Bubblenomics And The Future Of Real Estate

Submitted by Ramsey Su via Acting-Man blog,

Behold the Monet

? Economics is like a Monet painting.  Stand too close and all you see is a bunch of seemingly random paint strokes.  Back up a few steps and an image emerges.  

The painting of bubblenomics started with the Plaza Accord, September 1985, where five nations agreed to manipulate the dominant currencies at the time.  Japan enjoyed a 50% devaluation of the US$ vs the yen, artificially enriching its citizens so they could travel the world in busloads with eighty pounds of cameras around their necks. 

The consequences of that bubble have yet to be corrected.  Twentyfour years of fiscal and monetary accommodation led Japan to sport the world's largest public debt-to-GDP ratio.

? The next big one was the US dotcom bubble, which was generating great wealth during the 1990s.  More importantly, it started the era during which income and savings became “old school”. Everyone could live off and retire on never ending asset appreciation.  When that bubble burst, in came Greenspan with the mother of all bubbles – the sub-prime bubble.  



Monet's famous “Twilight of the Bubble”

(Painting: San-Giorgio-Maggiore by Twilight, by-Claude-Monet)



? Amazingly enough, that mother of a bubble would soon be exceeded by the Bernanke/Yellen yield bubble. In Europe, unbeknownst to the world, the Euro/EC bubble was brewing.  Sub-prime countries like the PIIGS were allowed to borrow in a manner similar to how dishwashers in the US were given loans to buy McMansions.  Marginal economies such as Greece were able to buy Mercedes and import Armenians to do their work while the citizens collected pensions and crowded the coffee bars. The ability to repay was never a consideration.

This massive global bubble financing has unintended beneficiaries.  China, India and other emerging markets could never have had double digit growth rates without the flood of capital from the West and the importing of jobs that were deemed unneeded by asset rich Westerners. Countries like Australia and Brazil benefited from supplying raw materials to fuel these bubbles.  

? In summary, this Monet painting is becoming quite clear.  In the modern world, there are no economies, only bubbles.  There is not a country in the world that is not struggling to survive on yesterday's stimulus plan, other countries' stimulus plans, or waiting for tomorrow's bailout to live another day. 

To anyone who is not in denial, it is obvious that no central banker has a viable solution and no one is willing to take any pain. In reality, there is no stimulus, just a continuous game of borrowing by governments and printing by central banks to keep the peasants from revolting.



Comrades! See that 1%er castle yonder? Let's give 'em a pitchforking to remember us by!

(Image credit: C.l. Doughty)


Adjusting the Dials on the Radio

Forget Samuelson or Friedman, this is the way I define the economic jargon.  A stimulus is an investment into something that has future production value, at a cost today.  A bubble is the creation of pseudo demand for something that we do not need, made possible by debt and leverage that we cannot afford.  A bailout is a perpetuation of the bubble, using newly created fiat money and/or more debt to pay off the old.  It sounds awful like a Ponzi Scheme.

How does real estate fit into this picture?  For at least the last two decades, the real estate market is nothing but a byproduct of economic bubbles.  Going forward, the future of real estate is dependent upon on what the almighty policymakers want to do.  Ms. Yellen, unwilling to hide in the shadow of the QEs of her predecessor, is coming up with her own strategies, or terminologies.  

She has been promoting this thing called macro-prudential policies.  If I have ever heard that term in college, it has been long forgotten.  I had to look up the definition and found a good explanation by the IMF.  It is a very interesting paper with no practical use.  Who is Yellen kidding besides herself?  Does she really thinks she understands the subject matter, has all the necessary tools and knows how to deploy all these complex unproven theories in the real world, as if she were adjusting the volume of her radio?  Regardless of whether it is micro quantitative easing vs macro prudential, the bottom line is that the Fed will provide accommodation whenever it is needed.

Getting back to housing, I can only assume that Yellen will continue down the bubble path.  To illustrate how wrong that path is, here is a simple question:  

What is difference between a $100k loan at 6% and a $125k loan at 4%? The answer is: $3.   

In other words, the monthly payment for the former loan is $808, while it is $805 for the latter.  If the Fed members understood simple math, they would understand that all the effort spent trying to drive mortgage rates lower has no stimulating effect at all, if asset prices increase also.  In fact, it is a detriment to the first time buyers and the  same applies to trade up buyers.  

There is no incentive to trade.  The true underlying strength of a real estate market comes from strong employment, not only in terms of quantity, but in quality. Buyers buy when they have a good job and believe they are going to get a raise year after year, and vice versa if they think they may be laid off. 

The administration has been claiming job growth in the millions.  Naysayers said these are just part time low income jobs.  There is no disagreement that household income has not improved, per the following chart by the St Louis Fed. Any strength in real estate came from forces other than household income growth.



Real median household income: QE'd into the dumps, via Saint Louis Federal Reserve Research, click to enlarge.


Conclusion – Change Needed

In summary, in my opinion, healthier housing ratios should be no more than 1/3 of gross income, with adjustments based on other debt.  As a general rule, home prices should be between 3 to 4 times annual income. Based on these guidelines, the price of real estate is far too expensive today, or, more precisely, the cost of housing is too high.  

The correction does not have to come from price depreciation, but could come from obsolescing environmentally unfriendly tracts and urban sprawl.  Low density may need to be replaced by high density housing and better urban design to meet the life styles of the future.  I think we may need another crisis before the market will wake up to the needed changes.  

In the meantime, money printing and hype will continue.