Housing Bubble

The boom is unsustainable. Investment and consumption are higher than they would have been in the absence of monetary intervention. As asset bubbles inflate, yields increase, but so do inflation expectations. To dampen inflation expectations, the Fed withdraws stimulus. As soon as asset prices start to fall, yields on heavily leveraged assets are negative. As asset prices decline, increasingly more investors are underwater. Loan defaults rise as mortgage payments adjust up with rising interest rates. When asset bubbles pop, the boom becomes the bust.

Goldman Sachs listened (and read) Janet Yellen's remarks at The IMF and see them "generally in line." Despite waffling on for minutes about risk management and monitoring, no one at The Fed has mentioned the total carnage in the repo market, spike in fails-to-deliver, and record reverse repo window-dressing that just occurred. The use of the term "reach for yield" twice and "bubble" 5 times, and admission that the Fed should never have popped the housing bubble, leaves us less sanguine than Goldman and wondering if this was Janet's subtle and nervous 'irrational exuberance" moment.

The smart money had a goal, which it now reached via the “multiplier effect.”

Janet Yellen is an officious school marm. She constantly lectures us on Keynesian verities as if they were the equivalent of Newton’s Law or the Pythagorean Theorem. In fact, they constitute self-serving dogma of modern vintage that is marshaled to justify what is at bottom an economic absurdity. Namely, that through the primitive act of banging the securities “buy” key over and over and thereby massively expanding its balance sheet, the Fed can cause real wealth - embodying the sweat of labor, the consumption of capital and the fruits of enterprise - to magically expand beyond what the free market would generate on its own steam. Dr. Yellen, of course, claims there are no financial bubbles to worry about because the Keynesian bathtub of potential GDP has not yet been filled to the brim. Perhaps she would like to put in a bid for one of these homes...

"I am definitely concerned. When was [the cyclically adjusted P/E ratio or CAPE] higher than it is now? I can tell you: 1929, 2000 and 2007;" warned Bob Shiller this week, adding that "it's likely to turn down again, just like it did the last two times." As John Hussman reminds us this week, stock valuations now reflect not only the absence of any interest-competitive component of expected returns, but the absence of any expected compensation for the greater risk of stocks, which is not insignificant – as investors might remember from 2000-2002 and 2007-2009 plunges, despite aggressive easing by the Federal Reserve throughout both episodes. Investment decisions driven primarily by the question “What other choice do I have?” are likely to prove regrettable.

• Yellen Spending Recipe Lacking Key Ingredient: Bigger Wage Gains (BBG)
• Ukraine signs trade agreement with EU, draws Russian threat (Reuters)
• GM Documents Show Senior Executive Had Role in Switch (WSJ)
• Australian Report Postulates Malaysia Airlines Flight 370 Lost Oxygen (WSJ)
• World’s Biggest Debt Load Lures Distressed Funds to China  (BBG)
• GPIF Rushing Into Riskier Assets Before Ready, Okina Says (BBG)
• Japan Prices Rise Most Since ’82 on Tax, Utility Fees (BBG)
• Italian Debt Swells to Rival Germany as Bond Yields Slide (BBG)
• China’s Manhattan Project Marred by Ghost Buildings (BBG)
• BOE's Carney Says Rates Won't Rise to Levels Previously Considered Normal (WSJ)

All sorts of promises, explicit and implicit, were issued to win votes. All the promises are now empty, and we might as deal with this reality head-on... if we can muster up the almost-lost ability to deal with reality rather than rely on fantasy/wishful thinking.

I heard it said one day that I would never be as rich as my parents. They were baby-boomers, the people that benefited from the expansionary Thirty Glorious Years of the post-Second-World-War period.

When all the dust settles, Palo Alto is definitely going to look a lot more modern than it did when I first moved here. All I can say, though, is that when the current bubble finally bursts, whether it's next month or next decade, there are going to be an awfully lot of expensive, empty, class A office buildings situated around town, holding nothing but the memories of ping-pong games past.

While today's Case Shiller data was widely disappointing across the board, indicating a significant slowdown in price gains (and on a sequential seasonally adjusted basis, practically a decline), the one market we paid particular attention to was San Francisco. What we found is a red flag for everyone waiting to time the bursting of the latest housing bubble. Because after an unlucky 13 months of posting consecutive 20% Y/Y price gains, the San Francisco bubble appears to have finally burst, posting "just" an 18.2% price increase, the lowest since January of 2013.

While we will have much more to say about the price dynamics in the West in a follow up post, where the Western housing market appears to be appreciated right now is in the just released New Home Sales report, which showed that in May new home sales soared by a whopping 18.6%, orders of magnitude above the 1.4% increase expected, and resulting in some 504K new houses sold, far above the 439K expected, and certainly above the downward revised April print of 425K. What caused this surge? Simple: the West, which saw a 34% surge in new home sales, from 97K to 130K, the highest one month jump since February 2013.

Priceline announced last week that it will pay roughly 112x for OpenTable - the reservation app pioneer - even though its growth has stalled for two years, is assailed by numerous aggressive competitors (e.g. Yelp, GrubHub and numerous international players) and is not protected by any evident moat of technology or branding. The bottom-line is that the artificial attraction of massive capital and trading leverage  (through options) into rank speculation like the PCLN/OPEN deal here does not stimulate sustainable economic growth or a true rise in capitalist prosperity. It simply generates unearned rents for the 1% who have the financial assets and access to play in the Fed’s casino. One can't help but thnk of Dubai.

While California is by far the most vibrant market when it comes to the most expensive segment (at +6%, the highest in the nation), it is shambles when it also comes to the two lowest price buckets, both of which blow out any myth of a recovery for the "non-1%" out of the water, with a collapse of 40% in sales in the $0-100K range, and a 20% plunge in the prime $100-$250K market (the Median existing home price across the US in May was $213,400).

Ghandi was once asked, "What do you think about Western Civilization?" to which he famously replied "I think it's a good idea." He may as well have been talking about free market capitalism. Capital in the 21st Century has hit the world like a new teen idol sensation. Everybody is drinking the Kool-Aid and it's being held up as the most important book ever written on the subject of how runaway capitalism leads to wealth inequality. Paul Krugman of course, loves it. As does every head of state and political hack in the (formerly) free world. So let's do something different here and accept a core premise of Capital, and say that wealth inequality is increasing, and that it's a bad thing. Where the point is completely missed is in what causes it (ostensibly "free market capitalism") and what to do about it (increase government control, induce more inflation and raise taxes). The point of this essay is to assert that it is not unchecked capital or runaway free markets that cause increasing wealth inequality, but rather that the underlying monetary system itself is hard-coded by an inner temple of ruling elites in a way which creates that inequality.

Spend any time watching business media, and you could not help but notice the extreme amount of optimism about the financial markets. Despite weak economic data and geopolitical intrigue, the complacency and "bullishness" are at extreme levels. Considering that the markets have been primarily advancing on the back of continued flows of liquidity from the Federal Reserve combined with artificially suppressed interest rates; what do you think the impact on the financial markets will be? “Success breeds complacency. Complacency breeds failure. Only the paranoid survive.” - Andy Grove