The Housing Bubble

Are you able to attend LDS Sunday ward meetings in Shanghai?

The Intelligent Investor
When Does a Bubble Spell Trouble?
How to tell whether markets are in bubble territory today.
By Jason Zweig
Jan. 10, 2014 7:26 p.m. ET

The minutes of the latest Federal Reserve policy meeting, released this past week, show that central bankers have been worrying that the financial markets might turn into a bubble—the term for a perilously overvalued situation that can burst without warning or mercy.
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It isn’t easy to identify a … universal belief among investors today that the world is being swept up by an irresistible positive force. The artificially low interest rates set by central banks, while powerful, are hardly a technological breakthrough.

In every bubble, there are always people trying to burst it by declaring that financial assets have become overvalued. At first, Prof. Goetzmann says, such skeptics earn respectful attention. But eventually, investors turn on them with anger and ridicule.

Just think of Warren Buffett, who in 1999 and early 2000 was widely derided as “a dinosaur” and “out of touch” for his refusal to buy technology stocks. When I asked him in January 2000 how he felt about that, Mr. Buffett replied calmly: “I know what will happen. I just don’t know when.” Two months later, the Internet bubble burst.

In investing, as in life, ridiculing the people who disagree with you is a fairly certain sign that you don’t have the facts on your side.

“Once people buy in, they start to discount evidence that challenges them,” Prof. Goetzmann says. “There seems to be a hinge point where investors go from thinking about quantifying economic trade-offs to a kind of binary framework where anybody who disagrees with them is demonized,” he says.

That is when a bubble becomes trouble.

“When everyone starts to use ‘bubble’ anytime prices go up, it’s probably not one,” says Jason Hsu, chief investment officer at Research Affiliates, a firm in Newport Beach, Calif., whose investment strategies are used to manage approximately $150 billion in assets. “The time to worry is when people are using all kinds of rationalizations as to why it’s not a bubble.”

None of this means, of course, that today’s stock market is cheap; by most measures, it is at least slightly overvalued. But the fact that you can’t open a newspaper, watch financial television or visit an investment website without encountering a commentator worrying about a bubble is probably encouraging.

And the fact that market pundits can declare that this is a bubble without being insulted is almost certainly a good sign.

When hearing someone call the market a bubble makes you want to call the person an idiot, that is when you should ask yourself whether in fact the idiot is you. We probably aren’t there—yet.

Given that bubbles are only visible through the lens of history’s rear-view mirror, why would central bankers waste effort looking for them prospectively?

Bloomberg News
Krugman Urges Sweden to Drop Tightening Ambition in Bubble Fight
By Johan Carlstrom January 10, 2014

Sweden’s central bank should delay plans for interest rate increases to avoid aggravating a significant housing bubble, Nobel Laureate Paul Krugman said.

A low repo rate would limit risks of falling house prices and allow inflation to erode record household debt levels, he said today in Stockholm after speaking at a Skagen Funds conference.

“It’s possible, I would even say probable, that Sweden has a significant housing bubble and it does have a high level of household debt,” he said. “But given the borrowing has already happened and where you are right now the household debt issue is only made worse if you raise interest rates. It’s only made worse if you allow the economy to slide in deflation, so at this point what you want is an expansionary monetary policy to offset the risks of a housing decline or of a debt problem.”
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Living in a rental will never feel like a real home.

at least they can call themselves a homeowner at the water cooler.

You should lock yourself into a 30 year rental lease now.

You sound bitter.

Some MSM commentators seem perpetually wrapped around the axle over the notion that the Fed will some day have to unwind its massive bond portfolio accumulated in the wake of the Fall 2008 financial crisis. But what requires to ever unwind it? And if they don’t have to unwind, why would they ever do so?

Robert Lenzner, Forbes Staff
I’m trying to wise up 300 million people about money & finance

Investing
11/25/2013 @ 8:08PM
I Bet You Didn’t Know The Fed Owns 40% Of All Treasuries Over 5 Years In Maturity

Talk about creating moral hazard. The Fed has cornered almost 40% of all Treasuries over 5 years in maturity. I’ve just discovered the killer aspect line from Quantitative Easing. The Fed’s 4 years of QE, QE1, QE2, and QE3 has accumulated 36% of all Treasury securities between 5 years and 10 years in maturity plus 40% of those government bonds over 10 years in maturity as well as 25% of all the mortgage backed securities not owned by Fannie Mae and Freddie Mac. Just how do you suppose Chairman Yellen will devise an exit strategy to this concentrated ownership that makes up some $3 trillion of the central bank’s $4 trillion balance sheet?

Short of a miracle, Chairman Yellen faces one of the most imposing and possibly impossible challenges facing the financial markets over the next several years. If anything will derail the economy, force the stock market into a mighty retreat and destroy all hope of further expansion of the residential real estate market, it is the Fed’s quandry over the retreat from quantitative easing. And you can be sure that the potential overhang of Treasury securities and mortgage backed bonds overhanging the market are not going to look like bargains to the cash-rich central banks of China, Japan, Russia,or to the pension funds and endowments.

Preventing a depression in 2008 looks easier and more straight-forward to me than the devilish predicament the Fed faces when QE finally is played out and the central bank is left holding a record amount of securities that one way or another are going to start losing value as the cost of money creeps higher. All geniuses need apply at Fed with their schemes to get us out of this trap. We are going to have to start looking at this problem early in 2014 without denying its severity and multiple ramifications.

I say it will be impossible to liquidate $3 trillion in any short term or medium time period without causing the bond and stock markets to crash. And it’s even possible the Fed might have to position another $500 billion to $1 trillion bonds if the job numbers don’t look promising.

Therefore, the Fed might be forced to hold the bonds to maturity, requiring more than a decade to see the securities run off, delivering trillions in cash to the central bank. I can’t even get my head around what that predicament would mean down the road.

Or if the Fed begins to liquidate bonds and interest rates rise while the bond market declines it means that the Fed ‘s profits from its book will be reduced, wiping out its ability to pay a huge dividend to the Treasury for use in running the government. Honestly, I’m not going to shed that many tears for this loss, though others will be wailing and tearing out their hair.

I’m sure right now the economists at the regional Feds are writing papers to suggest the various policy choices we face. The potential nightmare I was warned about by a Wall Street elder is that once higher interest rates are a reality the Fed might face large paper losses on its portfolio of intermediate Treasuries. Thankfully it is not required to mark those securities to market and officially recognize the losses.
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they will hold them to maturity and then the govt will roll them over.

So long as central bankers are able to tax savers through ever-lower returns on savings, I don’t see any reason for concern.

Let’s see if I understand the reasoning behind central bankers’ modus operandus:

1) First use artificially low interest rates to encourage the buildup of colossal debt burdens at the household, municipal, provincial, national and international levels of transactions.

2) Next claim that deflation would destroy the economy, due to its effect in making colossal debt burdens unbearable.

3) Use argument 2) to encourage further use of low interest rates to stimulate the economy.

Hmmmmmm…

Italian joblessness hits record as it seeks higher foreign investment
Italian joblessness hits a fresh high, underlining challenge for the country’s fragile coalition in convincing the international markets it is on the path to recovery
The government is under pressure to attract more interest from foreign buyers to meet its borrowing targets, since Italy’s domestic banks are expected to slow their purchases of sovereign debt this year.
By Denise Roland
5:41PM GMT 08 Jan 2014

Italian joblessness has hit a fresh high, underlining the challenge for the country’s fragile coalition in convincing the international markets it is on the path to recovery.

Unemployment hit 12.7pc in November, up from October’s 12.5pc and the highest on record. Youth unemployment, at 41.6pc, is also at an all-time high.

The figures show that tentative signs of recovery in Italy’s recession-battered economy have failed to benefit the labour market.

Italy hopes to raise €470bn (£387bn) from bond sales this year, similar to its 2013 funding target. But the government is under pressure to attract more interest from foreign buyers, since Italy’s domestic banks are expected to slow their purchases of sovereign debt this year.

The Treasury is confident that high yields on its debt will entice international buyers. But political gridlock within the country’s fractious coalition is likely to put off investors looking for reassurance Italy can carve a path to economic recovery.
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Surprise drop in euro zone inflation shows deflation risk
By Martin Santa
BRUSSELS Tue Jan 7, 2014 6:08am EST
A customer keeps his purchases in a bag at a wine shop in Alella, near Barcelona October 30, 2013.
Credit: Reuters/Albert Gea

(Reuters) - Euro zone inflation fell in December after a small increase the previous month, increasing the European Central Bank’s challenge of avoiding deflation as well as supporting the bloc’s recovery.

Consumer price inflation in the 17 countries then sharing the euro stood at 0.8 percent year-on-year in the last month of 2013, compared with 0.9 percent in November, data from the EU’s statistics office Eurostat showed on Tuesday.

December’s reading takes inflation back to near a four-year-low of 0.7 percent in October.

“Today’s figures show that it’s too early for the ECB to become complacent about deflation risks, especially in peripheral countries,” said Peter Vanden Houte, ING’s chief euro zone economist, referring to the bloc’s weaker members.

An inflation rate that is well below the ECB’s target of close-to-but-below 2 percent carries risks in the longer term because it can deflate wages and demand, depressing the economy.

Reacting to the data, the euro rose to $1.3646 from $1.3618 on speculation the ECB could consider more steps to support the economy.

The October drop in inflation was the first fall below 1 percent since February 2010 and prompted the European Central Bank to cut its key interest rate to a new record low of 0.25 percent in November.

Still, the euro zone is far from the deflation that Japan suffered from the early 1990s.

ECB President Mario Draghi said last week there were no signs of deflation or an urgent need for another rate cut, but added that it was vital to avoid a scenario where inflation gets stuck permanently below one percent and slips into a danger zone for the economy.
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The Outlook
Where Deflation Risks Stir Concerns
In Europe, Fears Grow of Falling Prices and the Economic Destruction They Cause
By Stephen Fidler
Updated Jan. 5, 2014 7:11 p.m. ET

Relatively few people alive today in the West have experienced deflation, but for Europeans, that may be changing.

Anxieties are rising in the euro zone that deflation—the phenomenon of persistent falling prices across the economy that blighted the lives of millions in the 1930s—may be starting to take root as it did in Japan in the mid-1990s. “Deflation: the hidden threat,” ran a headline emblazoned across a December research note by economists at HSBC.

At last count, prices are falling only in Latvia, Greece and Cyprus. And most forecasters, including those at HSBC, see low inflation as more likely than deflation on average in the euro zone.

But inflation is stubbornly low, under 1% on average across the 18-nation bloc, despite the money that the European Central Bank has been pumping into the economy with the aim of spurring investment and growth, actions that often push up inflation. That is way under the ECB target of “below, but close to 2%,” and, if the average is below 1%, more economies using the euro are at risk of deflation.

Why worry? If economies cope with inflation, why not with deflation? For centuries until World War II, capitalist economies experienced periods of severe deflation interspersed with spells of inflation and continued on a path of long-term growth.

But historical experience is one reason policy makers don’t want a return to the 19th century. Germany’s hyperinflation in the 1920s was followed in the 1930s by deflation that created widespread economic hardship in that country as prices fell 23%.

Today, German policy makers aren’t too worried. A paper published in December by the Bundesbank, Germany’s central bank, proclaims, “No deflation in sight.” In Germany, that may be true: The latest figure for November shows annual inflation of 1.6%, the third highest in the euro zone.

But others are less sanguine. Jean Pisani-Ferry, head of France’s economic-policy planning council, argues in an article for Project Syndicate, “It’s past time to recognize the deflation danger facing Europe.”
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Global Economics
Deflation Is Coming, and It Doesn’t Have to Be Bad
By Chris Farrell December 19, 2013

A specter from the past hovers over the major industrialized nations: deflation. A decrease in the overall price level, deflation was a term relegated to economic history, with the notable exception of Japan following the bursting of its land and stock market bubble in the late 1980s. The everyday experience of the post-World War II generations has been inflation or rising prices. Besides a few exceptions, such as New York Times columnist and Nobel laureate Paul Krugman, many economists, central bankers, and Wall Street strategists primarily fret over prospects for inflation. Sure, prices may be tame at the moment, but inflation’s resurgence is inevitable—or so we’re repeatedly told.

Really? The trend in consumer price indices clearly point toward increasing deflationary pressures. The epicenter of current concern is Europe, with its latest consumer price index reading at 0.7 percent, down from 1.1 percent a month earlier. Spain’s year-over-year inflation rate is at 0.1 percent. Germany sports a mere 1.2 percent annual inflation rate, and a number of smaller, troubled countries are in deflation, such as Greece, Latvia, and Bulgaria. A parallel story unfolds in the U.S. America’s CPI is running at a 0.9 percent year-over-year pace, down from 2.2 percent a year ago.

Here’s the thing: Deflation has become the modern condition. The emergence of deflation isn’t a temporary phenomenon reflecting the economic weakness and high unemployment. No, the underlying trend toward deflation stems from heightened international competition for markets (globalization), widespread migration (immigration), and rapid technological advances (Amazon.com (AMZN)). The Great Recession and the anemic recovery simply accelerated the trend from disinflation and toward deflation.
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Currencies
The ‘Bitcoin Consumer Price Index’ Shows Massive Deflation
By Peter Coy
December 12, 2013

Mention “deflation” and the first thing people think of is the Great Depression of the 1930s. But the worst-ever deflation going on right now is in the Bitcoin world. It’s not that Bitcoins are losing value; this year, Bitcoin is up 64-fold. As a result, prices of real things in terms of Bitcoins are plummeting.

For this article, I created a Bitcoin Consumer Price Index1 that’s the exact equivalent of the U.S. Bureau of Labor Statistics’ Consumer Price Index. The only difference is that it measures prices of goods and services (from food to clothing to gasoline to haircuts) in terms of Bitcoins instead of dollars.

According to the official BLS measure, prices measured in dollars are up 1.3 percent since January. That’s mild inflation. Prices measured in Bitcoins are down 98.5 percent over the same period.

This is a great development if you own a lot of Bitcoins. But it would be a disaster if it were the official currency of the United States—the coin of the realm, so to speak.

Deflation is all about the buying power of a currency. It’s not just prices of things people buy that fall in a generalized deflation. Wages and salaries also fall. So cheaper goods aren’t really any cheaper in terms of your buying power.

Two bad things happen in a deflation. First, people tend to postpone purchases as they wait for prices to get lower. That slows the economy to a crawl. Second, debts get more and more burdensome because they don’t shrink the way everything else does. If you owed 1,000 Bitcoins before the deflation, you still owe 1,000 Bitcoins after it, only now your paycheck has shrunk by 98.5 percent. The only solution is to default. That’s what happened on a massive scale in the Great Depression.

The Bitcoin CPI is just another way of demonstrating that Bitcoin isn’t remotely suited to becoming a real currency, as numerous economists have pointed out. Better to use it to buy a round—or a hundred rounds—at the local bar.
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8:22 am Jan 7, 2014
Europe
Mr. Draghi Plays Chicken With Deflation

How close to outright deflation will the euro zone be allowed to go before the European Central Bank blinks?

The latest data will make for uneasy reading in the corridors of the ECB’s Eurotower in Frankfurt. Preliminary estimates show that consumer prices rose a mere 0.8% on the year to December in the single currency region. Analysis had forecast a 0.9% rate. Stripping out volatile food and energy, the picture looks even worse, with core CPI running at just 0.7%.

These sorts of numbers raise alarm bells. Economists frequently recall the downward trend in Japanese consumer price inflation in the years following the bursting of the country’s property and stock market bubbles on the eve of 1990 until it became outright deflation. And for much of the past two decades Japanese authorities have struggled to generate positive inflation.

Deflation has become so closely associated with low Japanese growth that it’s commonly held to be the cause of low growth. There’s debate on whether this is actually true–Japan’s overall GDP performed poorly but this was likely to be more a function of an ageing population than deflation, after all GDP per capita largely kept pace with other western economies. But it is generally accepted that deflation can prove a big drag on economies. By increasing the real value of debt it hurts borrowers, who tend to have a higher propensity to consume than savers (whom deflation benefits), thus depressing aggregate demand. Deflation also encourages people to delay purchases as they wait for things to get cheaper, also hurting demand.

In any event, most of the ECB’s policymakers accept deflation is a bad thing.

And the euro zone has been on a deflationary path.
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Is the word “debt” a sad word or is it a happy word?

Isn’t acquiring debt something that one should yearn to do? Used to be it was.

Wasn’t all the fuss about one’s credit score - one’s FICO score - wasn’t this a measure that is used to be used to determine how much debt one could acquire? And the higher the score the more debt he could acquire? And the more debt he could acquire the better off he was - in a sense the better person he was?

Wasn’t that the thinking not so long ago?

there is nothing available in nice areas around here for under 100 per sq ft. people are at the mercy of a manipulated market around here. there only hope is to leave CA.

You should start a moving service out of CA.

“I will bet 100 dollars we can all remember our first male teacher.”

+1. I don’t agree with many of your posts, Spook, but as for this one you are right on target.

My first male teacher was in elementary school and of all the teachers I had throughout elementary school he is the only one that I can remember.

The memory of all the other teachers, all the female teachers, is a blur.

“It is time to get women out of the schooling of boys. It is way past time. Women in our feminized classrooms are consigning generations of our sons to years of misery and diminished futures”

http://takimag.com/article/notes_on_the_pussification_of_america_fred_reed#axzz2q981L83G

So in other words, Dollar Tree DOES know something about San Francisco that the local rubes cannot discern.

Sorry, Cali. The rest of the country can no longer economically afford to cover your idiocy.

Steel yourself. The several steps down are headed your way.

The Ivy League MBAs won’t rest until every job is outsourced to China.

I knew it was a toupee!

Accenture was the consulting half of Author Andersen.

Accenture: happily outsourcing American jobs anyway it can. One of the leading globalization corps on the entire planet.

I once met an Accenture recruiter. He claimed that Accenture could train anyone to be a “software engineer” in just two months.

“Obama vows more executive orders”

Mr. Checkov, power-up the deflector shields.

Best of luck, Joe, this sounds like a good move for you. Well thought out.

When I think of the law, I’m always reminded of the Al Pacino-Keanu Reeves movie “Devil’s Advocate”. One of Pacino’s best roles, IMO, in an over the top sort of way. Best line in the movie was when he was asked “Why the law?” and his response of evil joy was “Because it gets us into everything!”

Downlow Joe is exiting the building.

Glad to see you are getting out and going somewhere where you can better develop your skills using your own judgment and reasoning. The boomers have set up their own Ponzi schemes and need younger ones to exploit. Good riddance to them.

Joe,

If more young people had your attitude, this country would be a finer place for all of us. I’m incredibly pleased to hear that you chose quality of life over greed, for in the long run, your wealth will surpass that of any partner who sold his soul to the machine.

Best of luck to you; you escaped!

If homes that are delinquent, or foreclosed, but have not yet hit the market are part of “Shadow Inventory”, then of course there is a “normal” level of “Shadow Inventory”.

Just like there is a “normal” level of vacancy.

None of these numbers ever hit 0.

The big question to ask is WHERE is the Shadow Inventory? Are there markets where it is approaching “normal”?

Non-judicial states are much farther along in the market clearing process than judicial states.

If you look at the report from CoreLogic, you will see dramatic differences between judicial and non-judicial states.

We reviewed your job application but have decided to hire another applicant.

Good luck!

“Speak up Donkeys….”

I think he is saying he was Robo signed and he deserves a free house.

http://www.youtube.com/watch?v=1ySxtIFwIX4 - 111k -

This is a rather lengthy post.

the U.S. Constitution and its Mexican and Canadian counterparts could soon be rendered irrelevant

Mexicans are very nationalistic. The notion of surrendering their sovereignty to Washington (because at the end of the day, that is how it will be perceived) will be a very hard sell south of the border.

Rut Roh! Inventory up 24% and 34% both places while prices up.

Timberrrrr!

phantom appreciation that will eventually evaporate

“phantom appreciation” from house flippers — popular house price gauges measure rehab materials and labor as “appreciation” — pushed up prices and price indices in the most popular housing “trade” regions to nose-bleed levels

http://mhanson.com/archives/1467

DenverDonkeys suck

Distracting yourself from the fact that your Chargers are getting crushed and that Peyton is showering all of us here with millions of dollars of new equity?

Why the market could see a 17% drop in 2014
Published: Monday, 30 Dec 2013 | 1:14 PM ET
By: Jeff Cox | Finance Editor

Politics and the stock market always have had an uneasy relationship, but things could get especially messy soon.
Getty Images

As the second year of the presidential election cycle approaches, market watchers are bracing for a period likely to be significantly more disruptive than the relatively calm sailing Wall Street saw as gains approached 30 percent in 2013.

While there are a slew of potential catalysts for a substantial correction, one that stands out is the presidential cycle. (This study from Pepperdine University helps spell it out.)

While the cycle has been a less effective signal in recent years, it is still a popular barometer used to predict market moves.

Simply stated, the cycle indicates that the market tends to perform less well in the two years following a U.S. presidential election and better in the years leading up to the next one. Obviously, 2013 did not confirm the presidential cycle, with its 29 percent gain in the S&P 500.

More particularly, the second year of the cycle—the year when midterm elections are held—tends to be volatile, with substantial pullbacks, corrections or outright bear markets not at all uncommon. The typical return during such years is just 5.3 percent, or barely half the norm.

Corrections tend to be particularly violent, which is why the otherwise relentlessly bullish forecasters at Piper Jaffray are issuing a warning that while the market should post decent gains in 2014, it won’t be without some turbulence.

The firm points out that since 1930, pullbacks during midterm years have averaged 17 percent.

“However, we believe that this pullback will unfold post the achievement of our next price objective of 2,000 on the SPX index in early 2014, and that (the) market will be higher by year’s end,” Craig Johnson, technical market strategist at Piper Jaffray, said in his weekly report for clients.
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WILL THE STOCK MARKET EXPERIENCE A 10 PERCENT CORRECTION BY MIDYEAR?
Tell us what you think: Go to
By Roger Showley
12:01 a.m. Jan. 12, 2014

NO I do believe there will be a correction – only less than 10 percent. Investors had a great run in 2013. However, many stocks are trading above the 200-day moving average, which suggests a sell-off in the future. I see 2014 as year where investors sell some positions they acquired in the last year and cash in on the gains. However, once a correction happens, there are still good buys for some stocks. Investors will re-enter the market again.

NO A modest correction is more likely in late-2014, but a quick 10 percent decline the first two quarters, in the absence of a government budget crisis or major terrorist event, is extremely unlikely. All of us were too pessimistic for 2013. My own pessimism was based on expected fallout from a paralyzed government, but the outlook today is for modest growth and modest interest rate increases suggesting 2014 as a good year to stay in the market.

NO: 46%
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Dec. 21, 2013, 10:50 a.m. EST
Doomsday poll: still a 98% risk of 2014 stock crash
Commentary: Psychological realities as new year dawns end irrational exuberance
By Paul B. Farrell, MarketWatch

SAN LUIS OBISPO, Calif. (MarketWatch) — Yes, “Doomsday poll: 98% risk of 2014 stock crash” was my midyear headline. And yes, it still fits. Why? Because in the new year, after the irrational exuberance of the “Christmas rally” passes, reality will set in.

Remember the dark warnings from last January through the fall? Fed even saw an “unsustainable bubble” … Bill Gross: “Credit Supernova” … Jeffrey Gundlach: “Kaboom Ahead” … Charlie Ellis: “Don’t own bonds” … Gary Shilling: “Shocker” … Nouriel Roubini: “Prepare for perfect storm” … Peter Schiff “doubling down” on his “doomsday” prediction … InvestmentNews’s warning to 90,000 advisers: “Tick, tick … boom!”

Then a sudden, dramatic psychological twist: The investors’ collective brain tired of the negativity in mid-October after the last bearish headline: “America’s economic guillotine dead ahead.” A week later the reversal: “2014 ‘Year of the Boom’ bet on the bulls,” quoting Bank of America’s chief strategist: “Bulls roaring. Hot race to the New Year. Then beyond into a booming, bullish 2014 rally … Great Gatsby’s spirit is back in America. Top billing. Let the good times roll. Come join the party.”

By November irrational exuberance was accelerating, in full holiday mode: Headline, “Shiller’s hot P/Es powering a ‘Roaring Bull’ till 2017,” dubbed the 2014 “Katy Perry market.” A week later, another headline added: “10 reasons to be a bull in 2014.”
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I figured pot smoke. :shrug:

The Opinion Pages|Op-Ed Contributor
The Bubble Is Back
By PETER J. WALLISON
JAN. 5, 2014
Peter J. Wallison, a senior fellow at the American Enterprise Institute, was a member of the Financial Crisis Inquiry Commission.

WASHINGTON — IN November, housing starts were up 23 percent, and there was cheering all around. But the crowd would quiet down if it realized that another housing bubble had begun to grow.

Almost everyone understands that the 2007-8 financial crisis was precipitated by the collapse of a huge housing bubble. The Obama administration’s remedy of choice was the Dodd-Frank Act. It is the most restrictive financial regulation since the Great Depression — but it won’t prevent another housing bubble.

Housing bubbles are measured by comparing current prices to a reliable index of housing prices. Fortunately, we have one. The United States Bureau of Labor Statistics has been keeping track of the costs of renting a residence since at least 1983; its index shows a steady rise of about 3 percent a year over this 30-year period. This is as it should be; other things being equal, rentals should track the inflation rate. Home prices should do the same. If prices rise much above the rental rate, families theoretically would begin to rent, not buy.

Housing bubbles, then, become visible — and can legitimately be called bubbles — when housing prices diverge significantly from rents.

In 1997, housing prices began to diverge substantially from rental costs. Between 1997 and 2002, the average compound rate of growth in housing prices was 6 percent, exceeding the average compound growth rate in rentals of 3.34 percent. This, incidentally, contradicts the widely held idea that the last housing bubble was caused by the Federal Reserve’s monetary policy. Between 1997 and 2000, the Fed raised interest rates, and they stayed relatively high until almost 2002 with no apparent effect on the bubble, which continued to maintain an average compound growth rate of 6 percent until 2007, when it collapsed.

Today, after the financial crisis, the recession and the slow recovery, the bubble is beginning to grow again. Between 2011 and the third quarter of 2013, housing prices grew by 5.83 percent, again exceeding the increase in rental costs, which was 2 percent.

Many commentators will attribute this phenomenon to the Fed’s low interest rates. Maybe so; maybe not. Recall that the Fed’s monetary policy was blamed for the earlier bubble’s growth between 1997 and 2002, even though the Fed raised interest rates during most of that period.

Both this bubble and the last one were caused by the government’s housing policies, which made it possible for many people to purchase homes with very little or no money down. In 1992, Congress adopted what were called “affordable housing” goals for Fannie Mae and Freddie Mac, which are huge government-backed firms that buy mortgages from banks and other lenders. Then, as now, they were the dominant players in the residential mortgage markets. The goals required Fannie and Freddie to buy an increasing quota of mortgages made to borrowers who were at or below the median income where they lived.

Through the 1990s and into the 2000s, the Department of Housing and Urban Development raised the quotas seven times, so that in the 2000s more than 50 percent of all the mortgages Fannie and Freddie acquired had to be made to home buyers who were at or below the median income. To make mortgages affordable for low-income borrowers, Fannie and Freddie reduced the down payments on mortgages they would acquire. By 1994, Fannie was accepting down payments of 3 percent and, by 2000, mortgages with zero-down payments. Although these lenient standards were intended to help low-income and minority borrowers, they couldn’t be confined to those buyers. Even buyers who could afford down payments of 10 to 20 percent were attracted to mortgages with 3 percent or zero down. By 2006, the National Association of Realtors reported that 45 percent of first-time buyers put down no money. The leverage in that case is infinite.

This drove up housing prices. Buying a home became preferable to renting. A low or nonexistent down payment meant that families could borrow more and still remain within the monthly payment they could afford, especially if it was accompanied — as it often was — by an interest-only loan or a 30-year loan that amortized slowly. In effect, then, borrowing was constrained only by appraisals, which were ratcheted upward by the exclusive use of comparables in setting housing values.

Today, the same forces are operating. The Federal Housing Administration is requiring down payments of just 3.5 percent. Fannie and Freddie are requiring a mere 5 percent. According to the American Enterprise Institute’s National Mortgage Risk Index data set for Oct. 2013, about half of those getting mortgages to buy homes — not to refinance — put 5 percent or less down. When anyone suggests that down payments should be raised to the once traditional 10 or 20 percent, the outcry in Congress and from brokers and homebuilders is deafening. They claim that people will not be able to buy homes. What they really mean is that people won’t be able to buy expensive homes. When down payments were 10 to 20 percent before 1992, the homeownership rate was a steady 64 percent — slightly below where it is today — and the housing market was not frothy. People simply bought less expensive homes.

If we expect to prevent the next crisis, we have to prevent the next bubble, and we will never do that without eliminating leverage where it counts: among home buyers.

George Leef, Contributor
I write on the damage big government does, especially to education.

Op/Ed | 1/10/2014 @ 12:00PM
One Bad Law Usually Leads To Others: The Housing Bubble and Dodd-Frank

Let’s start with a pop quiz. Here’s the question.

The housing bubble was caused by:

a) The boundless greed of Wall Street fat cats

b) The natural instability of markets under capitalism

c) Deregulation

d) Foolish laws passed as long ago as the 1930s

Putting the possible answers that way is almost cruel to those who have been schooled in “progressive” thinking because the first three answers all seem equally correct. How can one choose?

The correct answer is d). We would never have suffered through the housing bubble if the federal government had not blundered into the housing market, which used to function efficiently on its own. Politicians of both parties, however, imbued with what Hayek called the “fatal conceit” that government regulation is superior to the spontaneous order of civil society, thought they could improve upon that market.

Instead, they made things far worse, creating a destructive bubble and then reacting by passing another disaster-laden law – Dodd-Frank.

Right now, America is transfixed on the unfolding cataclysm of Obamacare, but it’s worthwhile to look back on Washington’s last policy blunder to see if it holds any lessons for us. It does.

For a clear, concise explanation of the genesis of the housing bubble, I recommend the November, 2013 Hillsdale College Imprimis, “The Case for Repealing Dodd-Frank” (available here), by Peter J. Wallison of the American Enterprise Institute. Wallison shows how the government’s serial meddling in the housing market brought about the housing boom and bust, which in turn led to yet another damaging law.

The story begins in 1934, with the creation of the Federal Housing Administration. Before then, the housing industry had functioned without any trouble, settling on various standards for safe lending, especially the 20 percent down-payment rule. The market’s standards efficiently allocated credit to those who had shown themselves to be credit-worthy. Even though the FHA could have issued mortgages on weaker standards, for a long time it didn’t.

Between 1957 and 1961 however, Congress decided that the housing market needed stimulation and decreed that the FHA would go to a 3 percent down standard. “Predictably,” Wallison writes, “this resulted in a boom in FHA insured mortgages and a bust in the late ‘60s. The pattern keeps recurring and no one seems to remember the earlier mistakes.”

Precisely – no one remembers the earlier mistakes.

The feds left the housing market pretty much alone until 1992, when Congress thought it would be politically advantageous to posture as champions of “affordable housing.” The politicians decreed that the two mortgage giants it had created, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) would have to meet quotas for mortgages from lower-income people. Creatures of politics, the two government-sponsored enterprises had no choice but to comply.

Initially, 30 percent of the mortgages Fannie and Freddie purchased had to be lower income mortgages but as the housing mania kept growing, the quota was raised repeatedly, reaching 56 percent in 2008.

None of that had anything to do with Wall Street or capitalist greed. It was a case of politics overriding the free market to help politicians win re-election.

Of course, most of those mortgages written and purchased to meet arbitrary quotas were high risk ones that would never have been made by capitalists who have to balance the possibility of profit against the risk of loss. The resulting gusher of bad mortgages was not due to any inherent instability in the natural workings of the market. It was due to instability caused by meddling politicians who stood to lose nothing if their decisions turned out badly.

Because Fannie and Freddie were regarded as having the government’s backing, financial institutions that would otherwise have carefully looked into the riskiness of the paper they were buying from them were lulled to sleep. Why worry about Fannie or Freddie paper when it has the U.S. Treasury behind it? Bad investments spread through the financial system like a metastasizing cancer.

Then, in 2007, the house of cards fell. Home prices that had been bid up too high began collapsing. The bubble popped, taking down huge numbers of jobs in the housing industry, erasing billions in paper wealth, and costing many individuals homes that they should never have borrowed to purchase.

Have we learned a lesson?

Obviously not, because the response from Congress was to pass a new law (Dodd-Frank) that was supposed to deal with the problems caused by the previous laws. Wallison details the ways in which Dodd-Frank both fails to cure the underlying problems and creates new ones in his book Bad History, Worse Policy.

Dodd-Frank imposes huge new regulatory costs, while sending this message to the financial industry: don’t take risks. Banks have had to substitute compliance officers for lending officers. As a result of this counter-productive mountain of a law (over 360,000 words), there is today much less investment capital available for entrepreneurial activities and small business growth, both of which are crucial to our economic vitality. Dodd-Frank is a considerable part of the federal drag that has kept the economy’s recovery from the bubble so sluggish.
…

“The Housing Bubble’s roots are far deeper than many people recognize.”

The housing bubble is a symptom of a far deeper problem in this country. The solution won’t be found in the courts either.