Saturday, April 02, 2005

Housing Bubble Not Feds "Business": Gramlich

In statements that should put the housing bubble in the spotlight, Fed Governor Edward Gramlich told a conference that the bank neither could, nor should target asset manias. Reuters; "If you worry about asset prices, that represents a trade-off with your primary objectives."

The article rhetorically put forth the charges, "It has been accused of fueling a housing boom in the United States after aggressive monetary policy action to get the economy back on track cut interest rates to just 1.0 percent, the cheapest borrowing terms in decades."

"It would be impossible for the central bank to target a single asset class such as equities or housing." Balderdash! How about the corrupted lending standards? Requiring downpayments?

The report will certainly create a swirl of controversy as it seems to at once imply that the bubble exists, but that there is nothing to be done about it. And one quote from Mr. Gramlich should put a chill through millions of homeowners. "If you catch it too late, it could be very destablizing."

There are now more questions than answers. Who is responsible for preventing asset bubbles? And doesn't "catching it late" suggest a move should have come long ago? This blog has been making the case that the housing market is severely destabilized as is. And now it seems the central bank will wash its hands and leave us to our fate.

25 Comments:

At 3:44 PM, Anonymous Anonymous said...

Presumably if hyperinflated asset prices are not the Fed's business then neither are decade-long corrections in asset prices.

So the Fed will keep interest rates at a neutral level (say 4.5%) as long as CPI stays around 2%, regardless of whether or not house prices correct by, say, 20% over the next 10 years.

 
At 3:48 PM, Anonymous Anonymous said...

Why in a market economy we let the gov't control/influence interest rates I'll never know. you just can't control the money supply, the economy, unemployment and all else through one bank. it just can't be done.

get rid of the Fed system and restore gold and silver!

 
At 3:50 PM, Blogger Ben Jones said...

Anon,
Good question. If this gets the press it should, maybe we will finally get the debate we deserve.

 
At 3:52 PM, Blogger Ben Jones said...

(get rid of the Fed system and restore gold and silver!)

I'm with you. Maybe the bust will put a padlock on the central bank!

 
At 5:44 PM, Blogger John Law said...

when I say get rid of the Fed and return to gold and silver people usually laugh...they've never read 'Special Privilege."

 
At 6:03 PM, Anonymous Anonymous said...

This makes me furious. Here is a gov't official saying that the FED can't be concerned with inflated asset classes and yet when stocks (presumably an asset class) crash and make some people poor (idiot investors) then the FED should step in and drop interest rates to zero so that they (and thus our economy) doesn't suffer too much. WOW.

So it is OK to be worried about asset class crashes but not asset crash bubbles ??? This is CLEARLY a government that favors SPECULATION over prudent investment. Now that I understand this, I'll be dramatically changing my investment strategies.

So, what is going to happen when the housing bubble bursts ? Is the FED going to step in again with artificially low rates so that the homeowners (and the economy) aren't hurt too much ?

The folly of this whole situation is that Asian investors read US newspapers and by now they must realize that a) we have a housing bubble, b) when it bursts it is going to do some real damage and c) the US consumer is going to send the US economy into a death spiral when this all happens.

I'll tell you one thing: if foreign investors have ANY brains, the US FED won't be setting the interest rates anymore. The investors will. They will STOP BUYING US DOLLARS until this situation is taken care of.

Didn't Japan learn what happens to an economy when you grow and then burst a housing bubble ? And now they are growing one here to see if the same thing will happen to the US economy ????

OUTRAGEOUS !!

 
At 6:12 PM, Blogger John Law said...

(Didn't Japan learn what happens to an economy when you grow and then burst a housing bubble ?)

You would think people learn, but the Central Bankers and their following will always claim past problems were because of mistakes that today's Fed won't make. they've used that excuse for the depression and for japan.

 
At 6:24 PM, Anonymous Anonymous said...

(it is mandated by Congress to preserve price stability while seeking sustainable full employment)

Apparently HOUSING price stability was NOT on their agenda. Furthermore, the only place the Fed has created full employment is in CHINA. We certainly do not have full employment here in USA.

This is absolutely stupid. That banker is just trying to justify the way things are, hiding the fact that they accidentally created a SECOND bubble.

He can say all he wants, but they either deal with the housing bubble now or it will grow and they'll have to deal with an even bigger problem later.

I can't ever remember when an economy was so screwed up and by the Fed none the less.

There is a great quote in the Intelligent Investor about how a young Greenspan issued comments about how great the stock market was immediately before it crashed the next day.

 
At 6:34 PM, Anonymous pb said...

..of course Mr. G. famously closed debate on the subject of bubbles by announcing that a: you can't tell when one exists and b: shut up, please.

Letting the state set the price of money (ie. credit rates) is like letting it set the price of apples or gasoline. The price will always be set lower than the price that will clear the market, and demand will exceed supply. Of course, apple growers can't decree apples into existence...

 
At 6:43 PM, Blogger John Law said...

to keep the housing bears sane, I'll pass along a few links:

Another ratio is the Housing/Silver ratio, which over the last 100+ years peaks at around 20,000 and bottoms at an average of 5,000 (under 2,000 in 1980). What that means is that at the peaks it typically takes 20,000 ounces to purchase a "median" priced home. Today the average home purchased in silver stands at an amazing level of around 50,000, meaning it takes around 50,000 ounces of silver to purchase the "median" priced home !!!
-Eric King
July 27, 2003

here is a link where gold and housing is discussed:

http://www.financialsense.com/Market/archive/2003/0117.htm

he might have sold his gold a little too soon, that's the price of avoiding disaster though.

 
At 7:27 PM, Anonymous Anonymous said...

(Furthermore, the only place the Fed has created full employment is in CHINA.)

I disagree - the Fed has also helped to boost employment in India, Mexico, Japan and all the other countries that enjoy a trade surplus with the US.

 
At 7:28 PM, Blogger Ben Jones said...

Excellent posts. This guy made me mad, too. Good point that the Fed hasn't worried about price stability in houses the past few years. This bubble was created on purpose.

The Fed funds rate is near negative now. Maybe he's just letting us know there is nothing they CAN do. What arrogance!..Ben

 
At 7:28 PM, Blogger dryfly said...

I am going to be a bit contrarian here...

I don’t think the Fed can manage bubble mania’s well – either positively or negatively. When people are damned and determined to throw money away they will.

Where I agree with everyone is that the Fed has massively mismanaged monetary policy in general and in that regard has INDIRECTLY created the conditions that has allowed the bubble to form and grow.

*******************

Another thing... I don’t think the Fed is able to control interest rates much anymore... they are increasingly sounding like dogs barking at the moon.

I think Alan’s ‘Conundrum’ admission proves they know it too. When the bubble goes *POP* they can try to lower rates all they want... but with the deficits we are running and the trade imbalances... if the international markets don’t buy the bonds... what can Alan do? Nothing but raise rates to make our paper attractive again...

I don’t know who said it... I think it was Warren Buffett... but on being asked “When will Alan Greenspan start raising interest rates?” replied, “When the Japanese Central Bankers say he will...”

 
At 7:32 PM, Anonymous Anonymous said...

-- Fed Is Impotent Against Deflation --

I recommend reading Robert Prechter's Conquer The Crash. It has an excellent explanation of how the Fed is ultimately impotent against deflation.

Deflation is caused by a contraction of credit. This is set in motion by default. It is self-reinforcing. Once defaults rise then banks get defensive and tighten their lending standards. As lending standards tighten the economy falls further into recession which causes more defaults which cause bankers to behave even more conservatively, etc...

The Fed cannot just start printing money because the federal government has to pay it's bills so it will protect the value of it's T-bills. The government must protect it's credit rating or go bankrupt itself. It is beholden to foriegn borrowers like at no other time in history. Therefore, it will have to offer interest rates that are acceptable to foriegn central banks.

Greenspan has painted himself into a corner. People will come to realize that he was just like the wizard of Oz.

Meanwhile, we will all suffer for the poor decisions that this deception spawned.

Baton down the hatches and prepare yourself for economic turbulence dead ahead!

 
At 7:45 PM, Anonymous Anonymous said...

(The Fed cannot just start printing money because the federal government has to pay it's bills so it will protect the value of it's T-bills. The government must protect it's credit rating or go bankrupt itself. It is beholden to foriegn borrowers like at no other time in history. Therefore, it will have to offer interest rates that are acceptable to foriegn central banks.)

The Japanese government is much more indebted than the US - I think total US federal debt is around 75% of GDP, whereas Japanese government debt is well over 150% of GDP. Yet Japan has managed to keep the lowest interest rates in the developed world for at least a decade. Japan would appear to be a counterexample to your hypothesis, no?

 
At 8:21 PM, Anonymous Anonymous said...

(The Japanese government is much more indebted than the US - I think total US federal debt is around 75% of GDP, whereas Japanese government debt is well over 150% of GDP.)

The difference between Japan and the US are twofold:

1) The Japanese savings rate is much higher than the US so they had a larger base of savings to start with and is less dependent on foriegn savings. Also, I am not too much of an expert so I might be wrong, but I don't think that the Japanese are allowed open foriegn bank accounts so the government more or less forces them to purchase their securities.
2) The Japanese exporters still had the US consumer help dampen their recessions. That will go away when the US falls into recession.

So, yes the federal government will go much further into debt (and probably faster than any of us seem possible) so it will survive for a while. But I suspect that radical left wing politics (aka Hilary) will take over and "soak it to the rich". You can expect higher taxes and more socialism so government can "solve our problems for us".

My prediction is that before this is over, the USA will have been sold out to foriegn central banks - much like Argentina was.

Sounds depressing, but I believe this is the reality that we face.

John from Washington State

 
At 8:30 PM, Anonymous Anonymous said...

(My prediction is that before this is over, the USA will have been sold out to foriegn central banks - much like Argentina was.)

Didn't Argentina experience a huge currency devaluation and hyperinflation when it defaulted on its debts?

If the same thing happens in the US, folks with dollar-denominated cash-equivalents will lose the most (i.e. the traditional life-savings of the middle-class will be wiped out). Owning land and servicing debt secured on that land at a fixed rate in a devaluing currency would appear to be a shrewd financial move if the scenario you're describing unfolds. So are you recommending that folks should be buying houses now?

 
At 8:34 PM, Anonymous Anonymous said...

(Another thing... I don’t think the Fed is able to control interest rates much anymore... they are increasingly sounding like dogs barking at the moon.)

This is already happening. See here:

Things that go bump in the night. http://wallstreetexaminer.com/?itemid=615
The overnight FED rate hits 4% !

(I think Alan’s ‘Conundrum’ admission proves they know it too. When the bubble goes *POP* they can try to lower rates all they want... but with the deficits we are running and the trade imbalances... if the international markets don’t buy the bonds... what can Alan do? Nothing but raise rates to make our paper attractive again...)

Agreed, agreed, agreed. The FEDs ability to control the interest rate relies on someone wanting to buy the bonds. Actually, there is another limit, as discussed here:

liquidity limits:
http://www.federalreserve.gov/boarddocs/speeches/2005/20050330/default.htm

(I don’t know who said it... I think it was Warren Buffett... but on being asked “When will Alan Greenspan start raising interest rates?” replied, “When the Japanese Central Bankers say he will...”)

Agreed. I think our financial destiny will be in other countries hands in the near future. That should make for interesting FED speaches !

 
At 8:36 PM, Anonymous Anonymous said...

(Today the average home purchased in silver stands at an amazing level of around 50,000, meaning it takes around 50,000 ounces of silver to purchase the "median" priced home)

The irony here is that silver is at nearly an all time high price itself. I think gold is a better measure because it is a currency itself, whereas silver is a commodity used in making steel, catalysts, etc.

 
At 8:57 PM, Anonymous Anonymous said...

(If the same thing happens in the US, folks with dollar-denominated cash-equivalents will lose the most (i.e. the traditional life-savings of the middle-class will be wiped out). Owning land and servicing debt secured on that land at a fixed rate in a devaluing currency would appear to be a shrewd financial move if the scenario you're describing unfolds. So are you recommending that folks should be buying houses now?)

I was thinking the same thing and I'm an RE bear. If we do get hyper inflation, people holding real assets with a 30 year 5% mortgage are going to be laughing. The ironic thing is that I don't think anyone is doing that these days. Everyone is financing short. I don't know much about ARMs. What options do they have in 2,3 years ?

Are we going to get hyper inflation ? If we do, we should get hyper interest rates, which should flood the market with houses when people can't afford the payments.

Furthermore, people with cash should get an excellent return on their cash via fixed income investments. The REAL interest rate should be positive meaning that cash grows faster than inflation. House prices will fall and thus cash will purchase a house easier then than it does now, by a long shot.

Here is something to think about: most crashes over correct. Ie when the adjustment happens, the housing prices will drop UNDER their actual value. That will be the time to dive in and buy.

 
At 9:01 PM, Anonymous Anonymous said...

(So are you recommending that folks should be buying houses now?)

First of all I'm not recommending anything. What I meant by saying we are heading in the same direction as Argentina was in regards to our massive foriegn debts. Yes, I think that it will eventually lead to currency devaluation. But not until deflation wipes out most peoples debts through default.

The government will protect our currency because that is in it's interest. We are dependent on foriegn central banks and so, in reality, the foriegn central banks are in control. The primary interest of the federal govt is to remain solvent. So they will do what the foriegn central banks want.

I'm not an expert on Argentina economic history, but I'm sure that it took a number of years before the government was pressured enough to default. I was trying to draw an analogy that we are ultimately headed in that direction.

As for investment recommendations, I am not a professional so I am not qualified to give advice. However, what I have done is opened a foriegn bank account and diversified into other currencies. I also have a modest holding of physical gold.

IMO I think housing and precious metals will deflate long before the government resorts to desperate measures like currency devaluation (But it probably will eventually happen).

I, like most people on this thread, think that the FRB should be abolished and interest rates set by the market.

 
At 9:41 PM, Blogger John Law said...

Argentina pegged the peso(that is the currency?) to the dollar, so when hyperinflation happened their debts were often dominated in dollars but they were still dealing in pesos. so when the peso devalued versus the dollar it was a disaster

our debts are denominated in our own currency since the dollar is the world's reserve currency.

if you can make your mortgage during hyperinflation, you're pretty golden. but from marc faber's accounts, both in Weimar Germany and Argentina prices for homes/offices fell big time- especially in foreign currencies or gold. so most likely in hyperinflation the price of houses will fall big time. since most people on here seem to be up to speed on owning gold/silver and commodities, most here would probably own the town at the end. banks won't make loans during hyperinflation and people won't have the real income to buy them, or they'll be too scared too.

(The difference between Japan and the US are twofold:)

the yen carry trade seems to keep Japanese IRs low.
another difference is the US has twin deficits and takes in somewhere around 80% of the worlds savings. roach said the last time this happened was around 1987...

(The irony here is that silver is at nearly an all time high price itself. I think gold is a better measure because it is a currency itself, whereas silver is a commodity used in making steel, catalysts, etc.)

somewhere dave morgain is screaming at you- haha. silver is money, plain and simple. when it's down, it's a commodity. silver is very cheap adjusted for inflation and seems to have fallen since the 1400's. it's UNDERVALUED compared to gold if you look at the gold/silver ratios. so housing is overvalued next to gold which is overvalued next to silver. silver seems to be near a 600 year bottom!

http://www.financialsense.com/fsu/editorials/2004/images/0505silverprice.gif

I too am not a pro and I can't say with certainty that it's going to be inflation or deflation. at some level I believe in the Marc Faber/Jim Rogers view on China driving commodities through the roof.

I suggest if you want to learn about hyperinflation, read Marc Faber's book- Tomorrow's Gold.

 
At 10:43 AM, Anonymous Anonymous said...

(My prediction is that before this is over, the USA will have been sold out to foriegn central banks - much like Argentina was)

Or our critical resources, ie water, minerals, forests, etc.

 
At 11:30 AM, Blogger John Law said...

let's remember though, argentina couldn't open up the press and crank out dollars. wasn't that the problem? they borrowed in dollars and their income was in pesos?

we are the reserve currency, our debt is in our own currency.

 
At 3:24 PM, Anonymous Anonymous said...

Correction: we were the currency reserve ! When the US dollar crashes I don't think we will be the currency reserve. I don't know what the currency reserve will be. Will it be anti 1970, ie gold will become the currency reserve again ?

 

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