Housing Bubble

Josh Barro of Bloomberg has an interesting theory.  According to him, conservatives in modern day America have become so infatuated with the school of Austrian economics that they no longer listen to reason.  It is because of this diehard obsession that they reject all empirical evidence and refuse to change their favorable views of laissez faire capitalism following the financial crisis.  Basically, because the conservative movement is so smitten with the works of Ludwig von Mises and F.A. Hayek, they see no need to pose any intellectual challenge to the idea that the economy desperately needs to be guided along by an “always knows best” government; much like a parent to a child.  CNN and Newsweek contributor David Frum has jumped on board with Barro and levels the same critique of conservatives while complaining that not enough of them follow Milton Friedman anymore.

To put this as nicely as possible, Barro and Frum aren’t just incorrect; they have put their embarrassingly ignorant understandings of Austrian economics on full display for all to see.

Steve Forbes has a message for a nation dominated by increasingly short-term decisions made on Wall Street and in Washington D.C., and by ever greater economic, financial and currency instability.  As long as America continues moving away from sound money; away from sound financial and economic policies; and, ultimately, away from freedom, its future grows more dim.  The dot-com and housing bubbles followed by the 2008 financial crisis and the most severe economic decline since the Great Depression serve as powerful lessons.  A future of bigger government, higher taxes, more burdensome regulations, less consumer choice and more unrealistic government promises requires more and more Federal Reserve play money. Steve Forbes has a quintessentially American policy prescription rooted in American history.  The answer to America’s economic problems is—and has always been—new wealth creation.  New wealth creation doesn’t come from the government or from the Federal Reserve’s printing press.  New wealth creation is what happens naturally with stable money based on the gold standard, lower taxes on individuals, a simplified tax code, reduced bureaucracy and free markets.

Every government entity that reckoned it was moated from the market economy will be snapped back to "discover" risk and consequence. Let's lay out the dynamic:

1. Every government can only spend what its economy generates in surplus.
2. Every government transfers risk and consequence from itself, its employees and its favored vested interests to the citizenry and taxpayers.
3. Every government collects and distributes the surplus of its private sector to its employees, favored constituencies and vested interests.
4. Since the government (State) promises guaranteed salaries, benefits and entitlements to its employees and favored constituencies, these individuals believe they are living in a risk-free Wonderland that is completely protected from the market economy.
5. Risk cannot be repealed or eliminated, it can only be masked or transferred to others.

... continued

Brad DeLong makes an odd claim:

So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.

Larry Summers? If we’re going to base our economic policy on trusting in Larry Summers, should we not reappoint Greenspan as Fed Chairman? Or — better yet — appoint Charles Ponzi as head of the SEC? Or a fox to guard the henhouse? Or a tax cheat as Treasury Secretary? Or a war criminal as a peace ambassador? (Yes — reality is more surreal than anything I could imagine).

Forty five years after the War on Poverty began, there are 49 million Americans living in poverty. That’s a solid good return on the $16 trillion spent so far. It’s on par with the 16 year zero percent real return in the stock market. We have produced a vast underclass of ignorant, uneducated, illiterate, dependent people who have become a huge voting block for the Democratic Party. Politicians, on the left, promise more entitlements to these people in order to get elected. Politicians on the right will not cut the entitlements for fear of being branded as uncaring. The Republicans agree to keep the welfare state growing and the Democrats agree to keep the warfare state growing -bipartisanship in all its glory. And the middle class has been caught in a pincer movement between the free shit entitlement army and the free shit corporate army. The oligarchs have been incredibly effective at using their control of the media, academia and ideological think tanks to keep the middle class ire focused upon the lower classes. While the middle class is fixated on people making $13,400 per year, the ultra-wealthy are bribing politicians to pass laws and create tax loopholes, netting them billions of ill-gotten loot. These specialists at Edward Bernays propaganda techniques were actually able to gain overwhelming support from the middle class for the repeal of estate taxes by rebranding them “death taxes”, even though the estate tax only impacts 15,000 households out of 117 million households in the U.S. The .01% won again.

There are roughly 19 million vacant dwellings in the U.S., of which around 4 million are second homes and a million or two are on the market. Let's stipulate that several million more are in areas with very low demand (i.e. few want to live there year-round). Let's also stipulate that several million more are in the "shadow inventory" of homes that are neither on the market nor even officially in the foreclosure pipeline, i.e. zombie homes. Even if you account for 9 million of these homes, that still leaves 10 million vacant dwellings in the U.S. which could be occupied. That means 1 in 12 of all dwellings are vacant. Even if you discount this by half, that still leaves 5 million vacant dwellings that could be occupied. Given that the total rental market is 40 million households, that constitutes a very large inventory of supply that remains untapped. Lastly, it is important to note that the ratio of residents to dwellings is rather low in the U.S., with millions of single-person households and large homes occupied by one or two people. The potential pool of existing homeowners who could enter the "informal" rental market by offering bedrooms, basements and even enclosed garages for rent is extremely large, and that is a difficult-to-count "shadow" inventory of potential rentals.

We have no doubt that everyone is tired of bad news, but we are compelled to review the facts: Europe is currently experiencing severe bank runs, budgets in virtually every western country on the planet are out of control, the banking system is running excessive leverage and risk, the costs of servicing the ever-increasing amounts of government debt are rising rapidly, and the economies of Europe, Asia and the United States are slowing down or are in full contraction. There's no sugar coating it and we have to stop listening to politicians and central planners who continue to downplay, obfuscate and flat out lie about the current economic reality. Stop listening to them.

The middle class has a gut feeling they are being screwed by somebody, they just can’t figure out who to blame. The ultra-wealthy elite keep up an endless cacophony of propaganda and misinformation designed to confuse an increasingly uneducated and willfully ignorant public while blurring the facts for those educated few capable of understanding the truth. They have been able to keep the masses dumbed down through government run education; distracted by sports, reality TV, Facebook, internet porn, and igadgets; lured by mass media messages of materialism; and shackled with the chains of debt used to acquire the goods sold by mega-corporations. We’ve become a society oppressed by a small faction of ultra-wealthy masters served by millions of impoverished, uneducated, sedated slaves. But the slaves are getting restless and angry. The illegally generated wealth disparity chasm is growing so large that even the ideologue talking head representatives of the elite are having difficulty spinning it. Even uneducated rubes understand when they are getting pissed on.

The revaluation that is underway now is beyond the simple scope of corporate earnings valuations, going to the very core of the system itself.  Just like the equity pricing regime (and investor expectations for equity assets) needs to adjust to the twelve-year-old bear market reality, pricing within the global banking system as a whole needs to adjust to the reality that the artificial growth of the economic textbook is not replicable.  The economic truth of 2012 is that much of the science of economics, and the foundation that gives to finance and financial pricing, was a temporal anomaly befitting only those specific conditions of that bygone era.  In other words, the entire financial world needs to reset itself outside the paradigm of pre-2008.  The secular bear market in US equities is one strand of this changing landscape, perhaps the first stirring of the collapse of the activist central bank experiment. In the end, the potential selling pressure of the dollar shortage is irresistible, no matter how “cheap” stock prices are to earnings, but none of it may matter in the grander scheme of a dramatic reset to the global system.  The inability of that global system to escape this critical state, to simply move beyond crisis and function “normally” again, demonstrates conclusively, in my opinion, the foundational transformation that is still taking place well beyond the stock bear.  Everything is a locked feedback loop of negative pressures in this age, no matter how much we want to see “value” where and how it used to exist. 

Paradigm shifts are rarely orderly, but there are warning signs.

The real estate industry announces the housing recovery is finally underway every year. 2012 is no different from previous years: various positive data points are duly cherry-picked (multiple offers are back in West Hollywood, sales are up year-over-year in Las Vegas, inventory is down, etc.) to back up the claim the "bottom is in" and the recovery in sales and prices is rock-solid. We understand the industry's extreme self-interest in attempting to re-inflate housing, but let's begin with the obvious question: what's the housing recovery based on? The standard answer is of course "super-low mortgage rates, courtesy of the Federal Reserve."  But people need a sufficient income to qualify to own a house, regardless of rates, so let's look at income by age, and focus on the key homebuying ages of 25 to 44. The only age group whose incomes continued rising during the past five years is the over 65 cohort--the very group who is "downsizing" or selling their homes to live in assisted living. The key homebuying cohorts have seen their incomes plummet since the housing bubble popped.

 Spain is toast. I’ve already assessed that none of the key players (the IMF, the ECB, the EFSF, or the ESM) has the firepower to prop up Spain whose real capital needs are more in the ballpark of €300 billion -€500 billion. Thus, it’s GAME OVER for the EU. Sure it may take a while for this to manifest as politicians offer various hair-brained schemes to attempt to put off the inevitable debt collapse, but that debt collapse is coming and it will hit before the end of 2012.

Leading all others “by the nose through the ring.”

Indeed, one has to wonder… just how does a €100 billion bailout solve Spain’s banking woes when its Prime Minister was suggesting the real damage is more to the tune of €500 billion in a text message to his Finance Minister??? Indeed, if Rajoy’s text is even remotely truthful, then we can assume that Spain’s real capitalization needs are multiples of the €100 billion bailout… something that the EU media is picking up on already. As one example, JP Morgan believes that when all is said and done Spanish banks could be looking at €350 BILLION in capital needs.

All you can read.

Incentivize debt, and you end up relying on debt as a sustitute for productivity and income. Increase debt, and there's not enough income left for productive investments that might boost income. Incentivize debt via making interest tax deductible, and you create a self-reinforcing feedback of a rising share of declining income being devoted to interest payments. With demand and borrowing both suppressed by debt-serfdom, demand for housing, goods and services declines. Borrowing more to consume simply speeds the cycle of rising interest and falling net incomes. Incentivize debt and you create multiple overlapping death spirals. We are seeing the death-spirals play out in a fractal manner, from households to nations to entire regions. High debt levels lead to high interest payments which lead to low investment and savings rates which lead to lower productivity which leads to stagnation of income, consumption and investment: in other words, a death spiral.