only be mildly succsesful, because the the dollar will tank because of the inflation and low iterest rates. You think $3/gal for gas is bad … you aint seen nothin yet! And of course that will sink the economy (what little is left), and eventualy, houses will go down in price again. I hope the FED doesn’t reflate. Let’s get this over with!!!
If you can’t buy you can’t buy!
just look at what happened in countries like the UK and Netherlands which were at a similar stage about 5 years ago.
If you can’t pay, the RE/mortgage sector just invents more funny subsidies or commit fraud to make it possible. Prices can keep rising for a long time even if everybody is theoretically priced out.
And obviously, if the FED blinks and reflates (and I expect that to happen) all bets are off.
Nah… people are going through a fundamental psychological change now. For the past few years people have been driving through neighborhoods looking at houses and seeing giant treasure chests… now more and more people are taking a second look and seeing giant coffins instead.
Once that happens to enough people there’s no going back.
Yikes people, the man owns a printing press. He can begin printing money and buying MBSs until interest rates on 30Yr fixed mortages drop to 3% -REGARDLESS OF WHAT HAPPENS WITH T-BILL RATES. Once mortgage rates are at 3% PITI will fall back in line with rents and we’ll have the permanently stable plateau that the RE bulls keep going on about. Or if that’s not enough then he can keep paying more for the MBSs until they fall to 0%, or -5%, or -100%. He can drive price levels on real estate to whatever his little heart desires. The only thing that he can’t do is keep real estate permanently inflated without igniting general inflation.
If I were him then my goal would be to end the speculation while having a scape goat ready to accept the blame for the pain. Then once the collapse has started he can come in and support RE prices to prevent recession from turning into depression.
So my guess for the end game is that he keeps raising short term rates until the collapse begins and the speculators are driven out of the market. At this point the mortgage and appraisal fraud scandal should explode onto the front pages. You will see endless news reports, loan originators doing their perp walks, congressional hearings, etc. Until it is drummed into the common person’s psyche that, “IT’S ALL THE CROOKED LOAN ORIGINATORS FAULT”. Then we get the news conference. I can see it now, Bush at the lectern, Bernanke on his left, Snow on his right.
“My fellow americans. As you have no doubt become aware, through the actions of unscrupulous financiers, millions of hardworking, honest americans have had the dream of homeownership turned into a nightmare. The actions of these unscrupulous few have brought our economic system to the point of crisis and caused widespread pain throught the economy. To stabilize the situation I have directed Chairman Bernanke and Secretary Snow to create a fund to inject much needed liquidity into the real estate market, and stabilize home prices. While homes will never again be a source of unearned riches they can, over time, return to what they should be, a place for real american families to realize their dreams of hearth and home. Good night and God bless.”
Then we get to sit around and wait for this to collapse the dollar in the foreign exchange markets. Thus creating insta-inflation in everything that we import and export, which at this point is everything except houses and wages. What fun!
“he can keep paying more for the MBSs until they fall to 0%, or -5%, or -100%”
yes..but desperation moves of that level would crash the stock market, the US dollar and the bond market too…so it STILL won’t rescue real estate in my opinion; by that point the entire economy would be finished
“IT’S ALL THE CROOKED LOAN ORIGINATORS FAULT”.
Interestingly enough, someone in government would be telling the truth for a change.
Yes and No. Money wouldn’t have flooded into MBSs if Greenspan hadn’t lowered the FF rate to 1%.
Your story depends on a great deal of ignorance and/or complicity on behalf of the bond market. Not to say that this is impossible, given the evidence of such from the housing market…
The bond market knows that the game is rigged. As long as they know how it is rigged so that they can profit from it they don’t care.
Ditto for the stock market. But as Malkiel astutely notes and supports with a plethora of statistical evidence in his book “A Random Walk on Wall Street,” even the most rigged and belief-suspended market eventually reverts to fundamental values. This is happening now in the housing market, as the wave of supply hitting the market will swamp any efforts to prop up the prices through govt and industry tricks to artificially stimulate demand.
Ahhhh. I never said what I thought would happen to the real value of houses. That I think will go down no matter what the Fed tries. My point is that they can set nominal values to whatever they want.
The Fed can pump liquidity into the market….They just can’t say where it goes. I’ll bet that AG’s biographers will say that the cash put into the system post 2000 was destined for businesses. It ended up in houses.
More liquidity will end up in greater inflation. The liquidity trap looms large. At 4.5%, there is little room to move.
I can agree with much of it, but the perp walk? Let’s face it, you’d get more hard time for stealing a VW than a billion dollar fraud –if in doubt, Arthur andersen, Enron, Worldcom, GlobalCrossing, etc.etc.
It depends on how much heat they are getting and how much responsibility they have to unload. Think Abu Graib. The military decided to publicly persecute as many grunts as was required to keep any accountability or responsibility from the people who actually gave the orders. The independent appraisers who were required to falsify appraisals or go out of business will be the ones put on the show trials.
I recall so many loser decrying, “Our gov. should be run like a corporation”.
It sure looks like that’s what they’ve got. The cowardice of the current group of leaders is astounding.
Please keep your politics out of this blog.
Ah, what a wonderful world it would be if money were something fixed and immutable like gold instead of being subject to the whims of politicians.
But that’s not the world we live in. Monetary policy and politics are joined together at the hip. Greenspan started inflating in 1995. Perhaps that had nothing to do with bolstering Bill Clinton’s reelection campaign, but it did. When the tech bubble that was created by that money printing burst, perhaps Greenspan should have let the imbalances correct through a recession or perhaps lowering interest rates to 1% was the right thing to do. I don’t know although I have my opinions. But one thing I know for sure. If Greenspan had kept rates high Bush would have been a one term president. Lowering the interest rates created the temporary prosperity of the housing bubble which made him a two term president.
In my view, breaking the link between monetary policy and politics is one of the strongest arguements for a return to the gold standard.
It really is all connected bulwark!
to diemos:
I agree with most that you are saying; however, I think that Greenspan started inflating right away, in 1987. He has followed the same recipe ever since: every crisis or perceived threat was countered with a flood of money printing which often was the start for the next crisis.
He has been a serial bubble blower, and because of this policy the bubbles became bigger and more frequent.
Wallstreet and politicians loved it, because they can make fat profits from this very predictable inflation politicy.
This can only end badly but I agree with you that we could see some more (and even bigger) FED bubbles before the whole financial system blows up.
Housing bubble = money/economics = politics. The housing bubble does not exist in a vacuum.
bulwark is just one of a dying minority desperately defending a crumbling political ideology.
Let go or be dragged…
Buying MBSs will not result in a change in 30yr mortgage rates. If he buys MBSs, the govt. will just be holding the bag on a bunch of devalued real estate with high rates and a collapsed dollar. Mortage rates ARE, by the way related to the 10-yr. T-note.
In a free market economy where private investor money can go into either bonds or mortgages then the two will be linked with the spread between them reflecting the perceived credit risk. Once Ben starts printing money and deciding that he’s going to put that money into mortgages no matter what then he can drive down rates. The private money liberated by this will then go somewhere else and show up as either lowered bond rates, stock market bubbles or general inflation. But the link between the two rates only exists if there is a free market.
Diemos…right on buddy. Bush’s vision only extends to January, 2009 and he can care less what happens after that. I find your scenario quite plausible, especially the part about politics. Attention will be diverted away from the building inferno of dollar inflation by blaming the mortgage banking business. By the time reality sets in, the Shrub will be back in Crawford and only then will everyday Americans and the press begin to understand how f@cked we are economically.
“He can begin printing money and buying MBSs until interest rates on 30Yr fixed mortages drop to 3% -REGARDLESS OF WHAT HAPPENS WITH T-BILL RATES.”
Nonsense. The Federal Reserve is a group of banks, real businesses that are in it to make a profit. Why in the world would they buy up a bunch of loans for prices that they know will cause them to lose a huge amount of money?
What you are saying is that the Federal Reserve Banks will be willing to sacrifice themselves by paying more for the MBS’s than they are worth, and take the loss in order to keep mortgage rates down. This is something they will never do.
Nonsense. Read, from the Open Market Operations summary for 2005: “The Desk solicited propositions across the entire pool of eligible government securities collateral on all RPs arranged in 2005. All RPs were arranged as three separate simultaneous operations (tranches), differentiated by the type of collateral eligible. In the first tranche, only Treasury debt was accepted; in the second, direct federal agency obligations were also eligible (in addition to Treasury securities); and, in the third, mortgage-backed securities were eligible in addition to the first two collateral types.”
MBS’s are elligible collateral for Open Market Operations.
You didn’t read my post carefully; I didn’t say they COULDN’T buy MBS’s, I said they WOULDN’T buy them for more than they were worth in the open market, which is they only way they could drive the interest rates down through buying them. If they buy them at the market price they will be getting the same rates as anyone else and that would have no effect on interest rates.
During the Great Depression the Federal Reserve only offered to buy the very highest quality debt, and only after the drop in prices had already occurred. Why do you think they will be willing to buy low quality debt at high prices now to save the nation from a RE bubble collapse? Do you think they would be willing to take the loss themselves, instead of letting everyone else take it?
I agree — the bubble is mostly a mob psychology phenomenon. It was touched off by low interest rates and the collapse of the dot-com bubble, but really fueled by speculative mania and astoundingly lax lending standards (if you can say any standards exist at all at this point).
I’m not sure that Bernanke has any interest in rescuing the bubble. I think that the Fed is secretly much more concerned about the bubble than they let on publicly (if they were candid, the markets would react violently). My guess is that the Fed wants to kill this thing once and for all before it bankrupts the county. They know that as long as home prices remain unnaturally elevated, the housing ATM will continue pumping money to China and Japan, and that will worsen the current-account situation, further destabilize the global financial system, and make it more difficult to manage the economy through monetary policy. They’re probably trying to figure out if they can pop the bubble without bringing down the entire banking system and the economy with it.
I agree that they will not try to keep inflating the bubble. However, even if all his intervention did was stabilize home values that would be enough to end the housing ATM, put the country into recession and close the trade gap. Allowing the housing bubble to free fall would put us into the 2nd Great Depression and would collapse the financial system.
However, even if all his intervention did was stabilize home values that would be enough to end the housing ATM, put the country into recession and close the trade gap.
I agree with you in principal, but moneytary policy is a blunt instrument, not a fine-tuning knob. I think there’s little chance that the Fed can get housing prices to simply remain where they are.
I agree; we passed the point of no return some time ago, there cannot be a soft landing because of the amount of speculation in housing and also because the economy has been jacked up by the ATM effect instead of a real recovery.
This article suggests that historically, the first concern of the US government and its monetary policy is maintaining the hegemony of the dollar, above all else:
“…..Foreign dollar holders began dumping their dollars as a protest to the foreign policies of the Jimmy Carter Administration. It was to deal with that dollar crisis that Carter was forced to bring in Paul Volcker to head the Federal Reserve in 1979. In October 1979 Volcker gave the dollar another turbo-charge by allowing interest rates in the US to rise some 300% in weeks, to well over 20%. That in turn forced global interest rates through the roof, triggered a global recession, mass unemployment and misery. It also ‘saved’ the dollar as sole reserve currency. The dollar was not a ‘petrodollar.’ It was the currency of issue of the greatest Superpower, a superpower determined to do what it needed to keep it that way.
The F-16 dollar backing
Since 1979 the US power establishment from Wall Street to Washington has maintained the status of the dollar as unchallenged global reserve currency. The role, however, is not a purely economic one. Reserve currency status is an adjunct of global power, of the US determination to dominate other nations and the global economic process. The US didn’t get reserve currency status by a democratic vote of world central banks, nor did the British Empire in the 19th Century. They fought wars for it.
For that reason, the status of the dollar as reserve currency depends on the status of the United States as the world’s unchallenged military superpower. In a sense, since August 1971 the dollar is no longer backed by gold. Instead, it is backed by F-16’s and MI Abrams battle tanks, operating in some 130 US bases around the world, defending liberty and the dollar.
A Euro challenge?
In order for the Euro to begin to challenge the reserve role of the US dollar a virtual revolution in policy would have to take place in Euroland. First the European Central Bank, the institutionalized, undemocratic institution created by the Maastricht Treaty in order to maintain the power of creditor banks in collecting their debts, would have to surrender power to elected legislators. It would then have to turn on the Euro printing presses and print Euros like there was no tomorrow. That is because the current size of the publicly-traded Euroland government bond market is still tiny in comparison with the huge US Treasury market.
As Michael Hudson explains in his brilliant and too-little studied work, ‘Super Imperialism,’ the peverse genius of the US global dollar hegemony was the realization, in the months after August 1971, that US power under a fiat dollar system was directly tied to the creation of dollar debt. The debt and US trade deficit was not the ‘problem,’ they realized. It was the ‘solution.’
The US could print endless quantities of dollars to pay for foreign imports of Toyotas, Hondas, BMW’s or other goods in a system in which the trading partners of the USA, holding paper dollars for their exports feared for a dollar collapse enough to continue to support the dollar by buying US Treasury bonds and bills. In fact in the thirty years since abandoning gold exchange for paper dollars, the US dollars in reserve have risen by a whopping 2,500% and grows at double-digit rates today.
This system continued into the 1980’s and 1990’s unchallenged. US policy was one of crisis management coupled with skilful and coordinated projection of US military power. Japan in the 1980’s, fearful of antagonizing its US nuclear umbrella provider, bought endless volumes of US Treasury debt even though they lost a King’s ransom in the process. It was a political, not an investment decision.
The only potential challenge to the reserve role of the dollar came in the late 1990’s with the European Union decision to create a single currency, the Euro, to be administered by single central bank, the ECB. Europe appeared to be emerging as a unified, independent policy voice of what Chirac then called a multi-polar world. Those multi-polar illusions vanished with the unpublicized decision of the ECB and national central banks not to pool their gold reserves as backing for the new Euro. That decision not to use gold as backing came amid a heated controversy over Nazi gold and alleged wartime abuses by Germany, Switzerland, France and other European countries.
Since the shocks of September 11, 2001 and the ensuing declaration of a US global War on Terror, including a unilateral decision to ignore the United Nations and the community of nations and go to war against a defenceless Iraq, few countries have even dared to challenge the dollar hegemony. The combined defense spending of all nations of the EU today pales by comparison to the total of current US budgeted and unbudgeted defense spending. US defense outlays will reach an official, staggering level of $663 billion in the current Fiscal 2007 year. The combined EU spending amounts to a mere $75 billion, with tendency declining, in part owing to ECB Maastricht deficit pressures on its governments.
So today, at least for the present, there are no signs of Japanese, EU or other dollar holders engaging in dollar asset liquidation. Even China, unhappy as she is with Washington bully politics, seems reluctant to rouse the American dragon to fury.
The Origins of the Oil Bourse
The idea of creating a new trading platform in Iran to trade oil and to create a new oil benchmark crude apparently originated with the former Director of the London International Petroleum Exchange, Chris Cook. In a January 21 article in the Asia Times, Cook explained the background. Describing a letter he had written in 2001 to the Governor of the Iranian Central Bank, Dr Mohsen Nourbakhsh, Cook explained what he advised then:
‘In this letter I pointed out that the structure of global oil markets massively favors intermediary traders and particularly investment banks, and that both consumers and producers such as Iran are adversely affected by this. I recommended that Iran consider as a matter of urgency the creation of a Middle Eastern energy exchange, and particularly a new Persian Gulf benchmark oil price.
’It is therefore with wry amusement that I have seen a myth being widely propagated on the Internet that the genesis of this “Iran bourse” project is a wish to subvert the US dollar by denominating oil pricing in euros.
’As anyone familiar with the Organization of Petroleum Exporting Countries will know, the denomination of oil sales in currencies other than the dollar is not a new subject, and as anyone familiar with economics will tell you, the denomination of oil sales is merely a transactional issue: what matters is in what assets (or, in the case of the United States, liabilities ) these proceeds are then invested.’
A full challenge to the domination of the dollar as world central bank reserve currency entails a de facto declaration of war on the ‘full spectrum dominance’ of the United States today. The mighty members of the European Central Bank Council well know this. The heads of state of every EU country know that. The Chinese leadership as well as Japanese and Indian know that. So does Vladimir Putin.
Until some combination of those Eurasian powers congeal in a cohesive challenge to the unbridled domination of the USA as sole superpower, there will be no Euro or Yen or even Chinese Yuan challenging the role of the dollar. The issue is of enormous importance, as it is vital to understand the true dynamics bringing the world to the brink of possible nuclear catastrophe today.
As a small ending note, a good friend in Oslo recently forwarded me an article from the Norwegian press. At the end of December, Sven Arild Andersen, Director of the Oslo Bourse, announced he was fed up with depending on the London oil bourse trading oil in dollars. Norway, a major oil producer, selling most of its oil into Euro countries in the EU, he said, should set up its own oil bourse and trade its oil in Euros. Will NATO member Norway become the next target for the wrath of the Pentagon?
* F. William Engdahl is a Global Research Contributing Editor and author of the book, ‘A Century of War: Anglo-American Oil Politics and the New World Order,’ Pluto Press Ltd. He may be contacted through his website, http://www.engdahl.oilgeopolitics.net.
http://www.globalresearch.ca/index.php?context=viewArticle&code=%20EN20060310&articleId=2076
versus:
http://www.globalresearch.ca/index.php?context=viewArticle&code=CLA20060210&articleId=1937
and more alarmist:
http://www.europe2020.org/en/section_global/150206.htm
Courtesy of:
http://bighousingbubble.blogspot.com/
The author has it backwards. Economic power proceeds military power in most cases. You need economic power to pay for the weapons even on credit. Paul Kennedy’s book, “The Rise and Fall of the Great Powers” does an excellent job of making this point. You have too go back to the Mongols too find warlike people dominating high tech people.
This letter writer further acts as if the US defense budget and war in Iraq are out of control comparing 660 billion in the USA to 75 billion in Europe. The fact is that under Kennedy the USA spent 51% on defense and under Bush 18-20% including the war. The author fails to understand that the reason that Europe does not spend near what the USA spends on defense is that they do not fear America to the degree that so many leftist thinkers argue. If Europe really felt the USA was out of line there would be an arms buildup in Europe. They complain about the USA but are grateful that the naiton is the world’s policeman. They are attempting to have it both ways to please the third world audience.
The author speaks of nucleur war. He looks in the wrong places. The major danger of war is a collapse of the world economic system. This will then create trade wars and expansionsist arguments too solve the problems created by the down cycle. Alliance systems will change as trade adversaries possibly become military. The flash point will probably not be the Middle East. Best candidate an attempt by China to recover Taiwan not unlike the German claims for the return of territory (and more) lost to Poland after World War One.
The author’s comments seem to argue that some kind of an evil yet brilliant game has been played by the USA ledership since at least 1971. Bismarck once said, “god has a special love for asses, apes and Americans. Our nation isn’t that collectively smart. The author seems to view history from a “great man” perspective. Others think (myself included) that “events make men” and not the other way around. It is the mass cycle that drives history. The perception by some of an evil America determined to rule the world is a stretch.
Mob psychology, indeed.
The above passage is from a wonderful old book entitled “Extraordinary Delusions and the Madness of Crowds” by Charles Mckay, originally published in 1852. I found my copy in an old box while unpacking this weekend, and reading it sent shivers up my spine. There really is nothing new under the sun. Get rich quick schemes and bubbles may start in different ways, but they always end the same. BANG!
Here is a link to a chapter from Volume 1 called The South Sea Bubble. Happy reading.
Let’s try that link again…
Grrrrrr. OK, I’ll type it out!
http://www.econlib.org/library/Mackay/macExContents.html
if they want to kill this bubble they should do something about the easy money.
Just look: there is NO intention at the FED to do anything about that. It is very easy for the FED to enforce strict lending standards (simply like we had 15 or 20 years ago), to stop all the stupid programs going on at Freddy & Fannie that prop up the bubble at the cost (risk) of the taxpayer etc. and all the other bailouts that we here about in the regular news.
The only thing the FED is doing now is stopping the flood of speculators (by raising shortterm rates), and stopping the most extreme leveraged plays at F&F - probably because these make the system less predictable and introduce additional systemic risk.
sorry, meant to say above:
and all the other bailouts that we do not hear about in the regular news.
I agree. People underestimate the role that market psychology plays in determining market trends.
Fear and greed are the true drivers of all market trends.
There is a very bright economist at Harvard that is studying psychological impact on traditional economic theory.
Clearly, markets are influenced by more than we learned as econ. majors in college.
He has a lot to study…Just look at the bubbles that happened over the past 2 decades.
Maybe bubbles are just a fact of a modernizing economy.
Maybe that’s my problem. I’ve been out of school for over 25 yrs.
Try a Fed managed economy with a fiat currency.
‘once the expectation of future returns diminish the amount of risk home buyers are willing to take on also diminishes’
It is true that ‘once expection of quick profits evaporates in the blink of an eye’ it will be everyman or woman for themselves while the mortgage lenders be looking for alternative ways to save their butts. Gonna be a lot of RE related people drawing unemployment or looking for other jobs. How many teachers quite to make more in RE and now are wishing they had that good paying job back?
Gonna be a lot of RE related people drawing unemployment
Most real estate agents, appraisers, and home inspectors, etc., are self-employed and have no access to unemployment benefits. Throw in the lack of a pension, accrued vacation time, health insurance, sick days, plus a double social-security levy thru the self-employment tax, and you have an industry which really is at the bottom of the barrel profession-wise.
Ohhhh Deeeeer! That’s Deer and Headlights, by the way.
The problem the Fed has, is that it needs to keep interest rates high enough to support the dollar. A falling dollar means higher inflation. Now that the U.S. has become so dependent on cheap imports. A falling dollar can get out of control.
I think they’ll continue to provide liquidity but not be aggressive with lowering interest rates. The Fed will try to engineer a slow devaluation of the currency. Controlled inflation is their objective. Commodities are the place to be in the future, as the dolloar gets devalued. The Fed doesn’t have to report the M3 money supply anymore. So it will be very hard for foreign investors to know how much the dollar is being devalued.
It’s important to remember that long term rates are controlled by investors in long term bonds. Up till now they’ve been willing to accept a low risk premium. So the Fed’s Fed’s lowering of the overnight rate may not affect mortgage rates that much, if the foreigners that have been recycling money back into U.S. treasuries, decide that it’s becoming riskier to do so and demand a higher rate of return or preceive the devaluation of the dollar requiring a greater return to compensate.
The devaluation of the dollar will be evident without M3 data. It is simply a matter of US bond yields less the US rate of inflation vs. other nations yields and their respective rates of inflation. This reveals a real rate of return for US currency vs. other nations. You may also factor in the current account deficit to measure the inherent risk of a nation’s debt. In the case of the US, it does not bode well.
There is yet to be an inverted yield curve. You can only compare the low end (91da. t-bill) of the yield curve to the long end (10yr. bond) and right now it’s pretty flat.Let China and others stop holding the 10 bond yields down and we might move things along in a more rapid manner.
China is in the driver’s seat. Here’s why:
They don’t need the money and they want to continue selling the U.S. stuff. They are the company store. The more they sell, the more they can call the shots down the road. They don’t care about inflation of the dollar. At the time of their chosing, they can flood the market with dollars, thereby killing the imperialist dollar once and for all. I would not want to be in Taiwan when they do so.
The only way the Feds would cut interest rates if the economy started to take a dump. In this case that still would not re-inflate the bubble because no one has the money for risky investments. The housing bubble is just a microcosm of the real picture. Once people start losing there houses they will be indebt to the Government and the sheeple will follow along with the orchestrated plan of America being financially crippled.
Seriously folks, how many people are in this jeopardy? I know it is popular to talk about the % of no-down and I/O neg am loans over the past 3 years, but what percentage of total homeowners is this?
How many are seriously at risk of forclosure? As an overall percentage of total homeowners, I am not saying the number is totally insignificant, but, we may be giving too much weight to it.
It depends…
1) How many HELOCked homeowners spent all their home equity on toys?
2) How many homeowners used their home equity as collateral to buy investment homes?
3) How many I/O ARMS holders will get wiped out by resets?
4) How hard will prices fall when expectations adjust in response to the end of the double-digit-gain home equity money tree?
Yes, but where can we get a handle on the actual numbers of irresponsible idiots out there? People with other assets are not going to foreclosure - no matter how highly levered their house might be.
Also, people won’t wreck their credit unless they are desperate. Frankly, I would cash-in the IRA’s and borrow on the 401 before I went to foreclosure. How many of these people are out there?
Most of the flippers I know are smart enough to cut their losses. I’ve talked to several.
Sure the ever increasing prices have saved alot of people from foreclosure. But absent something catastrophic (illness, job loss, divorce, etc.) I don’t see the huge defaults looming. Educate me please if I’m missing something.
* Overall private debt is at an all-time record high
* Mortgage debt is at an all-time record high
* The ratio of debt to equity is at an all-time record high
* The national savings rate is zero
I have plenty more.
Keep in mind, too, that all of these figures are understated due to a significant minority of Americans who are fiscally prudent.
It’s the modern mindset… if the monthly payment fits into your monthly take-home, it’s yours. Homes, cars, plasma TVs, you name it. Better yet, you deserve it.
Housing won’t just correct; it’ll over-correct. Housing related jobs won’t just fall back; most will disappear for a decade. Credit won’t just revert to normal; it’ll tighten so much that a proctologist will have to sign off on loans.
Think this won’t affect everyone psychologically, regardless of their finances? The wholesale switch from “wealth effect” spending to “scared silly” saving will stop the economy dead in it’s tracks, and throw millions more out of work.
It’s a vicious cycle, and no amount of Fed reflation will save it, although the resulting hyperinflation will be a thing to behold.
“* The ratio of debt to equity is at an all-time record high”
This is very significant because after a large increase in “home values” the equity ratio should be higher than ever as peoples homes have increased in value, but instead the opposite has happened because so many have erased the new found equity by taking on more debt, and this debt is backed only by inflated home “values” that will most likely evaporate as quickly as they appeared, leaving only the debt with no backing.
GetStucco,
Re #2 and #3, I agree completely.
Re #4, I don’t think this matters to most homeowners unless they happen to also be at the mercy of #3.
Re #1, could you explain? I know plenty of these super-consumers. This is not going to change their ability to pay their bills. So let’s say their hom value plummets — sure, they’ll be crying “woe is me” as they watch paper value disppear (value that they foolishly already spent), but their lives won’t be fundamentally different in terms of ability to pay (unless of the other categories applies to them). Am I going wrong someplace?
And don’t forget:
5) Anyone whose job is directly tied to real estate is going to be in real trouble.
I’m not sure I agree, vainvestor. I know quite a few people who have taken out risky loans. And remember, prices are set at the margin. The percentage of property owners who are speculators is also relatively small (compared to those who are owner-occupiers) but look at the effect that speculators have had on prices.
Treasury yields reflect interest in the purchase of US debt. If they are low, it is a reflection of interest on the part of buyers in purchasing the debt. If interest wanes, or buyers look to other debt for better returns, yields rise to attract customers.
The Fed has maintained customers for US debt thus far by continual rate increases. Our debt has appeared more secure and has had better relative value due to a strong dollar.
If, however, the Fed announces an end to rate increases, the dollar will likely weaken in relative value to other currencies and drive down demand for US debt. This will cause a substantial rise in yields to make US debt more attractive. A rise in yields means a rise in interest rates, eroding housing prices (and the economy) even further and faster.
Conversely, if they continue to raise rates, they will enhance the relative strength of the dollar while driving up interest rates, thereby slowing the economy and the housing market.
In short, here are the Fed’s alternatives and the probable results:
1. Continue to tighten
a. Higher rates
b. Stock market correction
c. Stronger dollar temporarily
d. Higher trade deficit
e. Higher unemployment
f. Housing market correction
g. Lower inflation
h. US and global recession or worse
2. Stop tightening or cut rates
a. Higher rates
b. Initial stock market rise, then correction
c. Weak dollar
d. Lower trade deficit
e. Higher unemployment
f. Housing market correction
g. Higher inflation
h. US and global recession or worse
Well sumarized. We’re screwed either way. I think the Fed’s goal is to make the process slow and controled, to avoid panic and collapse.
Think Japan. The worst thing we can do is stretch this out. We aren’t Japan, we aren’t that patient nor do we have the banking safeguards or long term outlook they had. We need to RTC (Resolution Trust Corp) this mess again and take the hit and move on.
We aren’t “screwed.” That’s the panic talking. Nobody is going to Debtors Prison and as unfair as as it seems (is) we are going to forgive trillions. We are going to inflate away some, forgive some, tax (incorrectly) the innocent for some more and reduce or living standards for the rest. The Fed is not as powerful as it once was and nowhere near as influencial as it imagines. THe housing bubble is out of its control but the consequences are not out of its responsibility.
Who’s going to forgive trillions? Most of the MBSs (73%?) are held outside the GSEs. This will not collapse the government so much as it will make a mountain of excess liquidity and investment in MBSs disappear.
That’s sounds “screwed” to me.
We also don’t have their savings rate.
Either way there screwed, just a matter of time.
“Ok; the housing market is rolling over. I’d like to hear from the minds on this blog if it will continue to do so, and why, if Ben Bernanke stops raising interest rates soon?”
It could. The real estate industry would likely use the halt in rate hikes to pitch the market as “you’d better buy now before they start-up again.” Imo, it’s the psychological “heard mentality” which often drives up prices upward at a fast clip. However, I think we’ll see the astronomical gains of the past few years. Yet I wouldn’t be surprised if home prices rebound to a high of 2005 in many parts of the country.
Correction:
However, I DON’T think we’ll see the astronomical gains of the past few years.
I would be very surprised, no one has the money to afford, the heard mentality sees everyone losing there home and they stop buying.
The herd can only respond in a favorable lending environment. If the Fed cuts or stops raising rates, yields and rates will rise regardless, due to the devaluation of the dollar.
A couple of strange things are happening, one being the elimination of the M3 report. I was just informed yesterday that FDIC is increasing the insurance coverage on IRA’s to $250,000, but leaving the coverage on non-IRA accounts at $100,000. I’m thinking of withdrawing my IRA’s, paying taxes and penalties. I am absolutely certain that taxes will skyrocket in the coming years and would rather pay the taxes and 10% penalty now. Odd that I’ve heard none of this FDIC change in the media, and I watch FN and CNBC all day.
Whasssup? http://www.fdic.gov/news/news/press/2006/pr06029.html
Interesting….what would have been your time frame for withdrawls? In other words, how old are you?
50, and I was planning annual withdrawals beginning at 55.
ya know, I’ve been pondering a related question. Everyone pushes for the 401k/IRA as tax deferred. It’s viability in that regard is based on having a lower marginal rate @ withdrawal. This may be a fundamentally flawed assumption. With our TOTALLY out of control federal budget (what happened to FISCAL conservatives), graying of the workforce, bankruptcy of PBGC,etc., it seems like it would be better to squirrel most of it away post-tax today.
Moving from a tax-deferred (income-tax withdrawl) account to normal account (capital gains tax withdrawl) mitigates a rise in income tax rates. However, that doesn’t mitigate against a rise in capital gains tax rates.
There’s nothing to say the gov’t won’t increase capital gains taxes as well as income taxes — particularly if lots of assets flow away from 401k/IRA accounts because of high income taxes.
I wouldn’t even take the Roth IRA tax exemption as sacred.
An excellent point that I hadn’t considered. I was thinking only of nominal income tax rates. Silly, ignorant me! Long term capital gains will also be increased over the current 15% rate.
I think that the Roth IRA tax exemption in the future depends largely on how popular this program becomes. If the total dollar amount is relatively small, no one will get that exercised about you taking out earnings ‘tax-free’. However, if there is $1-2 trillion in Roth accounts in 10-20 years, I can easily see the feds screaming about ‘greedy-geezers’ getting money scott-free, and that ‘no one could have imagined’ retirees winning such an unearned windfall.
The one advantage of the classical IRA is that the government (feds and local) get a piece of each dollar. In a way, it’s sort of like being in business with the mob - they don’t mind you getting something, as long as they get their piece of the action.
In this respect, Roth IRA’s are much more vulnerable to tampering. And by the way, the feds are always changing/tampering these programs.
Regarding the yield curve, it is a great indicator of the direction of the economy. I took its rise from inversion to mean the economy has begun its downslide. It should now begin to steepen and rise to reflect lower interest in US debt due to rate increases in other foreign central banks and higher US deficits. Precious metals have only just begun to rise…
My opinion is that:
1: The fed is still going to 5. They planned it, and ONE piece of data is not enough to stop them. Remember, existing home sales came in better then expected
2: If they started to lower rates within the year, the bubble will continue to grow. In fact, I think we really only just began to let the air out of the bubble, so it’s not hard to start putting are back in.
3: I disagree with a previous comment in that if the fed stops tightening rates will go up. I think they will go down, as YEILDS will decrease. The drive mortgage rates down.
We did a decent post on this on our blog, which you can check out. It talks about where we think all the rates are going- fed, mortgages, and bonds.
The thing to remember is that the fed drives short-term interest, which influences long-term T bonds, which competes with and influences mortgage rates. BUT, you have to look at bonds in terms of yields NOT rates. When the fed stops tightening, yields will go DOWN because buyers know that higher interest rates are NOT coming in the future and they will drive up the price for current bonds. That lower yield results in lower rates in other markets, and eventually mortgage rates.
Check out our post if you want. If you want more detail on the rate cycle let me know.
Our story on rates is on our blog; just scroll down. It’s called “Mortgage Rates Heading North Of 7.5%”
BubbleTrack.blogspot.com
Only 9-9.5% 30Y mortgage rates will slow down this out of control train, as it was in ‘94 when Greenspan hit the brakes with his 10+ rate hikes.
yeah, my fed goes to 11!
What has kept rates down is foreign investment in US debt. They have been able to buy US debt with their own weak currencies and receive an inherently higher rate of return.
Just watch the dollar vs. other currencies when it is rumored the Fed will stop or that one of the other central banks is raising. The dollar weakens.
If the Fed stops, foreign interest in US debt will decline significantly due to what would be a low if not negative real rate of return on US debt (bond yields minus inflation). Money will flow into the Euro or Yen, driving up US bond yields and interest rates.
Two words: liquidity trap. Or, in English, the Fed cranked rates so low after the bubble in equities popped that folks had no where else to put there moolah other than housing. They certainly weren’t going into stocks after the 80% hit (or whatever) the NAZ had. So the Fed kept the economy rolling along fairly well (according to the warped data points the gov’t puts out) after the stock bubble. But there was so much global liquidity (i.e. cheap money to borrow; think Japan, EuroZone, USA) that people could borrow at negative real rates (inflation was greater than the rate on their loans). And a ton of that money found its way into real estate. So now the economy is clearly on its last legs, it was really driven by real estate (directly and indirectly), yet the Fed is still raising rates because we’re still seeing bursts of inflation and economic growth. And the Fed has to keep raising rates to keep the inflation demon at bay. If it doesn’t, no one will finance the US gov’t’s debt. It’s as simple as that. Scary, too, because if the Fed turns into a wet noodle and gets soft on inflation, there are enough foreign purchasers of govvies that rates will really rocket if they decide to dump their (our) bonds.
But let’s play out the scenario. Housing is done and therefore the economy is done, too. Say goodbye to the HELOC orgy. And the Fed will of course have to lower rates at some point to try and get the party started going again. This time, however, there is so much DEBT in the consumer sector that the restart may only have a marginal effect because debt levels as a percent of GDP are already totally off the charts. The government is a debt addict, too, but I digress. Get this: consumer spending has grown every quarter for the last 14+ years! That’s insane. Now, bear in mind that the data is a little suspect because the gov’t is constantly revising the way it accounts for economic growth and inflation. But either way, the gov’t says Joe Sixpack has spent more each quarter for every successive quarter over the last fourteen years. Amazing. He’s of course been able to do that by dipping into his savings (think negative savings rate) and his house (whip it out baby, let’s have a HELOC lovefeast) and by borrowing an absurd amount of cash via credit cards or whatever. So there is this massive debt headwind the consumer is facing now, much greater than at any time in US history (it’s even greater than the level prior to the crash of 1929). Now, let’s add on top off all that the emotional scar that’s going to be left once the economy really starts to slide backwards. People have felt so good about their real estate for so long. Well, that’s probably going to change, and if we’re lucky, so too will folks’ attitudes towards debt. So fine, lower rates as far as you want Benny Ben. Who cares? Corporate America may care, but if the consumer isn’t biting, it won’t matter. Just look at the Japanese economy. What a nightmare. Zero nominal rates and what’s happened over the course of the last fifteen years? Nothing. Too much debt and bad loans and an unwillingness to deal with the situation quickly. I’m not saying it’ll be that long over here before things pick up again, but I am saying that just because the Fed eventually will decide to reflate, the reaction they get this time around is going to be different than after the equities bubble popped in ‘00. Too much debt needs to be repaid, and too many people are going to make an about-face with regards to their attitudes towards debt.
P.S. The cycle leading to the crash of 1929 was similar to today’s mess. The asset classes involved were different (real estate today is analogous to stocks in 1929, whereas stocks in 2000 are analogous to general business / industry in the booms of the early to mid 1920s), but the reaction of consumers and the economy as a whole may be similar.
Get Long Vega,
I enjoyed reading your perspective… keep it coming on other threads!
SB BB
Well put.
Great & thanks, Vega! The liquidity trap is a real conundrum for Bernanke.
Get Long Vega, you are absolutely correct. ‘Nuff said.
“So fine, lower rates as far as you want Benny Ben. Who cares? Corporate America may care, but if the consumer isn’t biting, it won’t matter. Just look at the Japanese economy. What a nightmare. Zero nominal rates and what’s happened over the course of the last fifteen years? Nothing.”
Agreed. I believe the term is “credit revulsion”. As I understand it, the GSEs were created to fix the “pushing on a string” problem by creating artificial demand for credit through loosened credit standards (and thus ever-rising asset prices), with the risks socialized onto whatever bagholders they could find to buy MBSes, and ultimately the taxpayers (I know Robert Cote disagrees, and I hope he’s right). These string-pulling engines just delay the inevitable backlash in which (a) burned lenders are afraid to lend and (b) burned borrowers are afraid to borrow.
I think the world suffers from excess saving and liquidity, asset prices are inflated across the board, and the Fed has limited control.
In countries like India and China, productivity is soaring as they develop but with income inequality and (in China) an aging population, much of the money is going into savings. Same in Japan, thanks to its aging population. Same problem that caused the Great Depression (yikes) as the now-developed world industrialized.
The U.S. has taken up some of the slack by having the opposite problem — excess spending, too much debt, not enough savings. But despite the Fed tightening, housing is so pricy it doesn’t make sense to buy, the price-earnings ratio is so high it doesn’t make sense to invest, and long term interest rates are so low it doesn’t make sense to save.
The issue is, housing prices have inflated so far that affordability has disappeared even without a rise in long term rates. And the same cheap money has inflated construction in non-bubble markets, leading to a glut. Thus, the air going out of the balloon.
The world needs a higher standard of living in those countries that have earned it, along with higher interest rates and a lower dollar here to cut down on asset price inflation and excess spending. If this can be achieved without some kind of crash remains to be seen. But it’s very worrysome now, with inflation and recession both more likely than stability.
They will deflate by having the overseas investors taken down while sparing the T-bill market with the “NewBank”. In a flight to safety investors will jump on treasuries strengthen the dollar and crashing gold.
The first US bank to go down will be JP Morgan. Over 800 US banks hold derivatives.
Most of the $570 trillion in derivatives are held by overseas investors. These will collapse from the housing bust causing defaults. The default follow like dominos to mortgage backed securities, then collaterized debt obligations and lastly to derivatives.
No, because then BB will turn on the printing press. And overseas investors will have no reason to hold dollar-denominated assets. The reason gold (and other PMs) have been steadily rising, despite the “experts’” predictions, is most likely because Asians and Arabs are dumping dollars.
They’re not going to stop doing that.
Will you please enlighten how and why Gold will crash. Anybody who has grasped the post above, will you please say that in simpler terms. Thank You.
One reason that gold might crash is that people might need to raise cash by selling it, unless the gold is in a form that they can use directly as money and it becomes an acceptable form of money for everyday purposes, which isn’t impossible.
Still doesn’t apply to foreigners, who don’t need dollars for everyday life and who might well be looking to exchange them for something tangible.
Remember all those dollars overseas. That’s what’s very different from the 1930s.
Foreigners might need cash, too. Why not? The depression of the 30’s affected foreign countries, too, and I expect the same will be true this time, only this time the US government won’t be fixing the price of gold like they did then. If the buying power of dollars is growing due to the deflation of RE and other assets as it did during the early 30’s why would foreigners want to exchange them for gold? I am not saying that I am sure gold WILL drop in value, I am just saying that it is quite possible that it could drop in value compared to the dollar, and anyone who is putting a large percentage of their money into gold should not assume that gold cannot drop but they need to consider all possibilities.
What on Earth could foreigners buy? Microsoft software, Boeing airplanes–and Nevada gold. They’ve already been told (and have internalized!) that they can’t buy things like ports or oil co’s (remember Unocal?). And there’s a movement afoot in Congress to put even more restrictions on what foreigners can use their dollars for!
The idea that the dollar is going to “rise” in value is simply risible. Look at the fundamentals. Too many dollars and dollar-denominated assets off our shores that are going to be looking for a place to go. And furthermore, when foreigners need “cash,” it ain’t dollars. It’s euros, or yuan, or pounds, or whatever.
The fact that the US had a glut of domestic oil in the 1930s is also a big difference. Nevada gold for Mideast oil? It could happen.
OK, I didn’t read your original point carefully enough the first time. I see what you are saying now. I agree that is something that could help prop up the price of gold. However, if we experience deflation in this counry, which is exactly what most of the people on this blog are expecting, although maybe they think it will only affect RE and not touch any other assets, then the value of the dollar will be going up as far as what it can buy here and a foreigner might say, “maybe I will wait for a while and buy some US RE after the prices drop.” In that case the foreign held dollars may not have as much effect on gold, at least during the deflationary period.
I have no idea whether gold will go up or down, I am just saying I don’t think it is such a sure thing that someone should put a huge percentage of their money into it right now after it has had a big run up in price already.
It’s interesting that you think that gold might crash—so many recommend buying gold now.
Such interesting times…
The “NewBank” is a transparent shell-game wherein the government finances it’s own debt by printing money. The idea is to support Treasuries; the reality will be their destruction. Gold will soar.
“Unfortunately, the Fed’s policy statement is about as obfuscatory as the English language will allow. Unless Chairman Ben Bernanke takes the unusual step of spelling out his intentions in clear prose, Wall Street’s uncertainty will continue. There are few market-moving economic reports due in the coming week, but there are a few that could prompt investors to change their strategies.”
So much for the theory that the sorcerer’s apprentice will start a new era of clarity at the Fed…
Credit makes the world go ’round, and easy credit has been what has allowed this bubble to inflate. But the low LEVEL of interest rates is only part of the reason, and likely less than half. More importantly, easy credit has been extended due to creative financing, no down payment options, and zero or negative interest loas. I think these lending factors are more important than low mortgage rates because it has only been in the last two years that mortgages on median house prices has exploded, yet mortgage rates have been relatively flat (or, they haven’t changed as much as they did from 2001-2004).
So, there must have been something else besides low mortgage rates that has driven demand. I see demand as having risen from both flippers and new home owners. In the last two years, creative financing has been much more important to them than low rates.
This tells me that interest rate changes by the Fed will not be as important as changes in lending practices. Once the Fed and others start to lean on lenders for their creative financing (greater scrutiny and regulation), and once holders of MBSs begin to demand higher standards, that is when the demand will dry up. Maybe some of that has already begun.
I agree with you Peter Bob, well said!
I agree with you 100% . I can’t see how the lenders can continue with these high risk loans . With such excess inventory now in most states pointing to a declining market : lenders will have no other choice but to pull back .
Doesnt the Fed or Office of the Comptroller decide on funny money loan regulation rules this week?
The Fed controls the lending standard with its banking examiners but it takes months to slap a lender into compliance.
Controlled deflation will be the Fed’s goal so that the dollar will rise. This will help the US government as investor, institutions and countries buy Treasuries as a safe haven. US Treasuries held as reserves will not be sold off avoiding a dollar devaluation. Win -Win for the Feds. Lose-lose for derivatives, MBS (which are explicitly not backed by the US).
Controlled deflation is the Fed best choice among bad choices.
I doubt the deflation can be controlled by lowering Fed rates to zero, but the Fed will try to “mop up”.
“The Fed controls the lending standard with its banking examiners but it takes months to slap a lender into compliance.”
There was an article from Robert McHugh a couple weeks ago that likened this to the Fed’s “fourth tool” (the other three being reserve requirements, the Fed Funds rate, and the discount window). I’d certainly be interested in reading more about this: how it works, how it’s played out in previous bubbles, etc.
“Controlled deflation will be the Fed’s goal so that the dollar will rise.”
This is the one scenario in which I can see gold falling (as other posters were asking about above). In an uncontrolled deflation, it should gain in value as something that can’t be blown away with a click of a mouse (as a lot of so-called “assets” are going to be, I expect).
I doubt I need to comment on the likelihood of an orderly deflation from a bubble like this.
ARMs, IOs, and Pay Option ARMs became more widely used when “affordable” financing from 30 yr and 15 yr mortgages ceased being affordable. Right now, we’re seeing the beginning of a lot of ARM resets from mortgages originated 3 years ago, at the nadir of the rate cut cycle. Anyone getting pinched by this phenomena is f*cked at this point because there’s nothing cheaper to get a lower payment now.
A lot of people say “we need a shock to the system to trigger a recession”. I think these rate resets are the straw that will break the camel’s back because you’ve got a bunch of folks ou there with a single common denominator: they refi-ed at the nadir of the rate cut cycle OR they stripped equity via HELOCs.
This ain’t gonna be pretty and there’s not a thing the Fed can do about it, IMHO.
It seems that a lot of what goes into predictions of what the fed will do hinges on what they fear more. Do they risk ingniting inflation? Or do they risk a collapse of the dollar? Or do they risk having the housing market tank and take the financial system with it?
I would suggest that there is something that this administration fears more than all of that combined. That is being blamed for an economic collapse, being booted out at the next election and having to live through the second coming of Franklin Delano Roosevelt.
We are in sad times indeed where the choices are between wide-spread inflation and deep recession.
Either way, if it becomes full blown by 2008, the party in power will be badly hurt.
Expect both.
Doesn’t matter which party’s in power afterwards, either… they’ll be no money, just hard choices. You can’t do a “New Deal” when the old one is already killing us.
The Fed has a problem. The global housing bubble will result in the greatest destruction of wealth in the history of the world. Thus, global liquidity is effectively dried up, okay, problem solved, right? Wrong! The result will be that trade deficits will continue as they have so that the Asians and Arabs can make up their losses, which would normally be good, the game continues. Here’s the catch: It doesn’t matter what the Fed does if the US government doesn’t get absolved of the huge government debt and address trade imbalances. They raise rates and get more T-Bill investors and print more money and pretty soon foreign governments have the upper hand again. I believe a huge recession/depression is coming that can only be solved with a new world financial system which includes some debt forgiveness for the US government. The world economy is to big and too fragile to be trusted to the US hegemony alone. What this will do to rates here I do not know, but at some point there must be a steepening devaluation of the dollar in the world currency markets. The US government could drop taxes to zero and print money ’til the cows come home, if they don’t deal with the twin deficits in a substantial way the entire world economy will eventually collapse. The rest of the world has not and will not allow the US to drag it down economically for a prolonged period. I predict either a serious war or a new global trading system, maybe both.
“The global housing bubble will result in the greatest destruction of wealth in the history of the world.”
Inflated housing prices are not “wealth,” although I keep seeing referances that say so. The real value (wealth) of a house that cost 200K in 2000, and 400K in 2005 has not changed unless some major improvements were made. Simply saying that your house you bought for 200K has increased in value does not mean that you have more wealth.
I think it would be more accurate to say that the destruction of the global housing bubble will result in a great transfer of wealth as people who are caught with losses directly or indirectly lose wealth and others who were lucky enough or forsighted enough to avoid the losses see an increase in the buying power of their cash.
They are only wealth if you sold RE and put the proceeds elsewhere.
US SAVE THE FEDERAL MARKET BY BANKRUPT FOREIGNERS AND US BANKS
They will deflate by having the overseas investors taken down while sparing the T-bill market with the “NewBank”. In a flight to safety investors will jump on treasuries strengthen the dollar and crashing gold.
The first US bank to go down will be JP Morgan. Over 800 US banks hold derivatives.
Most of the $570 trillion in derivatives are held by overseas investors. These will collapse from the housing bust causing defaults. The default follow like dominos to mortgage backed securities, then collaterized debt obligations and lastly to derivatives.
Controlled deflation will be the Fed’s goal so that the dollar will rise. This will help the US government as investor, institutions and countries buy Treasuries as a safe haven. US Treasuries held as reserves will not be sold off avoiding a dollar devaluation. Win -Win for the Feds. Lose-lose for derivatives, MBS (which are explicitly not backed by the US).
Controlled deflation is the Fed best choice among bad choices.
I doubt the deflation can be controlled by lowering Fed rates to zero, but the Fed will try to “mop up”.
Searching NewBank, check out
http://www.dailyreckoning.com/Writers/Mogambo/DREssays/MG030706.html
Very funny.
The housing bubble ( monster ) is dead!!!
With it will go the debt ridden and foolish.
My 2 cents worth of advice……….
Stay as liquid (cashed up) as possible and wait for the spoils.
Above all………BE PATIENT ……and that may mean years…….don’t buy any real estate until prices fall at least 25-30% and then only if there are signs that the bottom is in sight.
In the meantime………have fun…….enjoy life, and watch this train wreck happen in real time.
Good luck all
Another interesting article on petrol dollars, particularly as it relates to housing….
“….This means that the reason Reagan won, and gradually pulled the media and much of the public mood behind him, was that in a world which is zero sum - and the amount of oil being the basis of profit meant it was zero sum - people become conservative, grasping at whatever bits of their bundle of ultimate scarcity they hold. It meant that allowing the rich to become richer was essential to keep America under the control of Americans. It meant that corporations had to be allowed to become larger and larger, so that they were harder and harder to hold accountable through political means. It also created another vicious circle: Americans had more and more of their wealth in their homes, which created more pressure for sprawl, which, in turn, created more and more demand that gasoline prices remain low, so that people could trade cheap energy to pay less for expensive land.”
http://www.truthout.org/docs_2005/040305A.shtml (April 2005)
From the Daily Kos
http://www.dailykos.com/story/2006/1/28/122315/558
Daily Kos referenced on that badly translated alarmist article on the Europe 2020 website:
http://www.europe2020.org/en/section_global/150206.htm
Fascinating reading all of it. Enjoy!
Who allowed Kos crap onto this site?
China is in the driver’s seat. Here’s why:
They don’t need the money and they want to continue selling the U.S. stuff. They are the company store. The more they sell, the more they can call the shots down the road. They don’t care about inflation of the dollar. At the time of their chosing, they can flood the market with dollars, thereby killing the imperialist dollar once and for all. I would not want to be in Taiwan when they do so.
I agree that China and other foreign countrys hold the card on purchasing U.S Securities,but the Fed can hold FF at present levels and wait for the housing market to do its reset to lower levels as banks and MBS holders demand tighter regulation on appraisals and income varification on loan applications. This should take care of these fly by night mortgage lenders who pass of this risky paper. The general public is just now beginning to see a potential for lower housing prices and with that they can start a stampeed to lower levels as fear takes hold . Only time will tell but my bet is the Fed just has to stay firm and not feed the money ATM to those who do not need it.
NFSP activity has already disappeared for all practical purposes. The fear now is that they’ll dump what they already have. They haven’t done so because that would kill the goose that laid the golden egg (i.e., the US consumer).
However, since housing will put the consumer in a coma, the Chinese will soon have no reason to retain their US denominated holdings. Bye-bye USD, hello yuan.
the ironic thing is that the steady rate rises are keeping this bubble status quo. Once they stop the rate hikes stop the dollar will resume it’s secular decline, lose value, causing outside countries to dump the dollar further causing a decline in its value and thus causing long rates to shoot up in 1980’s fashion(or worse). But this measured pace is whats keeping the RE market up .
Its sort of like in Braveheart when the English heavy calvery are charging towards the Scots, and mel gibson screams hold….hold……hold…hold…..now then they raise up the long poles and stick all the horses and defeat the heavy calvery.
The modern day version is substutiting the heavy calvery for measured pace intrest rate hikes, the poles are the cause of the recession and popping of the housing bubble, and Mel Gibson is bernanke/Greenspan
Interesting way to put it. I’ve been meaning to watch that one for a long time.
“The one important interest rate the Fed controls — the federal funds rate — drives short-term interest rates. Sure, that’s important if you’re in hock to a credit card company. But the fed funds rate doesn’t drive long-term rates, which are set by financial markets and are far more important to businesses and home buyers.”
http://www.washingtonpost.com/wp-dyn/content/article/2005/10/31/AR2005103101675.html
And, an oldie but goodie -
“However, long-term rates may behave entirely differently. The actions of the Federal Reserve can have a dramatic influence on longer-term rates, but influence and control are very different things.
Long-term rates may rise, in spite of the Fed’s attempts to bring down rates. In fact, this has begun to happen. During the week of November 12, bonds sold off sharply, which means their yields rose. The Wall Street Journal reported that it was the worst bond sell-off since 1987. ”
http://www.mises.org/freemarket_detail.asp?control=388&sortorder=title
I think rates will continue to climb, there are simply too many inflationary pressures right now. The FED’s job is to combat inflation/deflation, not defend asset bubbles.
well if it gets really bad, the US can invade Iran because they are switching to petro Euros just like we did with Iraq…oh but wait Iraq’s oil is now traded again in US Dollars….
http://www.teamliberty.net/id209.html
oh and here’s one more:
http://www.teamliberty.net/id199.html
UK mort apps up this year ?
weird
Jas Jain’s take on this very issue:
http://www.financialsense.com/fsu/editorials/jain/2006/0327.html
The problem is the Fed tries to save people, they just don’t know who’s going to be saved, though. When Greenspan was cutting rates, wasn’t the assumption he was trying to help the stock market? He ended up helping RE & commodities. Also remember the last time there was a new Chairman, taking over for a well-respected one. 1987.
Here’s something to ponder: what if the Fed had NOT lowered rates as low as they did, AND, what if Bush’s tax cuts did not pass, AND what if the Congress had not added $ Trillions in spending the last few years? OR, if just one of those things had not occurred? IMO, it wasn’t just Greenspan that was injecting liquidity. NOW, however, two of the legs to the liquidity stool may not be come again (for political reasons). With that in mind, it may not be possible for the Fed alone to do the job of reinflating, if they decide to change course.
Then we would have faced the music sooner instead of later and it would have been less painful than it will be now. All the extra spending by Congress only adds just that much more to the final bill to be paid.