Friday, April 15, 2005

What Will You Do About The Housing Bubble?

If you could be any public or private person, and today you are tasked with actions to minimize the damage from the housing bubble, to save the economy. And for this moment let's put aside who got us here and what should have been done.

OK, so you are the Fed chairman, or a senator, or the President or the Toll Brothers; anybody. Please give us your best course of action from April 15th, 2005. Best idea gets to pick Greenspans succesor.

44 Comments:

At 12:39 PM, Anonymous Don said...

Let's be more clear on what the goal is please. Is it to maximize real GDP growth? Maintain a stable US dollar? Limit blowups caused by losses for those holding MBS & related instruments? Something else?

 
At 12:43 PM, Blogger Ben Jones said...

I'll take a shot.

I'm the Fed chairman. I would gather the world's financial leaders and start a concerted action to put the brakes on speculation and stiffen lending standards. In the US, I would start with a mandatory 20% down.

The markets are already falling. Perhaps corporations could be persuaded to use the pile of cash they are sitting on to buy back shares.

Congress should be advised to prepare for massive defaults. Industries need to prepare for a US consumer that will not be spending near as much. The foreign central banks would have to be consulted, as their cash is what is financing the boom.

Lastly, a frank statement to the public regarding housing; that we should return to viewing a home as an essential need and not a cash cow. But there will be no further credit binges. That, yes, speculators will be burned but if we all keep our heads, we can ride this thing out.

 
At 12:45 PM, Blogger Ben Jones said...

don,
What do you think the most important goal is, given the circumstance? And who or which institution is in the best position to acheive it?

 
At 12:53 PM, Anonymous Anonymous said...

I wish you were the Fed Chairman, Ben.

I don't think anything like that will happen.

First of all, the housing bubble isn't going to burst by itself. It is going to be very messy. It will take down the stock market and possibly the US dollar with it.

The first thing that has to be controlled is inflation and that message has to be made loud and clear. If we need 10% interest rates, so be it. I'd make it abundantly clear what "accomodative" and "nuetral" interest rates are and I suggest the later Fed rate is 6%+.

I have to go now... DOW is down 200 points. Later...


Next, we have to get our industries working again. I think I'd generate some sort of grant/low interest loans for businesses to invest in equipment and R&D. We have to get back to building and exporting things.

I'd spend heavily on technologies that would reduce our dependence on oil.

 
At 1:00 PM, Anonymous Anonymous said...

Absoloutely nothing. The sheepole deserve to go off the cliff. This mess was brought upon themselves.

Also, within the first 15 minutes of assuming office of the presidency I would render the Federal Reserve as unconstitutional and publically hang all its board members esp. AG for wrecking our currency and allow debt to spiral out of control.

Let the mkts collapse and start all over with no government intervention. Period.

 
At 1:04 PM, Blogger Ben Jones said...

(The first thing that has to be controlled is inflation and that message has to be made loud and clear. If we need 10% interest rates, so be it.)

Yes, people have to rewarded for saving!

(Let the mkts collapse and start all over with no government intervention. Period.)

I wouldn't argue against that. Certainly a valid position.

 
At 1:08 PM, Blogger Dave Johnson said...

Fund the coming government bailout of everything by buying puts now.

But seriously, the Congress yesterday voted to give an ADDITIONAL trillion-dollar tax cut to the top .5 percent. In that context, there's little that can even be contemplated before you just give up thinking.

 
At 1:13 PM, Anonymous Anonymous said...

(Let the mkts collapse and start all over with no government intervention. Period.)

That will be extremely painful. Think back to the 1930s. I think *something* has to be done, but obviously we need a Fed that can spot bubbles !

The DOW dropped nearly 200 points today. This is absolutely stupid.

 
At 1:45 PM, Anonymous Anonymous said...

P-A-I-N is exactly what is needed hence it will plant the seeds of financial prudence for future generations until the cycle repeats itself agian. The go-go days are over.

 
At 1:51 PM, Anonymous Anonymous said...

I agree that PAIN is needed. The problem is, it is going to hurt all of us, not just the speculators. I guess there is no way to avoid that.

I'm happy today. My wife and I rent. We've got no debt and I sold our stocks yesterday. We've got money in the bank. She has a good job and I own a good business. I guess we could survive a deep downturn.

I can't wait to hear all the grumbling. I've got friends that just bought a lot to build on and another set that are half way done building their house. In February all I heard was how great the housing market is.

We were, of course, idiots for renting. "You are just giving your money to your landlord. What do you have to show for renting ?"

 
At 2:00 PM, Anonymous Don said...

Anonymous Said:

That will be extremely painful. Think back to the 1930s. I think *something* has to be done, but obviously we need a Fed that can spot bubbles !

Are you aware that the Federal Reserve was created prior to the 30's, contributed to the excesses of the 20's and then couldn't stop the crash in the '30's? Intervention is not the answer, it simply create more and more moral hazard until the system breaks.

Ben: Just got back from lunch, thinking about your question. I'm basically concerned that this is going to snowball into a complete USD rout, so I think that I would, as President of the United States, attempt to have enacted an immediate and substantial tarrif on all Chinese goods to halt their mercantilist attack. I believe that this is the reason why our headline inflation numbers are so low, which is why interest rates are in absolutely the wrong place. To head off the substantial inflationary bais this would create, I would negotiate with the Federal Reserve to execute a 50 - 100 basis point increase in the FF rate simultaneous with this (i.e. off meeting cycle). How to get this to the money center banks so they can adjust their positions before they take a huge hit? I don't know, and I actually think it would be OK for us to lose a bank or two in this. IMHO, Greenspan's post LTCM tactic of trying to not surprise the market is absolutely wrong, it's put spreads in silly places, just like LTCM's enormous positions pushed spreads into places they shouldn't have been.

BTW, Brad DeLong says we've got no brains in the treasury dept to speak of, and he's way more knowledgable than I. Will the Federal Government be able to handle the crisis? Mayhap in addition to my housing shorts I'm going to make out like a bandit on my long gold position, BRK.B & foreign equities? Who knows?

 
At 2:06 PM, Blogger Sunny said...

I'd do away with PMI, lets let lenders assess and bear risk like they are supposed to. Next, I would do away with the "federally related" category of lending which means no Fannie Mae or Freddie Mac or FHA to which to shovel loans many of which are fraudulently originated. In other words, give real estate lending back to the private market. I don't know who could do these things; it would probably take federal legislation.

 
At 2:07 PM, Anonymous Anonymous said...

Trade tarifs with China. Sure. Except they will stop buying our dollars ! I'm not kidding. As their country grows they don't need us as much. If we hit them with a tarrif, they are going to stop supporting our currency. After today, that might happen anyway. I was very surprized that the dollar didn't fall today.

 
At 2:10 PM, Anonymous Anonymous said...


I'd do away with PMI, lets let lenders assess and bear risk like they are supposed to. Next, I would do away with the "federally related" category of lending which means no Fannie Mae or Freddie Mac or FHA to which to shovel loans many of which are fraudulently originated. In other words, give real estate lending back to the private market.


Hellejuha ! I'm not the only person in the world that thinks this !!!!!

 
At 2:14 PM, Anonymous Anonymous said...

"Trade tarifs with China. Sure. Except they will stop buying our dollars ! I'm not kidding."

That would be a good thing. And let's dissolve the federal reserve cartel while we're at it.

 
At 2:20 PM, Anonymous BoyInTheBubble said...

Make speculating on housing/real estate no more favorable than speculating on stocks, as follows:

Eliminate (completely) the homestead exemption on capital-gains taxes. Treat any house sold within a year of closing as a short-term gain if this isn't already done.

Establish "margin requirements" ie minimum down payments, on real estate. It's not restraint of trade or whatever when we already do it with stocks/ bonds/ futures. I'd set it at 10% down minimum, although we can argue over the exact level. Also, no IO loans, and no terms longer than 30 years, to force people to pay to principal.

Keep the mortgage interest deduction; deducting interest is a general principle in our tax code that goes far beyond housing (corporate debt, margin interest etc.)

Not directly related to housing: Stop raising the Fed Funds target unless the CPI rises substantially above 3%. There are signs the initial rate hikes may be having an effect; stop for now before we cause a recession. The Fed ALWAYS overshoots -- it's what causes the peaks and troughs in the first place.

Otherwise... not much. People need to learn from their mistakes. People who are stupid with their money deserve to lose it.

 
At 2:23 PM, Anonymous Don said...

Ben Jones said:

The markets are already falling. Perhaps corporations could be persuaded to use the pile of cash they are sitting on to buy back shares.

No, cash will be king in this kind of environment. Debt financing will get much more expensive, so buying back shares with cash now will just result in higher expenses as debt has to be rolled over instead of retired. Only when share price is close to or below book value does this make much sense in the current tax environment. (i.e. post the dividend tax change)

Trade tarifs with China. Sure. Except they will stop buying our dollars ! I'm not kidding.

You are completely right, but what of it? Reduced dollar purchases means higher interest rates US on bills and bonds, which is what we're expecting anyways. That's another reason for the simultaneous increase in the FF rate, get interest rates up, up to the point that private money starts doing what central bankers have been doing. For the record, the last time I held a 5 year CD it paid 9 1/4 %. If I'd had the brains to buy Govt debt instead of going through a bank I could have done even better.

 
At 2:26 PM, Anonymous Paul said...

"I'd do away with PMI"

Who pays PMI any more? I thought everyone just gets piggyback mortgages?

The problem isn't PMI. The problem is lack of interest in the ability of the borrower to repay.

 
At 2:34 PM, Anonymous Paul said...

I mostly agree with BoyInTheBubble, except that I believe the Fed should continue to raise interest rates as long as there is inflationary momentum. You can't wait until the CPI shoots over 3%, or you risk having to lift rates sky-high in order to counter the runaway inflation. "A stitch in time saves nine."

Even if the economy turns down, if there is momentum behind inflation the Fed must actively fight it with higher rates. Rather fight through a recession and be done with it than put up with a never-ending stagflation.

 
At 2:35 PM, Anonymous Don said...

boyinthebubble said

Treat any house sold within a year of closing as a short-term gain if this isn't already done.

That's already how it works.

Establish "margin requirements" ie minimum down payments, on real estate. It's not restraint of trade or whatever when we already do it with stocks/ bonds/ futures. I'd set it at 10% down minimum, although we can argue over the exact level.

China just did this, with the requirement of 20% down.

Keep the mortgage interest deduction; deducting interest is a general principle in our tax code that goes far beyond housing (corporate debt, margin interest etc.)

Deducting interest is what? Taxes = X * (income - expenses incured generating said income). For corporations, expenses include financing costs. For individuals that's only true when you are financing an income generating asset. That's why margin interest can be expensed.

The problem with the housing interest deduction is that the income side of the transaction doesn't show up as cash, so income - expenses = 0 - expenses.

If you want to deduct mortgage interest you should be charged income equal to the imputed rent of the place you're living in OR make rent deductable, since it's just as much an expense.

Not directly related to housing: Stop raising the Fed Funds target unless the CPI rises substantially above 3%. There are signs the initial rate hikes may be having an effect; stop for now before we cause a recession. The Fed ALWAYS overshoots -- it's what causes the peaks and troughs in the first place.

The real (i.e. inflation adjusted) FF target rate is about 0, and frankly I think CPI is understated. We'll talk when it's 2-3% real rate, which is about 5-6% nominal rate.

 
At 2:39 PM, Anonymous Anonymous said...


Trade tarifs with China. Sure. Except they will stop buying our dollars ! I'm not kidding.

You are completely right, but what of it? Reduced dollar purchases means higher interest rates US on bills and bonds, which is what we're expecting anyways. That's another reason for the simultaneous increase in the FF rate, get interest rates up, up to the point that private money starts doing what central bankers have been doing.


I'm sitting on cash and I'll soon be sitting on gold. The G7 group is meeting next week. I know the US is pushing China, claiming that China is causing the oil problem. Add a tarrif to that and they will stop buying our dollar. A dolar crisis would throw everything into chasos.

I agree that we should let market forces work, but experiencing a currency disruption would be terribly painful. Unemployment, debt crisis, etc. It would be great for those of us sitting on cash, IF THE FED DIDN'T TAKE TO PRINTING MONEY.

I don't know what to say about this. Maybe it doesn't matter. Maybe it is inevitible anyway.

The US economy is in bad, bad shape. Unfortunately people don't fully realize this yet.

 
At 2:49 PM, Anonymous BoyInTheBubble said...

The real (i.e. inflation adjusted) FF target rate is about 0, and frankly I think CPI is understated. We'll talk when it's 2-3% real rate, which is about 5-6% nominal rate.,

It probably is a bit, but then again, CPI uses rents to measure housing costs, and they have been essentially flat for the last several years. The overall CPI is now around 3%, so it follows that "everything besides housing" is rising at more than 3%. This is a distortion caused by the way the CPI measures housing, but there's really no other way to measure it.

That said, there are reasons why the Fed might want a little inflation without explicitly saying it. It would reduce the real value of the national debt, and would allow house prices to decline in real terms without necessarily decreasing in nominal terms. Hmmmmmmm.....

 
At 2:57 PM, Anonymous BoyInTheBubble said...

The problem with the housing interest deduction is that the income side of the transaction doesn't show up as cash, so income - expenses = 0 - expenses.

I'd argue that the "income" from buying a house -- the good it produces -- is your ability to live in it, ie the imputed rent.

 
At 3:15 PM, Anonymous Anonymous said...

Inflation numbers could be ugly:

http://www.marketwatch.com/news/yhoo/story.asp?source=blq/yhoo&siteid=yhoo&dist=yhoo&guid=%7B427975F4%2DD083%2D4319%2DA141%2DC59F5569AC9A%7D

 
At 3:20 PM, Anonymous Don said...

BoyInTheBubbleSaid

I'd argue that the "income" from buying a house -- the good it produces -- is your ability to live in it, ie the imputed rent.

That's kind of the point. Here's what happens now from a cash point of view:

I = Interest Cost
R = Rent Cost
Im = Imputed Rent Value

Renter:
0 - 0 = taxed on nothing

Owner occupied:
0 - I = taxed on loss = current deduction
IMPUTED INCOME IS FREE

Rented Out:
R - I = taxed on profit

So this creates the following situation:

Total tax base of renting from someone else:

(R - R) + (R - I) = tax on profit

Renting from yourself:

(R - R) + (0 - I) = free money!

Now, let's rationalize this, putting BACK IN imputed rent. In this case, renting from yourself becomes the same as renting from someone else

(Im - Im) + (Im - I) = taxed on your 'gain' of being able to find cheap financing relative to renting!

Now THAT's fair, everyone pays tax on their profit. In this case, renting from yourself is the same profit as renting to someone else.

 
At 3:28 PM, Anonymous Don said...

Anonymous said:

Inflation numbers could be ugly

I love the core CPI. Let's make our central measure of inflation not include food, energy and (effectively) housing because heck, who needs those?

One of my favorite financial quotes is "the CPI less everything is 0"

 
At 3:36 PM, Anonymous Anonymous said...

More consensus about the impending bust..

http://www.theglobeandmail.com/servlet/story/RTGAM.20050414.whouseprice0414/BNStory/Business/

 
At 4:28 PM, Anonymous Anonymous said...

Now why does that get press in Canada but not in the US ?

I think the problem here is that the press are all house owners and nobody wants to admit that they are part of an investment that is about to go bad.

 
At 4:42 PM, Blogger Ben Jones said...

(Now why does that get press in Canada but not in the US ?)

That's why I think a press conference to bring the matter out into the open is essential to addressing the crisis. We can't get a handle on it until we acknowledge the problem publicly.

 
At 4:46 PM, Anonymous Anonymous said...

What are you planning Ben ? Are you going to do a housing bubble press conference ?

There was a thing on CNBC last week or the week before. That didn't accomplish anything. I don't think people are willing to listen yet, althought they must be getting close.

 
At 5:31 PM, Blogger PunKtilious said...

Raise rates to 4% by year-end, starting with a 50 bp uptick in May.
B@#$ch slap Fannie Mae and reign in Raines by handcuffs. The sheeple love to put the blame on someone for their poor judgement, let him be the martyr.

Given the above, let the market absorb the losses of Fannie Mae, without government intervention, eliminate GSE's and the suggested gov't backing of there debt.

By the way Ben, if you were to have the U.S. step in and establish a mandatory 20% down, you will literally be able to hear the bottomm fall out of the market within the year. I'm not saying this is necessarily a bad thing.

Institute tariffs on Chinese imports immediately, that is until China laxes on their Dollar/Yuan peg.

 
At 6:11 PM, Anonymous Anonymous said...

Why only 20% ? I'd prefer 25 or 30% and make the maximum term 25 years at a fixed rate for the whole term.

 
At 6:27 PM, Anonymous Billy The Kid said...

TAKE THE GOVERNMENT PORK FROM THE BANKERS!

1) Close down HUD
2) Close down the Federal Reserve Bank. Let the market determine short term rates through Treasury auctions.
3) Close down the FDIC. Let banks insure their own deposits. Make depositors more responsible for the banks they chose to do business with.
4) Increase bank reserve requirements. Have standard risk assessments for depositors so they can decide where to put their money.
5) Make it clear to all investors that the federal government will not back any GRE loan obligations.
6) Close down the FHA.
7) Close down the Federal Home Loan Bank.

And this is just a start. Whenever you get the govt involved in business you always get mis-allocated capital. We need to get the govt out of the housing and banking business!

 
At 6:37 PM, Anonymous Don said...

Been thinking about the idea of deposit requirements. Part of me thinks this might be a bad idea, but at the same time after the crash of '29 the margin requirements were raised from 10% to 50% for stock purchases to insulate retail speculators from their own folly. Not that those requirements particularly matter in our now derivative driven world.

One of the problems as I see it is that the companies that write loans can transfer the entire risk to another party, and they do this a lot, collecting only the origination fee. Maybe the party that originates the mortgage needs to be required to hold to maturity the riskiest principal strip off each mortgage and back that strip with their own capital? Wacky I know, since MBS is intended to spread risk around, but I think that it's increasing risk while it spreads it through reductions in underwriting standards. Thoughts?

 
At 6:40 PM, Anonymous Don said...

Billy the Kid said:

Close down the FDIC

Now this I don't agree with. FDIC was instituted to prevent bank runs and has been very successful at doing that. It creates a small enough degree of moral hazard that I consider it acceptable given the benefits.

 
At 7:10 PM, Blogger Dan said...

Sorry to tell you guys, but your ideas will create a much worse situation than what is already going to be happening anyway!

The solution should not be to do away with anything, or make any sudden moves, rather a measured (yes, measured) increases in interest rates. The fed is doing the right thing, however they waited too long which caused this bubble.

Second, tarifs on chinese goods? That will hurt us more than it will hurt them. They are already numb to the pain their people suffer. The answer here is slowing down consumers use of credit to buy these goods. again, in a measured pace.

The more important part is to have a check and balances system where the fed is not able to not stongly warn of a bubble, where the fed is not allowed to speak from both sides of his mouth, where the fed is held accountable to projections and replaced (elected?) as neccesary.

Dan

 
At 7:29 PM, Blogger Ben Jones said...

(What are you planning Ben ? Are you going to do a housing bubble press conference ?)

No, I was thinking that the Fed or President could explain that we have a problem, lets keep our heads and work through it.

(We need to get the govt out of the housing and banking business!)

I agree; it would take a while but the system would be better off for it.

(if you were to have the U.S. step in and establish a mandatory 20% down, you will literally be able to hear the bottomm fall out of the market within the year)

The bottom is gonna fall out anyway, may as well try to control it.

(Maybe the party that originates the mortgage needs to be required to hold to maturity)

Good idea.

Hi Dan,
(The more important part is to have a check and balances system)

I don't know. Politics seems completely broken in the US. I'm not sure they are up to it.

 
At 8:27 PM, Blogger John Law said...

(Now this I don't agree with. FDIC was instituted to prevent bank runs and has been very successful at doing that. It creates a small enough degree of moral hazard that I consider it acceptable given the benefits.) no no no, this has only brought more money into the banking system than would be there w/o it. it's increased the moral hazard. soon the banks are so big they have to be rescued. so the banks have a lot of money to play with and make riskier investments because they'll get bailed out.

the FDIC may work small scale, but it puts more people at risk and gives the banks larger profits.

we are still paying for the S&L bailout...

 
At 9:27 PM, Anonymous Anonymous said...

Do Americans not believe in freedom and a free market anymore? I can't believe so many people are imagining themselves as financial czars, that they know precisely how to control other people's spending habits.

You want no boom and bust? Abolish the Fed. Put the US back on a gold standard. Let spenders negotiate with savers about terms of borrowing, without government interference. Housing clears at the market price. Problem solved.

 
At 10:50 PM, Blogger Ben Jones said...

(Let spenders negotiate with savers about terms of borrowing, without government interference. Housing clears at the market price)

I agree.

 
At 11:04 PM, Anonymous Anonymous said...

C'mon, 4% Fed Funds Rate? You gotta be kidding me. First of all, 4% is way too low. It should be much much higher than that, probably 6 or 7% minimum.

Of course, the problem is the unnaturally low rates we've had especially in the last few years(overall declining since about 1980). That has created a lot of speculation and a huge ballooning of debt. Now that amount of debt is so large that even a move from 1% up to 2.75% is enough to bring about serious stress in the system.

My guess is that the surprise of the year will be an about face in the Fed Funds Rate very soon. Probably a 25 or 50bp cut, you heard me right. They'll justify it with "lowered oil costs" as a sign of lower inflation. Inflation which they refused to measure in the first place, and never accurately reported whatsoever. As soon as they cut, the dollar rally fades pretty quickly and by year end, the price of gold should be looking pretty good. And we'll have a brief market rally for a few months, so get ready with those Rydex Bear shares probably just around the time summer turns to fall.

The housing market will deteriorate and the government will try to take our eye off the ball with a rally-round-the-flag expansion of the war on terror, most likely going into Iran in 2005.

Ben, there is nothing really that can be done. The liberal Keynesian monetary policies have been hijacked by the religious right and made even worse (I can't stand either side of that aisle) and at this point it is just a matter of much pain there will be. I guarantee that any government intervention to control that pain will simply put it off and make it worse.

 
At 11:22 PM, Blogger Ben Jones said...

(there is nothing really that can be done)

anon,
I can't argue with your analysis. It may very well be the goose is cooked. I hope this post generated some discussion that made the issue more real. What could be done is very relevant right now. Thanks for commenting.

 
At 7:13 AM, Anonymous John Vosilla said...

"Ben, there is nothing really that can be done. The liberal Keynesian monetary policies have been hijacked by the religious right and made even worse (I can't stand either side of that aisle) and at this point it is just a matter of much pain there will be. I guarantee that any government intervention to control that pain will simply put it off and make it worse."

Welcome to our new ownership society on steroids and a reckless misallocation of capital pushed by our current leadership to make as many American's as possible slaves to their mortgages and credit card debt. Meanwhile stock action in many industries like tech, auto and airlines are signaling a depression so I totally agree with you the fed must end the tightening cycle in the next 2 meetings. Greenspan I'm sure will do what is best to protect his banker friends. They are screwed either way since neither a flat yeild curve or much higher long rates is good given the stretched home and large cap valuations as well as record government and consumer debt levels. Could some goldilocks scenario of a still steep yield curve and 10 yr treasuries remaining under 5% save the day?

 
At 12:03 AM, Anonymous Anonymous said...

Well you could sell the bubble to the Russian and Chineese mafias. They are always looking for ways of laudering their money. The USA should make it an official policy.

 

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