In the United States and in the United Kingdom, it is clear that the housing boom has been a bubble. In the United States, the bubble has already burst — the only question is when the U.S. housing market will reach its low point. Britain is following the same track, but is somewhere between six and twelve months behind.

There are some important differences between the two markets. For most purposes, the British housing market can be regarded as a single market. There are, of course, regional variations which largely reflect the distance from London — the Inverness market fluctuates in a different cycle from London. But, over time all the regional markets tend to move in a similar rhythm.

In the United States, the regional differences have been much more important. The housing bubble, which is now receding, is the first nationwide housing bubble in American history. In the past, Americans have been drawn into local or regional housing booms, like the great Florida boom of the 1920s. This time the U.S. boom ran throughout the States.

I think that must have been caused by the universal availability of cheap credit, the same influence as created the boom in hedge funds and private equity. If the availability of credit is the chief determinant of house prices, then Florida and Chicago are likely to share in the boom and in the recession. Regional differences become secondary influences, as they are in the stock market.

The fall in the house market has wiped out very important assets of the banking system, leading to the collapses of Bear Stearns and Northern Rock and the distress of other banks. It is difficult to put a figure on the contraction of credit that has resulted. The I.M.F. has suggested $1 trillion, which is an impressive round number. What has actually been lost is a multiple of the fall in house values, since there is a multiplier effect on credit and on the willingness to lend. A bank which has lost a billion dollars in the housing market, or some derivative of the housing market, will feel itself to be short of capital and will seek to draw in as much cash as it can. It may well go from over-generous lending to exaggerated borrowing, which will take it from being a net lender to being a net borrower. This banking squeeze is pronounced both in the U.S. and the U.K.

However, there are other global price rises which are not bubbles. The oil market has risen to record highs, with Brent Crude at around $108 a barrel. This cannot be merely a reflection of excess liquidity, since the oil price has continued to rise at a time when credit was becoming much scarcer. In the case of oil there are non-monetary reasons for higher prices, including the high level of demand from Asia, the geopolitical risks of dependence on Iran and the physical loss of production in Iraq. The rise in oil prices extends to rises in products dependant on oil, particularly foodstuffs. There is a global increase of grain prices, causing most suffering in Africa and in the less developed Asian countries. These are not speculative increases, but are reflections of real economic and political factors.

I do not believe that the world is on the edge of another Great Slump, but the combination of the deflationary effect of the collapse of a widespread housing bubble with the inflationary effect of higher prices for oil and food does present Governments with the most difficult economic problems since the 1970s. It was then called “stagflation,” to reflect stagnant inflation. Both horns of the stagflation dilemma now look sharp and threatening.

Regards,
Lord William Rees-Mogg
April 11, 2008

Housing Bubbles and Booms was originally featured on Whiskey and Gunpowder

Greenspan on the Housing Bubble

Greenspan is blaming the decline of the Soviet Union and the end of the Cold War for worldwide housing bubbles:

“It was a geopolitical switch in which market capitalism very quietly overtook central planning, and that created substantial booms throughout the world …creating an excess of savings, which drove down long-term interest rates virtually everywhere. And virtually everywhere, it sprouted a housing bubble.”

In essence, he wants us to believe that housing skyrocketed 10-plus years after the fall of the Soviet Union in some sort of delayed reaction, and that it was just by coincidence that this happened after the Fed slashed rates to 1%. Clearly, Greenspan is attempting to absolve himself of his role in the housing bubble.

It gets more interesting:

“Central banks gradually began to lose the power of affecting longer-term rates, as we demonstrated rather conclusively in 2004, when we raised short-term rates very rapidly and ended up with no increase whatsoever in long-term rates, and indeed, it stayed that way in 2005 as we continued to tighten.”

Greenspan has selective memory. The Fed did not raise rates rapidly, as this testimony of Chairman Alan Greenspan on July 20, 2004, shows:

“In May, the FOMC believed that policy accommodation needed to be removed and that removal could be accomplished at a pace that is likely to be measured. At our meeting last month, the FOMC raised the target federal funds rate from 1% to 1.25%, and the discount rate was raised commensurately. Policymakers reiterated that, based on our current outlook, the removal of accommodation would likely proceed at a measured pace.”

And Greenspan kept the “measured” pace at a quarter point per meeting for 17 consecutive meetings. It was perfectly measured, and certainly not the “very rapid rise” he talked about in the Fox interview:

“What that demonstrated pretty much around the world is that central banks no longer have the capacity to significantly impact longer-term rates, and it’s the longer-term rates that create bubbles.”

The rebuttal to this nonsense is that by lowering interest rates to 1%, all sorts of speculative lending took place based on the spread between banks’ ability to borrow at 1% and lend at a higher multiple. It is highly unlikely the market would have lowered short-term rates to 1% or kept them there for long if it did. Greenspan either is being disingenuous or is a complete fool to put forth this set of arguments on the housing bubble.

Greenspan on the Central Bank and Gold

Fox: “So why do we need a central bank?”

Greenspan: “Well, the question is a very interesting one. We have, at this particular stage, a fiat money, which is essentially money printed by a government, and it’s usually the central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or currency board or something of that nature, because unless you do that, all of history suggests that inflation will take hold with very deleterious effects on economic activity…There are numbers of us, myself included, who strongly believe that we did very well in the 1870-1914 period with an international gold standard.”

Fox: “We did well without the Federal Reserve. People forget that.”

Yes, they do. And that last paragraph was one of the few things Greenspan has ever said that made any sense.

Regards,
Mish

Novmeber 19, 2007

Every Which Way But Me was originally featured on Whiskey and Gunpowder

“Former Federal Reserve Chairman Alan Greenspan said the current market turmoil is in many ways ‘identical’ to that which occurred in 1987 and 1998, when the giant hedge fund Long Term Capital Management nearly collapsed.

“‘The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907,’ Mr. Greenspan told a group of academic economists in Washington, D.C., [on Sept. 6] at an event organized by the Brookings Papers on Economic Activity, an academic journal…

“Bubbles can’t be defused through incremental adjustments in interest rates, Mr. Greenspan suggested. The Fed doubled interest rates in 1994-1995 and ‘stopped the nascent stock market boom,’ but when stopped, stocks took off again. ‘We tried to do it again in 1997,’ when the Fed raised rates a quarter of a percentage point, and ‘the same phenomenon occurred.’

“‘The human race has never found a way to confront bubbles,’ he said.”

The truth of the matter is the Fed (and, in particular, Greenspan) has embraced every bubble in history, adding fuel to every one of them. Let’s consider the last two bubbles.

The Fed’s Role in the Dot-com Bubble

Acting in misguided fear of a Y2K calamity, the Fed stepped on the gas with unnecessary liquidity, having previously stepped on the gas to bail out Long Term Capital Management in 1998.

And after warning about irrational exuberance in 1996, Greenspan embraced the “productivity miracle” and “dot-com revolution” in 1999. Midsummer 2000, Greenspan believed his own nonsense, and right as the dot-com bubble started to burst, he started to worry about inflation risks. The May 16, 2000, Federal Open Market Committee minutes prove this:

“The members saw substantial risks of rising pressures on labor and other resources and of higher inflation, and they agreed that the tightening action would help bring the growth of aggregate demand into better alignment with the sustainable expansion of aggregate supply. They also noted that even with this additional firming, the risks were still weighted mainly in the direction of rising inflation pressures and that more tightening might be needed…

“Looking ahead, further rapid growth was expected in spending for business equipment and software…Even after today’s tightening action, the members believed the risks would remain tilted toward rising inflation.”

How could Greenspan have possibly been more wrong? Over the next 18 months, CPI dropped from 3.1% to 1.1%, the U.S. went into a recession, and capex spending fell off the cliff.

The Fed’s Role in the Housing Bubble

In 2001, Greenspan went overboard in the other direction, embarking on a campaign that eventually slashed interest rates to 1%, while embracing the miracle of derivatives and encouraging consumers to get into ARMs along the way.

And right as the bubble was bursting, Greenspan dismissed the idea of a national housing bubble.

No National Housing Bubble

Flashback, May 21, 2006: Greenspan says housing prices won’t fall nationally.

History suggests that betting against Greenspan is the correct thing to do. Thus, I mockingly talked about his call on May 27, 2006, in “Greenspan Predicts Housing Bust.”

Confronting Bubbles

As for “confronting bubbles,” the Fed foolishly watches (takes action on) only consumer prices. Thus, the Fed ignores expansion of credit when that credit fuels asset bubbles, as opposed to the prices of consumer goods.

The Fed could easily target credit with higher interest rates if it cared to, but it does not.

This is not a matter of attempting to identify bubbles in advance — this is a matter of attempting to identify credit conditions that create bubbles. And the fact is runaway expansion of credit fuels one or both of two things in some combination: asset bubbles and/or consumer price increases.

Bernanke is equally as bad as Greenspan, if in fact not worse, by supporting positive inflation targets. (See “Inflation Targeting Is Flawed” and “Can the Fed Control Prices?” for more on the silliness of inflation targeting.)

Is It 1987 or 1998?

• In 1987, we had the Internet revolution to look forward to. Yes, that was a productivity miracle, but it also allowed the Greenspan Fed to open the credit spigots wide open because rapidly increasing productivity is highly disinflationary
• In 1998, as the Internet boom was starting to peak, there was still one more bubble up the Bubblemeister’s sleeve: the housing bubble
• In both years, the ability of consumers to take on (and afford) debt was vastly different than it is today
• In both years, there were numerous new credit products to exploit coming up on the horizon: CDSs, CDOs, SIVs, ABSs, LBOs, conduits, MBSes, “swaptions,” etc., etc., etc. See “Swaptions and Financial Turmoil” for more on swaptions and off-balance sheet conduits at Citigroup, as well as leveraged buyout turmoil at Citigroup, JPMorgan Chase, Lehman, and Bear Stearns
• Massive junk bond-financed share buybacks, LBOs, and speculation in mergers and swaps, etc. were on the horizon in 1998. Those are now history
• Credit standards were poised to fall to insanely low levels, but are now swinging back in the other direction. In fact, loose credit standards made a secular low that will not be seen again for decades, if ever
• Off-balance sheet garbage not marked to market was never as high as it is today
• Various carry trades fueled all sorts of speculative investments. Those carry trades have yet to be unwound, but they will be. And they are orders of magnitude bigger than anything we saw in either 1987 or 1998
• The China factor is vastly different today than it was even as late as 1998. The resultant deflation in wages as a result of outsourcing and manufacturing moving to China and service jobs to India is still being felt
• There is now $300-500 trillion (yes, trillion with a “T”) in derivatives floating around, depending on whom you believe. But even the smaller number is many orders of magnitude greater that either 1987 or 1998.

By suggesting that conditions are “identical” to either 1987 or 1998, Greenspan is one or more of the following:

• A misguided fool
• Lying
• Blinded by his own arrogance
• Attempting to rewrite history
• Attempting to lay the blame on Bernanke
• Some combination of the above.

Whatever it is, Greenspan is above all…wrong. Furthermore, Greenspan has been consistently wrong at every major turn in his entire history as Fed chair. The only thing he has been correct on is his unwavering support for free trade. And on that issue, ironically enough, hardly anyone listens to him.

With that in mind, I have to wonder just what Pimco thinks it can get out of hiring Greenspan as an adviser. All I can figure out is: 1) Pimco is hoping somehow to cash in on Greenspan’s list of contacts, or 2) Pimco is asking for Greenspan’s advice and betting the other way.

Regards,
Mish
September 11, 2007

No, Greenspan, Conditions Are NOT Like 1998 was originally featured on Whiskey and Gunpowder

1. Enthusiasm
2. Disillusionment
3. Panic
4. Search for the guilty
5. Punishment of the innocent
6. Praise and honors for the non-participants

Right now, we seem to be in an overlapping state centered around panic (this phase can last a long time) with lingering pockets of “disillusionment” and the beginnings of the “search for the guilty” now under way.

As anecdotal evidence as to where we are in the cycle, I point to “Foreclosure Crisis Sparks Investigation” :

“Amid Wisconsin’s deepening mortgage foreclosure crisis, Legal Aid Society of Milwaukee on Tuesday announced an inquiry into what went wrong.

“‘We need to find out who are the people being foreclosed, who are their servicers and original lenders, and what kinds of loans did they get,’ said Catey Doyle, the organization’s chief staff attorney. ‘There are a lot of questions about who bears responsibility for this situation, [and] the only way to find out who the players are is to manually go through court files’…

“Volunteers working under the group’s supervision recently launched a review of all Milwaukee County Circuit Court cases filed since June 2006, Doyle said. She said the group will report its findings this fall by lender, ZIP code, loan type, and other factors…

“‘Loans made in the last year got progressively more and more outrageous,’ Doyle said. ‘It was like a feeding frenzy. Now we’re seeing 20 foreclosures a day on average in Milwaukee County, and sometimes 30. It’s really depressing.’

“All year, her office has been awash in complaints of deceptive lending practices — ‘dozens of them,’ Doyle said.

As part of the “search for the guilty” phase, there is an ongoing denial and coverup by some of those who are guilty but are trying very hard to stop any fingers from pointing in their direction. This “One on One With David Wyss, Chief Economist of S&P” shows what I mean:

“SUSIE GHARIB, NIGHTLY BUSINESS REPORT: More analysis now on that subprime credit watch by Standard & Poor’s. Joining us, David Wyss, chief economist of S&P. Hi, David.

“DAVID WYSS, CHIEF ECONOMIST, STANDARD & POOR’S: Good evening.

“GHARIB: Let’s begin by getting your reasons of why S&P put these mortgage- backed securities on negative credit watch.

“WYSS: Well, the basic reasoning is they’re simply not performing as well as we expected. The housing market is not turning around in a hurry. We didn’t really expect it to. Home prices still have a ways to drop. And we’re already seeing substantially higher default rates on these securities than we had anticipated at this point. So it was time to move them.

“GHARIB: But why now? All of these factors that you’ve mentioned have been going on and the housing sector has been struggling for some time — why now?

“WYSS: Well, largely because we need to get enough record on these securities to see how they’re performing. We knew the housing sector was underperforming. We knew that when we rated these securities. But what surprised us is that even given the poor performance for the housing sector, the default rates are running higher than we would have expected given the FICO scores here, given the loan-to-value ratios in these mortgages.

“GHARIB: Now, I understand that there are 612 mortgage securities on your credit watch list. And you’re reviewing them and some of them will be downgraded. How many of them will be downgraded, do you think?

“WYSS: Well, if we knew that, we wouldn’t have to put them on credit watch. But I would say, you know, the great majority. My personal guess would be at least 90%. Let’s keep this in perspective. We’re looking at $12 billion. That sounds like a lot of money — it is a lot of money to most of us. It’s only 2% of the subprime securities we rated during that period. And it’s 0.01% of the U.S. mortgage market.

“GHARIB: All right. So if it’s 2%, then how serious is this announcement that you made today? How worried should investors be?

“WYSS: I don’t think you should be worried generally, but obviously, what we do worry about, is there a concentration of this risk that has built up in some of the hedge funds, for example, that could cause problems?”

David Wyss is trying like mad (as are numerous others in the state of denial) to contain the damage by containing the negative sentiment. It’s galling to see shills saying with a straight face the problem is only with 2% of subprime when a full 65% of the bonds in indexes that track subprime mortgage debt don’t meet the S&P ratings criteria that were in place when they were sold.

The 2.1% downgrade of debt by the S&P is a joke. I talked about this at length in “Stress Test.” The ploy by David Wyss at the S&P is doomed to fail. Sorry, David, no matter how hard you try, you can’t put air back into a popped bubble.

Regards,
Mish

July 12, 2007

Six Phases of the Housing Bubble was originally featured on Whiskey and Gunpowder

What Housing Bubble?

Neil Barsky, managing partner of Alson Capital Partners, LLC, wrote an absurd opinion piece about housing in the Commentary section of the July 28 online issue of The Wall Street Journal in which he claims there is no housing bubble.

Now, plenty of people, some just plain stupid, some with axes to grind, write the same thing. Typically, these opinions are not worth replying to, quite frankly, because they are so widespread and preposterous that one would spend all his time rebutting such nonsense. But Barsky is a special case, for reasons we will address later.

In the meantime, let’s review some of the nonsense spewing forth from Mr. Barsky. Here goes:

“In a free country, it is fair game for the media and economists to scare homeowners with words of gloom and doom, however knee-jerk, consensual, and misguided they may be…

“The reality is this: There is no housing bubble in this country. Our strong housing market is a function of myriad factors with real economic underpinnings: Low interest rates, local job growth, the emotional attachment one has for one’s home, one’s view of one’s future earning power, and parental contributions, all have done their part to contribute to rising home prices. Over the past quarter century, there has been an explosion of second home purchases, a continued influx of immigrants, and a significant reduction in existing housing inventory through tear-downs. Not all of these trends are accurately reflected in the unending stream of data published daily. Home prices on average have risen at a 6% annual pace since 1999, and 13% over the past year.”

Hmmm. It seems to me that Barsky is suggesting there is no bubble because prices are rising and there is an explosion of second home purchases. This is more or less the equivalent of saying there was no bubble in stocks in 2000 because prices were rising and people were buying more of them.  

Barsky writes: “What we do have is a serious housing shortage and housing affordability crisis. Despite robust construction, unsold inventory stands at four months, well below its 25-year average. Private builders complain they can’t get land permitted to meet demand. Low-income housing advocates complain housing prices are out of reach for many Americans, and that government subsidies have been slashed.”

A shortage of housing? Exactly what planet is Barsky on? Here is what I see: millions of vacant homes:

“There were an estimated 123.7 million housing units in the United States in the second quarter 2005. Approximately 107.9 million housing units were occupied: 74.0 million by owners and 33.9 million by renters.”

Indeed, 36% of all houses sold in 2004 were for either as second homes or for “investment.” Change the word “investment” to “greater fool speculation” and you have a clear picture of what is happening. People are chasing houses because they are going up. How many houses do people need, anyway? I suppose if everyone needs two or three houses, there might be a shortage of them.

Barsky writes: “What we have never seen in this country is a collapse of home prices without also seeing local economic weakness or significant capacity growth. Absent those factors, housing markets just don’t collapse under their own weight.”

Obviously, Barsky is no student of history. He ignores house prices falling for 18 consecutive years in Japan, and he ignores what happened in the Great Depression. He ignores what happened in the oil bust in Texas, and he ignores what is happening currently in Australia and the United Kingdom. In short, Barsky takes a Pollyannaish view that a recovery that has produced zero private sector jobs in spite of record low interest rates can go on booming forever.

Housing Bubble: Barsky’s Myths Aren’t Myths

“* Myth No. 1. There is too much capacity: According to Census data, over the past 10 years, housing permits have averaged about 1.63 million units per year — including multifamily units. Household formation has averaged 1.49 million families per year. So far, so good. But here is where the data get murky. Roughly 6% of the new home sales were for second homes (I have seen estimates that the number is actually twice as high), according to UBS. And while there are no precise numbers on this, approximately 360,000 units every year were torn down either because they were nonfunctional, or because they were tear-downs. When the latter two numbers are taken into account, the real number of new homes is closer to 1.2 million, or 19% fewer than the average number of new households formed each year.”

Obviously, Barsky has failed to take a look at data showing 15.8 million unoccupied units. Barsky also seems to assume that every family needs to buy a home. Some people, especially in large cities simply do not want to buy a home. Others, due to education and/or income or disabilities, will never be able to buy a home even if they do want one. In fact, it is this absurd ownership society that is pressuring people to buy homes (in conjunction with speculators driving up prices) that is playing a significant part of the bubble.

Barsky writes:

“* Myth No. 2. Risky mortgage products are fueling house appreciation: Sages from Warren Buffett to Alan Greenspan have warned of the increased risk from the use of new mortgage products, particularly adjustable-rate mortgages and interest-only mortgages. The theory here is that buyers are extending themselves to make payments, and when their mortgages reset, they will be in trouble. Put aside the fact that only a year ago Mr. Greenspan was advocating the use of ARMs (’American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,’ he told the Credit Union National Association last year), these concerns are wildly overstated. As virtually every mortgagee in the country knows, most ARMs are fixed rate for the first 2-7 years. Virtually all have 2% interest-rate caps. The average American owns his home for seven years. Why pay several hundred basis points to lock in rates he is highly unlikely to take advantage of? Moreover, very little equity has been paid off by a homeowner in the first seven years of a 30-year loan, so consumers have been effectively overspending on interest rates for generations. As Mr. Greenspan said in his 2004 speech, ‘The traditional fixed-rate mortgage may be an expensive method of financing a home.’”

Barsky writes:

The reason we are seeing these stories is because they are happening. Entire buildings of condos are being sold in Florida that are now 80% investor owned. People are buying homes sight unseen. Apparently, Barsky thinks that just because insanity is brewing in Manhattan as well, there is no bubble.

Let’s take a look at what some more sensible people are saying.

The Orange County Register suggests, in “Region’s House of Cards Ready to Topple as Prices Reach Unsustainable Levels”:

Hmmm. Only 11% of the people in Orange County and 24% in San Bernardino can afford a house. That’s not a bubble?

The OC Register continues:

The increase is much higher in hot housing markets like Orange County (99%), where the ratio of median home price to average monthly rent now stands at 433:1.

To recalibrate to more reasonable historical levels will require rents to rise sharply, which is constrained by household income growth, or home prices will have to fall, the only other possibility.”
That’s not a bubble?

OK, Mish, just why are YOU bothering?

Good question. You see I left off a couple snips from that article Barsky wrote. Let’s take a look at them:

Mr. Barsky writes: “I am now a money manager. I currently own stocks in several homebuilders; so I am putting my money where my mouth is.” The article concludes with “Mr. Barsky is managing partner of Alson Capital Partners, LLC.”
What peaked my interest in Mr. Barsky is the following chart. It is a large chart of Toll Brothers Inc. Ownership. Take a look at the second line from the bottom to see what Alson Capital Partners, LLC is doing with TOL.

I sense reader questions pouring in.

Enquiring Mish readers deserve answers, so let’s take a look. How about this?:

1) Mr. Barsky writes an article for the WSJ proclaiming there is no housing bubble.

2) Mr. Barsky calls housing bears “Chicken Littles.”

3) Mr. Barsky says, “I am putting my money where my mouth is.”

4) Mr. Barsky is managing partner of Alson Capital Partners, LLC.

5) According to the first chart, Alson Capital Partners, LLC sold 896,680 shares of TOL in the first quarter of 2005. That was a decrease (at the time) of 28% of their original holding of 3,166,680 shares to 2,270,000 shares of TOL.

I am sure enquiring Mish readers are wondering what happened to the other shares, since 1,135,000 plus 448,340 equals 1,583,340, not 2,270,000. Unfortunately, Mish has no answer to that question. At any rate, that is not relevant. What is relevant is that an original holding of 3,166,680 shares has now been reduced to 1,135,000 shares. This means that Alson Capital Partners, LLC has sold 64.2% of their holding of TOL (2,031,680 shares out of 3,166,680) in the first two quarters of this year.

Since there is a discrepancy in the numbers, it not clear precisely what percentage of TOL that Alson Capital Partners, LLC has been dumping. It does seem to be huge. What is clear is the fact that two sources show Alson Capital Partners, LLC dumping TOL while a managing partner of the corporation went out of his way to defend a housing bubble in a major publication. It is also clear that Mr. Barsky failed to disclose those facts while claiming to be putting his money where his mouth is.

Given the above, I have one question for Mr. Barsky: Is defending the housing bubble as you did consistent with Alson Capital Partners, LLC dumping huge percentages of its TOL holding?

Regards,

Mike Shedlock – “Mish”
August 2, 2005

Housing Bubble: What Housing Bubble? was originally featured on Whiskey and Gunpowder