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Fed/ECB and Housing Bubbles...

Patrick_C_Trombly
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3/27/2014 12:43:12 AM
Posted: 2 years ago
Is anyone out there still denying that the bubble and bust were caused by the central banks? If so, why? Do you WORK for the central bank? Are you so committed to a political ideology that you are unable to apply reason?

This was a textbook Austrian-style bubble - who can deny this?
ConservativeLibertarian
Posts: 54
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3/27/2014 8:01:16 AM
Posted: 2 years ago
Anyway, let me expand. The only ones who are stuck to a rigid ideology are the Austrians who argue that, in any conceivable case, inefficiencies in the economy must have resulted from government policy. It's the type of blind worship of markets that got us into the Great Depression, in fact. At the same time, they refuse to acknowledge that inflation is below expectations, interest rates are at negative real rates, there's no sign of an impending bubble, consumption is down, investment is down, etc.

Anyway, your willingness to equate the Fed with the ECB is laughable. They're hardly the same. The ECB has a single price stability mandate. It can only worry about inflation, and it can't even directly buy government bonds: it has to do it on the secondary market, which is why interest rates are so bloody high. Not to mention its incapacity to expand the monetary base ensures that it can't provide adequate liquidity to banks, and it can't move beyond the 2% target rate that's lower than the average inflation rates we had even during Ronald Reagan's term. The "bubble" in the European periphery was a function of a number of things: Greece ran deficits during good times, prices were out of line because of German wage flexibility policies and trade surpluses, capital inflows to the periphery because it was seen as a good investment -- creating a "bubble" -- and credit default swaps, in the case of Greece, which allowed them to push forward expenses on their balance sheet and hide deficits during good times. Now, the problem is being exacerbated by austerity.

As for the US, again, the Fed isn't to blame. Rates were fairly stable during the Greenspan years -- in fact, he cared more about inflation than unemployment, and remarked constantly that markets didn't need regulation, only to regret it later -- and massive deregulation allowed the largest financial institutions to gamble with complex financial instruments and overleverage into the subprime mortgage market, yes, creating a bubble. Again, there is no way to tie the Fed to this. If it weren't for the Fed, we would've had a 1930s-style depression.

So, again, people who have not the slightest clue of what they're talking about -- Austrians -- and only cling to a dogmatic ideology because it sounds simple and dogmatic enough that even a fourth grader could understand it need not pontificate on things they could not possibly understand. Austrian policies would destroy the economy, and the bubble would've been that much bigger.
DanT
Posts: 5,693
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3/27/2014 3:53:51 PM
Posted: 2 years ago
At 3/27/2014 12:43:12 AM, Patrick_C_Trombly wrote:
Is anyone out there still denying that the bubble and bust were caused by the central banks?
The bubble was most definitely caused by the central bank applying stimulus measures. Sadly most Keynesian would deny it, due to their confirmation bias.
If so, why? Do you WORK for the central bank?
Just because someone does not believe that is the cause does not mean they are working for the central bank. The central bank is not a bad thing; it is only bad when it is misused.
Are you so committed to a political ideology that you are unable to apply reason?

That would be confirmation bias.
This was a textbook Austrian-style bubble - who can deny this?
I would not call it Austrian-style, but it was definitely a bubble caused by bad banking policies.
"Chemical weapons are no different than any other types of weapons."~Lordknukle
wrichcirw
Posts: 11,196
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3/28/2014 6:07:04 AM
Posted: 2 years ago
At 3/27/2014 12:43:12 AM, Patrick_C_Trombly wrote:
Is anyone out there still denying that the bubble and bust were caused by the central banks? If so, why? Do you WORK for the central bank? Are you so committed to a political ideology that you are unable to apply reason?

This was a textbook Austrian-style bubble - who can deny this?

Animal spirits are responsible for every boom and bust. The central bank just adds a layer of control to the process. Sometimes it works (2008-present), sometimes it doesn't (Great Depression).
At 8/9/2013 9:41:24 AM, wrichcirw wrote:
If you are civil with me, I will be civil to you. If you decide to bring unreasonable animosity to bear in a reasonable discussion, then what would you expect other than to get flustered?
Patrick_C_Trombly
Posts: 3
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3/28/2014 10:16:57 AM
Posted: 2 years ago
At 3/27/2014 12:43:12 AM, Patrick_C_Trombly wrote:
Is anyone out there still denying that the bubble and bust were caused by the central banks? If so, why? Do you WORK for the central bank? Are you so committed to a political ideology that you are unable to apply reason?

This was a textbook Austrian-style bubble - who can deny this?

The detail in response to the various comments:

2001-2003- Fed cuts short rates in half. ECB does the same. The amount of debt that a given level of AGI at 35% debt/income or NOI at 1.25x DSCR will support goes up by 45% in the US, 50% in Spain (longer amortization), if one goes short on the rate and stays long on the amortization (which everyone in Spain already does, and which, after the rate cuts, is done in the US 1/3 of the time instead of the previous 1/10th of the time). Armed with this credit created out of thin air, buyers bid up houses/buildings by that same 45-50%. 3% of existing homes/buildings turn over in a year. These are the comps for the 60% of homes/buildings that refi, at lower payments and/or with cash out, as owners monetize paper equity. The rising values enable already-troubled debtors to sell out, which temporarily results in a sharp reduction in default rates. Some banks then go beyond the traditional ratios " because collateral values are rising and default rates have declined. Because of the expanded supply of credit, loans beyond the traditional ratios are priced only marginally higher. Meanwhile, also because of these temporary but large shifts in the signals (values and default rates), both foreign and domestic investors keep pouring into CMOs " there is a positive feedback effect here as the secondary market enables a further increase in originations. CMOs are criticized in hindsight but they were only a vehicle through which the original false signals traveled (don"t blame the messenger: CMOs were actually invented as a way to reduce risk, by enabling small savings banks to diversify their residential mortgage portfolios so as not to have all their risk tied up with one local market). The rate cuts did not come from savings " to buy even more/bigger houses later or to pay off debt when it re-prices at natural rates of interest. Thus the effects are illusory.

That"s the demand side: a house of cards built on credit expansion. The supply side is also a house of cards built on credit expansion. Developers are financed at short, floating rates, often with interest carry. The Fed"s rate cuts increase developers" WACCs dramatically. Meanwhile they interpret rising prices as increased demand. They borrow, expand, and hire millions of people into the construction field, where wages increase. A lot of men without college degrees find themselves making six figures or close-to, and make the typical life commitments (house/mortgage, family) that one in that situation makes.

Flash-forward a few years and the new money/credit has fueled inflation " through all the cash-out being spent, and margined investments in commodities. Wood, copper, fuel, labor are all up " and going into 2005 it is already the case that homebuilders are losing money on the actual building and making money only on the lot appreciation. Meanwhile consumers have doubled down " with low rates they not only stop saving, they borrow to increase spending. Keynesians see modest unemployment as a success, and see the simultaneous increase in spending and investment not as a mismatch but an aggregate, as "GDP" grows.

The Fed sees the rising prices and concludes that "the economy is overheated," and starts to hike rates. Going into 2006, while long rates are still inching lower, they are not as low as short rates were in "03-"04, and short rates are up. Buyers do not get an influx of buying power, but start to have it pulled back. Values do not rise and selling takes longer. Builders are 30-40% of the way through the massive development projects they"d started, and they now hasten to finish units and sell out before their cost-of-capital rises further (a few hundred bps is a big deal when you"re on interest carry). Temporarily, construction spending, hiring and wages increase. Janet Yellen refers to the resulting tightness of the labor market in the aggregate as a "puzzle."

With values starting to fall off and the time it takes to sell a property getting longer, it becomes more difficult for distressed debtors to sell out. Some of the initial ARMs re-price at the higher rates. With no new expansion of credit, consumption levels off. Mortgage defaults increase dramatically and the securities backed with mortgages lose their value. Developers see the writing on the wall and start mothballing projects, and laying off all the construction workers they"d hired during the boom " they can no longer meet the financial commitments they had taken on, and they default on their mortgages, and reduce their spending. The crisis ensues.

The issue is not the panic itself; it is not "fear itself;" it is not "animal spirits." Minsky does a nice job of describing the feeling at the time - but not the root cause. His analysis is like drinking three margaritas, then because you're a tipsy, drinking three more, then waking up with a hangover, and focusing on your mood at each of these instances rather than the margaritas.

The issue is not that somehow the boom was sustainable, just not sustained (also referred to as "insufficient aggregate demand"). To continue the analogy, these arguments are akin to Frank Sinatra"s quote about people who do not drink ("they wake up in the morning and that"s the best they"re going to feel all day").

The issue is simple: Greenspan blew a big bubble and it burst.

The issue is not that some banks, late in the game, went beyond the original thresholds, and it is certainly not that some banks did not keep an organized filing system for their appraisals: an appraisal is just a glossy report that documents how, temporarily armed with 50% more buying power courtesy of the Fed, buyers did, in fact, pay 50% more for a property of a particular type than buyers paid for a similar property two years earlier, before the credit expansion. The problem was the credit expansion, not the file-keeping of the reports that documented its effects!

And the issue is not market participants' entirely predictable reactions to false signals - it is the signals themselves.

At each step of this chain of events, you could come up with some kind of firewall. But even if that were successful, what would that firewall prevent? What is the "fire" in question but credit expansion! All a firewall would have done was to prevent the rate cuts from taking effect. That begs the question, why cut the rates in the first place then? Instead of building a system of firewalls to neutralize inflationary interest rate policy, why not just not implement the inflationary interest rate policy?