A Crystal Ball And Unrealistically High Expectations
A weekend topic on economists, policy and bubbles. Mortgage News Daily, “A new Economic Letter, Interest Rates and House Prices: Pill or Poison? from the Federal Reserve Bank of San Francisco, looks at the link between interest rates, mortgage lending, and house prices. So how much would interest rates have needed to increase to keep housing prices in check during the 2002-06 housing bubble? Since a 1 percentage point increase in the short rate translates into about a 4.4 percent decline in house prices, the authors calculated that keeping house prices on trend would have required about an 8 percentage point increase in the federal funds rate in 2002.”
“Instead the rate stayed between 1 and 1.25 percent from the end of 2002 until the June 2004 when it rose 4.25 percentage points, reaching 5.25 percent by June 2006. In the authors’ experiment, the rate would have been about 8 percentage points higher at the end of 2002, but would have ended at about the actual level of June 2006. Roughly speaking, such a large increase in interest rates would have depressed output more than did the Great Recession.”
“The authors conclude that slowing down a housing boom is likely to require a considerable increase in interest rates, probably one widely at odds with maintaining full employment and price stability and would also require the Fed have a crystal ball to foretell upcoming booms. ‘In restraining asset prices, while the power of interest rate policy is uncontestable, its wisdom is debatable,’ the authors say.”
PBS Newshour. “Former Treasury Secretary and Harvard economist Larry Summers has been arguing for well over a year that we should recognize that the economy has morphed into one that is no longer capable of growing in the way that it did during the second half of the 20th century and that it won’t again unless we happen to be in a financial bubble. Crucial to Summers’s argument is the observation that during the years prior to the meltdown of 2008 the economy was by no means overheating as one would expect in a boom.”
“As Summers explained, ‘Capacity utilization wasn’t under any great pressure. Unemployment wasn’t under any remarkably low level. Inflation was entirely quiescent. So somehow, even a great bubble wasn’t enough to produce any excess in aggregate demand.’ Summers’s thesis was a ‘radical manifesto,’ according to Nobel Prize winning economist and New York Times columnist Paul Krugman, noting that, ‘we may be in an economy that needs bubbles just to achieve something near full employment.’”
From Investing.com. “There are three classic metrics to determine when an asset has grown into a bubble: it becomes extremely over supplied, over owned and overpriced compared to historical norms. The real estate market circa 2005 was a great example of a classic bubble. However, even though home prices are currently vastly overvalued, the housing market is not in a classic bubble because the real estate market is not currently in the conditions of being over owned or over supplied.”
“But the bond bubble is a classic bubble thanks to Wall Street and the Federal Reserve. The bond market qualifies as being in a state of over supply because there has been an additional $60 trillion in total global debt that has accrued since 2007. I first explained the classic signs of a bubble at the start of the real estate crisis to help investors identify a problem before it grows too far out of control. Perhaps the Fed should now take heed and ask the question if seven years of zero percent interest rates could possibly lead to a bubble in fixed income. But even more importantly, the question everyone should be asking is: what happens when bond prices crash and who is going to buy all that debt?”
“The bottom line is that the bond market is the most dangerous bubble in history precisely because every asset class derives its value from the cost of money. Therefore, even though stocks and real estate aren’t in a classic bubble they have still become vastly overvalued due to the frantic search for yield over the course of seven years.”
From Bloomberg. “One of the strongest orthodoxies in modern economics is being challenged, and there could be big implications for the state of the profession. The new, rebellious ideas might also help us understand why financial bubbles happen. If economists insist on using an incorrect assumption as the core of their models, it will force them into ever more Byzantine theoretical contortions, as the models repeatedly fail to fit the facts. Cynics would argue that this is exactly what we see happening in macroeconomics, where the prevailing theories have led to precious few correct predictions during the past decade.”
“Now, a trio of economists from the Federal Reserve Board has gone further, exploring whether human mistakes can explain the housing bubble. The Fed threesome looked at data from the Survey of Consumer Finances, from before and after the housing crash in 2008. They found that more optimistic ZIP codes — that is, places where people had unrealistically high expectations for their own incomes — were more likely to overpay for houses in the bubble run-up before 2008. These overoptimistic people also took on more debt, and they were more likely to increase borrowing in response to rising house prices.”
“This looks an awful lot like a systematic mistake. If you were the government in 2005 and 2006, you might have been able to use expectations surveys as a warning sign that told you when to restrict mortgage lending.”
“In other words, rational expectations might really be wrong. People might make systematic errors, thinking that booms or busts will last forever. If that’s the case, then it will require the economics profession to abandon one of its strongest orthodoxies. But the payoff could be big if the profession devises models that successfully explain phenomena like bubbles and crashes.”
‘We should accept that secular stagnation has become the new normal. We should also ponder the implications of Gordon’s thesis of the productivity slowdown. We need to recognize that we’ve mutated into a new type of economy and come to terms with the slow growth that such an economy is likely to produce.’
‘Summers’s thesis was a ‘radical manifesto,’ according to Nobel Prize winning economist and New York Times columnist Paul Krugman, noting that, ‘we may be in an economy that needs bubbles just to achieve something near full employment.’
Don’t tell me we’re abandoning the space alien project!
Man, these guys are completely out of ideas. Now it’s all fallen in on them and their only answer is, “let’s just stay drunk every day all day.”
Here’s an idea Noble Prizeans; get the f— out of the way and let the rest of us (the real economy) clean up your mess.
“stagnation has become the new normal…”
You only wish!
It’s not likely that we have arrived at some kind of high plateau after decades of credit expansion and waste, and just get to sit here comfortably forever.
‘Capacity utilization wasn’t under any great pressure. Unemployment wasn’t under any remarkably low level. Inflation was entirely quiescent. So somehow, even a great bubble wasn’t enough to produce any excess in aggregate demand.’
I’d love it if Summers were asked to show where in the generaly accepted body of economics literature it says that great bubbles are what’s needed to raise the level of aggregate demand.
It seems like these eggheads make stuff up on the fly, and rely on mass ignorance of the American public to sell it.
“$60 trillion in total global debt …has accrued since 2007″
A near vertical rise when graphed.
“Since a 1 percentage point increase in the short rate translates into about a 4.4 percent decline in house prices, the authors calculated that keeping house prices on trend would have required about an 8 percentage point increase in the federal funds rate in 2002.”
I’d like to see the Fed test that theory with real data. Sounds completely wrong, with severe under estimation of the marginal effect of higher interest rates on housing prices.
‘They do allow that, perhaps, the Fed could have merely brought house-price growth down, and not to the trend, therefore requiring only a smaller rate hike. Alternatively, they suggest the Fed could have triggered a recession with a rate hike smaller than eight points, and that could have slowed house prices more than they calculated.’
Jeebus, Econ 101; recessions are how mal-investments are wrung out of the economy.
Here’s a link to the paper.
I’m curious, you allude to “real data”, but have you actually looked at the data?? There is plenty of it to test the theory.
I’ll focus on periods of rapid increase in Fed Funds Rates and then what happened to home prices during that rapid increase (”concurrent”), and then after another year cumulatively, and then after another 2 years cumulatively–the data is from Shiller’s NOMINAL home prices (after all you borrow nominally, and pay back nominally–you can do the inflation-adjusted math if you want, it will look less rosy).
1. May 1958 to January 1960 (0.6% to 4% Effective Fed Funds Rate);
+.2% concurrent
+.6% concurrent +1 year
+1.7% concurrent +2 years
2. August 1967 to August 1969 (3.9% to 9%);
+9.9% concurrent
+18.8% concurrent +1 year
+25.2% concurrent +2 years
3. February 1972 to July 1974 (3.3% to 12%);
+10.9% concurrent
+20.4% concurrent +1 year
+30.5% concurrent +2 years
4. July 1980 to July 1981 (9% to 19%);
+6.6% concurrent
+8.0% concurrent +1 year
+11.8% concurrent +2 years
5. May 1983 to August 1984 (8.6% to 11.6%);
+6.4% concurrent
+12.6% concurrent +1 year
+23.1% concurrent +2 years
6. January 1988 to May 1989 (6.6% to 9.8%);
+9.8% concurrent
+12.7% concurrent +1 year
+10.5% concurrent +2 years (nominal prices fell from month 12 after tightening finished to month 24 after tightening finished)
7. January 1994 to April 1995 (3% to 6%);
+2.8% concurrent
+5.0% concurrent +1 year
+7.9% concurrent +2 years
8. April 1999 to September 2000 (4.75% to 6.5%);
+13.3% concurrent
+22.1% concurrent +1 year
+32.7% concurrent +2 years
9. July 2004 to October 2006 (1% to 5.25%)
+20.8% concurrent
+16.5% concurrent +1 year
+4.5% concurrent +2 years
Let me be clear, before people start jumping up and down accusing me of being a cheerleader–
When rates have been too low for too long (and thus pricing has been influenced more than in situations where rates are only low as we bounce off the bottom of an economic cycle), there is substantial risk to prices when rates start to rise again. As such, I expect prices to come under pressure more than in other eras.
In other words, I don’t expect prices to rise up to 10% per year as they have in SOME other eras of increasing interest rates…the rates being too low for too long has brought some of the price increases forward (we’ve already gotten the price increases that usually come along with a stronger economy).
HOWEVER, the “real data” on historical periods of increasing rates does NOT support the view that prices will fall as interest rates rise. Apparently the positive effects of a good economy have largely outweighed the increasing cost of capital during those times.
Here’s some data for you….
Current asking prices of resale housing are 2x construction costs(lot, labor, material and profit) and 2.5x higher than long term trend.
This is the reason we have so many excess, empty and defaulted houses.
‘even though home prices are currently vastly overvalued, the housing market is not in a classic bubble because the real estate market is not currently in the conditions of being over owned or over supplied’
‘Construction on San Francisco’s massive Parkmerced redevelopment project will start in February, kicking off the three-decade buildout of 5,679 new housing units, according to the developer’s filings with the city this week.’
‘The Planning Commission on Thursday got a peek at the designs of the first five residential complexes that will dot the 152-acre complex on lots that are now mostly vacant. The buildings, which will add about 1,000 units to the development, range from 14-story cylindrical towers with heavy amenities to five-story buildings full of replacement units for eventually demolished rent-control units.’
I respect this gentleman’s approach, but I think anyone could see over-supply in New York City, Miami, apartments everywhere. I keep coming back to this; why are we told there is no inventory in big cities and small towns across the country? Are that many people living in cardboard boxes?
5,679 new housing units in SF… over a three-decade period? That’s absolutely nothing.
It’s just one article. But it shows where the inventory can be put; up. If Tokyo can be over-built any place can.
Manhattan is a perfect example….
25,677 properties found New York, NY Real Estate and Homes for Sale
http://www.realtor.com/realestateandhomes-search/New-York_NY
5,140 properties found New York, NY Price Reduced Homes for Sale
http://www.realtor.com/realestateandhomes-search/New-York_NY/show-price-reduced
Tokyo has a surplus of housing because they have a closed society and a declining population. That will never happen in the US.
It’s already happening Jingle_Fraud. There is a surplus of housing in all 4 directions.
-25 million excess empty and defaulted houses
-35 million houses just beginning to empty as boomers die off
-Population growth the lowest in US history
-Housing demand at 20 year low(30 year low in CA)
‘a surplus of housing …will never happen in the US’
After the Bubble, Ghost Towns Across America - WSJ
http://www.wsj.com/articles/SB121763228998406131
The Wall Street Journal
Aug 2, 2008 - Half-Built Subdivisions Are Lonesome Places; ‘There’s Just No Noise’.
I keep hearing this stuff. “You guys have been saying there will be a crash and it never happens.”
Jingle Male is actually correct, once you understand his intense bias. The “flyover” is invisible to his class of person. Hence you can’t have a surplus of housing in highly desirable areas (defined as places where there are few Blacks and many jobs). For the next several decades, you won’t find a surplus of housing in San Francisco, Boston, Miami, etc. … but you WILL find a surplus of housing in Detroit, Memphis, etc.
I am fortunate to live in a Rusty City in the Great Lakes region where housing collapsed but you can still find Lucky Ducky jobs. So it’s 1/3rd of the way on a housing-surplus scale from Detroit to San Francisco. I can make this work since I live a singular life of low overhead. In many other places in the nation I’d either be homeless or a lifelong renter.
Electronic toilet paper my friend…. electronic toilet paper.
There is already massive excess housing supply in Boston and Miami… Do you think that might be why prices are falling in Boston and statewide in MA?
Jingle_Fraud doesn’t have bias. He’s underwater.
California would have to build 150,000 housing units/year just to keep up w new demand, and another 75,000/year to meet the shortfall from the last 30 years.
I doubt we’ve average more than 100,000/year for the last 3 decades….with not much chance of increasing the number.
Not true. Housing demand is at 30 year lows in CA.
I lived near Parkmerced years ago and visited friends there, it is a big high density complex built in the ’50’s by Met Life who also built similar complexes back east, FWIW the evil Leona Helmsley owned it for awhile too. I read the article as saying the net increase will be about 1000 units. An often foggy and windy corner of S.F., was popular with students of S.F. State long ago when it was affordable as the school is within walking distance.
https://en.wikipedia.org/wiki/Parkmerced,_San_Francisco
“maintaining full employment”
Strange that is considering employment is at 37 year lows.
‘Commodity prices have tanked, gouging huge holes in both company profits and state and federal revenue, at the same time as providing scant incentive for new investment.’
‘Next year also marks the beginning of the end for Australia’s car industry.’
‘Ford is due to cease production at its Geelong and Broadmeadows factories in October, but may pull the pin even earlier. Its exit will be followed by those of Toyota and Holden in 2017, bringing to an end nearly 70 years of large-scale automotive manufacture in Australia.’
‘In addition to the thousands of direct job losses, the wider automotive components sector faces virtual annihilation, with a University of Adelaide report last year estimating potential job losses (mainly in Victoria and South Australia) at up to 200,000.’
‘That figure may be overly pessimistic, especially with the shock absorber of a weak Australian dollar, but even the most conservative estimates put job losses in the tens of thousands.’
‘Some economists see scope for growth and employment in the housing construction and retail sectors, though how sustainable Australia’s property market is – especially in Sydney and Melbourne – remains debatable, and there are limits to how much already highly leveraged Australian households can fire up consumer spending in a low wages-growth environment.’
‘Even putting aside the financial-stability dangers of imploding bubbles, there are already signs that construction investment may be starting to cool. In recent days for example reports have emerged that the Commonwealth Bank (and other lenders) has tightened its lending requirements for apartment developers, requiring more pre-sales and applying stricter loan-to-valuation ratios.’
‘In a macro context, the economy is largely treading water. Growth is below trend, and GDP growth per capita at a particularly low ebb.’
‘For its part, the Reserve Bank has been signalling that it has reached the point where further cuts in official interest rates (already at a record low of 2 per cent) will be increasingly ineffective and risk encouraging asset speculation rather than more entrepreneurial risk-taking in the real economy.’
‘Put all of this together and you don’t get a platform from which it is easy to craft a convincing political narrative of prosperity and economic growth, even allowing that, many factors such as the commodity-price collapse are well beyond the control of any government.’
Commodity prices collapsed because they were driven too high supplying the bubbles in China and elsewhere. China happens and now you’ve got over-capacity. In other words, governments and their central banks caused the commodity collapse.
‘Chinese exports tumbled 8.3 percent in July, their biggest drop in four months and far worse than expected. Imports also fell heavily from a year earlier, in line with market forecasts but suggesting domestic demand might be too feeble to offset the weaker global demand for China’s exports.’
‘China’s factory activity suffered its biggest contraction in two years in July as new orders fell. On Friday the central bank published a report warning of further economic weakness, but argued the economy needed a retooled growth engine, instead of short-term stimulus.’
http://finance.yahoo.com/news/chinas-july-exports-slump-8-053624027.html
I just read that article Ben…Trade surplus dropped 20% in the latest report…
There’s nothing China can do to force other countries to buy their stuff. That’s the inherent weakness of an export driven economy. Germany will soon learn the same thing.
‘China under mounting pressure to ease policy as economy stumbles’
http://finance.yahoo.com/news/china-producer-prices-slide-six-015101391.html
As if the Chinese have done anything but print money like crazy for over a decade.
‘China’s leaders are increasingly relying on the central bank to help implement government programs aimed at shoring up growth, in an adaptation of the quantitative easing policies executed by counterparts abroad.’
‘Rather than bankroll projects directly, the People’s Bank of China is pumping funds into state lenders known as policy banks to finance government-backed programs. Instead of buying shares to prop up a faltering stock market, it’s aiding a government fund that’s seeking to stabilize prices. And instead of purchasing municipal bonds in the market, it’s accepting such notes as collateral and encouraging banks to buy the debt.’
‘While there’s been no public unveiling of the strategy, China’s leaders are putting in place plans for the central bank to finance, indirectly, a fiscal stimulus program to put a floor under the nation’s slowdown. China will sell “special” financial bonds worth trillions of yuan to fund construction projects, and the PBOC will provide funds to state banks to buy the bonds, people familiar with the matter said this month.’
http://www.bloomberg.com/news/articles/2015-08-09/quantitative-easing-with-chinese-characteristics-takes-shape?cmpid=yhoo
People familiar = leak.
Where’s A-Dan ?
Daly City/Broadmoor, CA Housing Prices Fall 11% YoY; Demand Slips to 28 Year Low Statewide
http://www.zillow.com/market-report/08-15/97506/broadmoor-village-ca-94015.xls
North Bend, WA Housing Prices Crater 21% YoY
http://www.zillow.com/north-bend-wa/home-values/
Northwest/Portland, OR Housing Prices Plunge 10% YoY; Mortgage Defaults Rise
http://www.zillow.com/northwest-portland-or/home-values/
7,203 properties found Sacramento County, CA Homes for Sale & Real Estate
http://www.realtor.com/realestateandhomes-search/Sacramento-County_CA
1,901 properties found Sacramento County, CA Price Reduced Homes for Sale
http://www.realtor.com/realestateandhomes-search/Sacramento-County_CA/show-price-reduced
Keep on a’slashin’ boys….. keep slashin’.
the only thing close to being fairly priced in the sacramento area are in scary neighborhoods.
Not in 2008. There were lots of great choices and a few choice lots……. if you bought a few years ago
There’ll be plenty more Jingle_Fraud. Your shanties might fetch $50k.
Dump’em now.
“In other words, rational expectations might really be wrong. People might make systematic errors, thinking that booms or busts will last forever.”
I’m lookin’ at you, North Dakota, oh am I ever lookin’ at you…
“US Crude New Session Low: $43.87″
http://www.cnbc.com/2015/08/07/crude-oil-futures-up-slightly-in-early-asian-trade.html
Nothing accelerates the economy like oil falling 60%…… nothing.
Floating condos.
http://finance.yahoo.com/news/aboard-retire-ship-145715018.html
sweet people will be flipping them soon.
New term
Capsizing
+20,000
,……….leagues.
Pacific Beach/San Diego, CA Housing Prices Fall 4%
http://www.zillow.com/pacific-beach-san-diego-ca/home-values/
Las Vegas, NV Housing Prices Crater 7%
http://www.zillow.com/las-vegas-nv-89135/home-values/
I hope this means they won’t raise my rent next Feb., when my lease expires.
$64 Million Mortgage Fraud Scheme
http://www.housingwire.com/articles/34707-mortgage-firm-owner-pleads-guilty-to-64m-mortgage-fraud-scheme
With mortgage, realtor and appraiser fraud back at rampant levels, post the stories here.
“A Miami-area real estate developer and owner of a mortgage company…”
Florida… a sunny place for shady people.
You are so 2006.
Bubbles may have some positive consequences, briefly. I’d love to hear what bubble proponents consider their negative consequences.
The robber barons of yore left infrastructure and technology in their wake. What are today’s financial sector robber barons leaving in their wake? Bubbles? Central planning? A subversion of the democratic process?
Paul Volcker said the only useful financial innovation of the past 30 years was the ATM. Of course, the ATM is not financial innovation but technological innovation. So that leaves precious little.
The true result of the financial innovations since the 70s are two things:
1) The financial sector being able to extract more and more wealth from the population at large through a variety of mechanisms.
2) The enshrinement of the “Privatize the profits, socialize the losses” business model for the financial sector.
And this is all done by buying politicians and regulators.
Better yet, take a look at the geographic epicenters where these bubbles either started or ended. Nothing but poverty left in their wake.
Californica is a prime example.
‘Paul Krugman, noting that, ‘we may be in an economy that needs bubbles just to achieve something near full employment.’
‘If economists insist on using an incorrect assumption as the core of their models, it will force them into ever more Byzantine theoretical contortions, as the models repeatedly fail to fit the facts. Cynics would argue that this is exactly what we see happening in macroeconomics’
This isn’t theoretical. Bernanke and friends have already run up several bubbles; bonds, stocks, housing. And note that there are several classes of all these assets. And California is a perfect example. The poorest state, precisely because of housing!
Zillow shows ferguson prices going up 3.5%
The land of gentle giants
When the backbone of a country comes down to a wrist watch that everybody fears could sink Apple ,online buying like Amazon and Netflix (???).
Well folks you don’t have to attend the school of Wharton is it (I believe Trump went there ) Cal Tech, MIT, NorthWestern, Ivy league, any league, this country is in bankruptcy ( real debt last I heard 95 trillion) not ever going to be imaginable to any sane person on Earth. It looks like the depression of 2007 to 2011 and the recession 2012 to present will blossom to the greatest depression, it is a stone throw away from where you live, sorry to report.
Nothing to fear so long as you’re prepared. Get out of debt and save your cash. You’ll thank me later.
http://www.cnbc.com/2015/08/09/-are-dying-a-slow-death.html?__source=yahoo|finance|headline|headline|story&par=yahoo&doc=102900126
‘That widely watched commodity index has fallen 17 percent the last three months, and a whopping 42 percent in the past two years. It’s not just an energy issue, either. Copper, platinum, lumber, coffee, sugar, wheat, oats and lean hogs are all down double-digit percentages this year. While each specific commodity obviously responds to its own distinct supply-and-demand dynamics, a few fundamental factors appear to be weighing on commodities as a whole.’
‘And in fact, many investors bought commodities to get protection from a Federal Reserve stimulus-stoked rise in inflation that never came. As the Fed ended its quantitative easing program—and now appears months away from raising rates—what now appears to have been a massive bubble in commodities like gold has slowly popped.’
‘Commodities are the gift that keep on not giving. The sector is in the throes of an ‘annus horribilis’, having gotten wrecked over the past few years despite massive liquidity that should have boosted their value. Bullish investor after bullish investor has tried to call a bottom, in a set of calls that now appear ill-conceived and money losing.’
‘massive liquidity that should have boosted their value’
It did increase their value, as the Chinese built cities and the commodity producers ramped up capacity. Then it all falls in on itself because it’s phony demand. But the now over-capacity is real. Yet as I’ve pointed out, the easy money keeps doors open that should have shut, so these past few years and today, QE and artificially low interest rates ultimately result in deflation via bubbles.
Bring it on Janet.
They fail. Their arrogance will never allow them to admit it and concede their incompetence.
Maybe they’ll just disappear like A-dan did.