“He may look like an idiot and talk like an idiot but don't let that fool you. He really is an idiot.”
Scheduled to do a hit on housing and financials with Lauren Lyster on YahooTicker this AM. And yes I will be at ASF in Las Vegas. Come say hello. -- Chris
New York -- Earlier this week I received a missive from my friend John Silvia at Wells Fargo. For an economist of his stature in the industry, his warning was stark:
“While the current housing recovery is welcome, are low interest rates setting us up for an asset price boom again? Current 15-year fixed mortgage rates are 2.66 percent and, according to CoreLogic, the home price index is up 7.4 percent year over year as of November, the highest reading since May 2006. Home prices are rising faster than the mortgage interest rate (top graph), similar to the housing boom of 2004-2006. So, the real interest rate on home buying is now negative 4 percent? We appear to have again entered into an era of a misallocation of credit when the Fed’s support of the housing market has extended so far that we are repeating the same pattern of behavior we promised to avoid. Single-family housing starts rose 8.1 percent in December to a 616,000-unit pace and are up 18.5 percent over the past year. Is this a take off to another period of housing speculation?”
For some time now, the Federal Open Market Committee has been playing in a real life Marx Brothers movie, making up monetary policy as they go in the same way those wonderful characters would ad-lib their lines through whole films. Nobody on the Fed’s staff in Washington can explain what they are doing or why, in part because the last three decades of US monetary policy have been a pretense. We pretend that the “greatest nation on earth” can borrow endlessly against the national patrimony, either explicitly or via inflation. Inflation is the ultimate tax – a steady erosion of value that affects all Americans but that we pretend does not exist.
The corollary of ad-lib monetary policy is bubbles. We live in a world of bubbles instigated and engineered, deliberately or reflexively, by the central bank. Charged with both maintaining “full employment” and price stability, the Fed does neither. Instead we embrace a kind of silly neo-Keynesian socialism that allows President Obama to declare that we cannot balance the federal budget because it would be unfair. The Republicans, mind you, are hardly better, preferring to cave into Democratic demands for endless increases in federal spending. And both parties know that consumers and working people in particular bear the ultimate cost via steady inflation on the cost of basic necessities.
While the Fed pretends to display some degree of rectitude with respect to inflation and consumer prices, the reality is that the central bank is at once the enabler and apologist for the now familiar cycle of boom and bust that is engineered in Washington. Members of Congress and federal agency heads spend lip service on preventing systemic risk in markets and capital adequacy for banks, but the real game is nominal growth via excessive debt creation and big federal deficits. Even as the Fed has been dealing with the ill-effects of the 2007-2009 subprime boom, they create the circumstances for numerous new bubbles in multiple asset classes.
Consider two examples, Apple Computer (AAPL) and housing. In both cases, the zero rate policies by the Federal Open Market Committee are driving up the price of an entire asset class. You could argue that AAPL, at its current $400 billion market cap, comprises an asset class all by itself, kind of a surrogate for the entire technology sector. But inflation is low, right? Higher and higher the market cap of AAPL went, this even though anyone who has followed the tech sector knew that the stairway to heaven built upon handset sales must eventually end badly. And so it has.
Of course while many previously happy campers may no longer be happy with AAPL, the fact is that stock prices are headed north. The migration, some might say exodus, out of bonds and into stocks is well advanced and driven by fear that the FOMC is getting ready to shift policy after years of easy money. My old boss Jack Kemp (R-NY) used to say that “a rising tide lifts all boats.” He spoke then of real economic growth, but in this case it is merely the rising tide of monetary inflation.
As John Silvia notes in his rant above, the real rate of inflation clearly makes current interest rates deeply negative, yet the US economy is barely moving. Decades of self-delusion by the greatest ever generation has left the US economy in a situation where the Fed can print money with reckless abandon and almost nothing happens with jobs or consumption. Somebody gently break the news to our chief economist Paul Krugman and his new sidekick, the former Republican Bruce Bartlett.
But of course there is good news. Even though the real economy of jobs and private business is under siege, the Fed can certainly create new bubbles. The supposed recovery in the housing sector is a case in point. Most of the increase in home prices can be traced to a handful of states where the boom was especially bad and investors now dominate the market. Driven to desperation by low investment returns, armies of doctors, dentists and private equity bankers are paying retail prices for foreclosed homes. The strategy? Pricey rentals in sand states with leverage. And Chairman Bernanke and the rest of the FOMC want us to thank them for this great accomplishment?
The spectacle of Blackstone spending billions in 2012 to buy foreclosed homes in markets like Tampa, FL, speaks volumes about the speculative nature of the “recovering” housing sector. But while relatively warm markets such as FL, AZ and CA are showing significant recoveries in terms of housing prices, at least for now, many judicial states remain mired in foreclosure backlogs that still stretch ahead for years to come. Because Barack Obama and Tim Geithner refused to restructure the truly sick parts of the US housing sector (and the zombie banks with these exposures), only sectors where speculative capital can be deployed quickly and easily are showing signs of life. You don’t see private equity firms buying homes in Scarsdale, NY, or Greenwich, CT, now do you? Even ignoring the horrible effects of SS Sandy, was NJ housing really recovering?
So welcome to the new age of financial bubbles. Just as the Fed did in 2001, the central bank has stoked the hell furnaces of future inflation and financial contagion. Many parts of the US economy are so badly damaged that they will not participate in this latest round of economic pump priming, but those sectors that are able to access easy money are likely to soar in future weeks and months. The good news is that stocks will go up, but bonds will go down and the cost of everything else will be higher. As any Marxist knows, “Time flies like an arrow. Fruit flies like a banana.”
Equities will not do well because banks have good fundamentals or consumer stocks see strong demand. Quite the opposite. But, to paraphrase our friend Marc Faber, equities are one of the best asset classes in times of hyperinflation. This rule holds even if it means that you only lose most of your value in stocks (in real, inflation-adjusted terms) while mere savers get wiped out completely by financial repression and the heightened market volatility which comes along with Fed efforts to fix the last crisis.
When your central bankers make up policy as they go and with an eye on politics first and foremost, you could hardly expect a better outcome. This is the real strength of democracy, you understand. Another Marxist principle to bear before us, almost as a torch in the cold darkness, is the rule of relativity as it applies to national economics. “Those are my principles,” Marx said. “And if you don't like them... well, I have others.”