Monetary Policy & Real Estate
by Eric Englund, John Tyler, Ole Bear, Rob Kirby, & Sol Palha, Realty Reality - Global Real Estate Markets Forum. June 2005
How does the Federal Reserve use monetary policy [and get laws passed in its favor for the Federal Banking (Mortgage)Cartel] at the expense of the consumer and real estate tohold up the smoke and mirrors of the irrationally exuberant consumer based/service based American Economy?-- and what are the implications for real estate prices in the micro and macro real estate market in relation to HR1295 or what are your views on Big Brother GovernmentSanctioned Predatory Lending at the Demise of the RealtyValuation Community and the US Consumer? -- and how[if it does] this impacts the financial markets[including real estate]? Same question asked two different ways!
by Eric Englund
Surety Bond Underwriter
Over time, under a 100% gold standard, a house would gradually depreciate in value. A house, after all, is nothing more than a durable consumer good it is a capital good if it is a rental property. However, when living under a fiat-currency regime, perceptions can be radically altered. For example, not only is a house believed to be an appreciating asset, it is considered to be an investment. Additionally, under conditions of rapid money and credit growth (which, for a period of time, leads to artificially low interest rates), people will come to think of themselves as real estate entrepreneurs wisely "investing" in a house, to live in, with the confidence that a big payday looms ahead upon sale of same house. Presently, with lending standards so low "to keep credit flowing" the housing boom has become an outright speculative bubble in many parts of the U.S. I would argue, in fact, that a hyperreality has emerged in which real estate is perceived to be a one-way street to wealth. The bust will come, inevitably, and millions of Americans will be wiped out financially, and only the Austrian School of economics provides the correct explanation as to why the housing boom contains the seeds of its own destruction.
As Roger Garrison explains in The Austrian Theory of the Trade Cycle, the boom-bust cycle emanates from the Federal Reserve:
The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.
We certainly know, today, that Americans are saving little if any money. Thus, America's housing boom has emerged directly as a result of Alan Greenspan's easy-credit policies not from savings.
For the time being, the real estate party is in full swing. Americans are clamoring to participate in this ride to "Easy Street." People are willing to take on punishing mortgage debt loads "knowing" that houses will always appreciate in value and that the higher the leverage, the higher the rate of return. Moreover, as a house appreciates, home equity loans can be taken out to purchase consumer durables such as high-end kitchen appliances, granite countertops, a hot tub, and even a kit to build a backyard barbecue. Once these consumer durables are "attached" to a house, they magically become investments that add value to, and appreciate with, the house. With Alan Greenspan at the helm of the Federal Reserve, Americans have discovered investment Nirvana. Indeed, the house has been transformed into a perpetual wealth creation machine.
To be sure, a house is a more enjoyable investment to own than a dot.com or a telecom stock. Just imagine, you can throw a Super Bowl party in your investment. You can sip on champagne while relaxing in your hot tub investment. Neighbors can compete as to who throws the best barbecue bash on the block (oh, it was so wise to invest in that bricks-and-mortar backyard barbecue). It is important, naturally, to keep the yard manicured in order to have the best looking investment on the block�which is important, for curb appeal, should one decide to sell for the highest profit possible. Finally, you can even procreate in your housing investment; try that in your stock portfolio. All the while, the hottest topic of conversation in the neighborhood pertains to how everyone's house is increasing in value. Every homeowner is brilliant and, in a sense, has become a real estate entrepreneur.
In the boom phase of the trade cycle, it is not predictable as to where the fiat money and credit will flow. In the late 1990s, we saw "Easy" Alan's money and credit flowing into internet-related companies such as the dot.coms and telecoms. Correspondingly, individual "investors" threw trillions of dollars into the tech-laden NASDAQ with the belief that the internet would lead us into a bold new cyber-world where wealth would be created simply by sharing and transferring information. When this mania ended (as bank credit and venture capital dried up), the NASDAQ bubble burst in early 2000 and the once high-flying dot.com and telecom companies came crashing down to earth. It was all an illusion fueled by the Federal Reserve's loose money and credit with a notable clustering of entrepreneurial and investor error associated with internet-related companies. Hence, in 2000, the economic bust (recession) descended upon the U.S.
Alan Greenspan, of course, would not tolerate a recession. Accordingly, the Federal Reserve went on a money and credit creation binge and eventually brought short-term interest rates down to 1% (in 2003). The Federal Reserve, in total, cut interest rates 13 times between 2001 and 2003. With interest rates so seductively low, Americans went on a borrowing and spending spree which pulled Uncle Sam out of the recession at least for now.
As Murray Rothbard explains, in The Austrian Theory of the Trade Cycle, America's debt-driven "prosperity" is a mirage built upon the opiate of easy credit. Alan Greenspan's multiple interest rate cuts, as Dr. Rothbard conveys, is nothing new in the field of central banking:
"The point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit.
Sadly, there will be a comeuppance. In this case, a clustering of errors will be exposed on the part of the high-flying housing developers, lenders, and homeowners. Mortgage lenders, eventually, will find that homeowners cannot handle such crushing debt loads especially as rising interest rates cause defaults on interest only and adjustable rate mortgage loans. As mortgage payment delinquencies and defaults rise, bankers and other mortgage lenders will begin to see the error of their easy-credit ways. This is where boom turns to bust, as described by Dr. Rothbard:
It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom..."
Not to forget the housing developers, at this juncture, they will be caught with too much inventory on hand right when housing prices and demand are on the decline.
Just as night follows day, bust follows boom as long as central banks exist. The housing bubble is merely another manifestation of the Federal Reserve's reckless manipulation of money and credit. Presently, most Americans believe that houses are a sure-fire investment while adherents of Austrian economics know they are nothing more than consumer durables caught up in a speculative frenzy. When the housing bubble bursts, millions of Americans will find themselves buried alive in debt while living in their financial tombs.
by Ole Bear, Editor
Broken Ribs, but the Spleen is AOK
When I first heard Fed$peak Greenspan tell folks several years ago that real estate markets could not be a markets bubble simply because they were all local, I laughed so hard I broke a dang rib falling out of my chair, and had to go to the Emergency Room at University Hospital to get it taped back up. With all the press out the past several weeks from Mr. Fed$peak and the rest of the Monetary Charlatans [aka Bad Boys at the Fed], our favorite central bank, that real estate is now frothily irrationally exuberant and just might be somewhat overzealous in some micro and macro realty markets, I fell out of my chair again laughing so hard that I got frothy at the mouth and couldn't swallow, and I cracked some more ribs and - you guessed it - ended up back at the emergency room getting taped up again!
Well, the banking cartel has already got their new bankruptcy bill passed to protect their assets, and now they are working on HR1295 to shore up some more loose ends to be able to point the finger at the realty valuation community if bad stuff happens in financial and realty markets, under the guise of "protecting the consumer." HR 1182 according to Leigh W. Budlong, MAI, is a far superior piece of legislation that the endorsers of HR1295 are trying to sweep under the dirty carpet. Since she's working on an HR1182 essay, I don't need to say much more about it. Knowing the accounting problems, dare we say just plain outright lying and fraud at our favorite bloated, false, and spurious GSEs, some of which are also candies, Houston we have a problem! Seeing what has come down the turnpike in all sorts of mechanisms of control by Big Brother, which include un-patriot act legislation, homeland insecurity, further restrictions on money and banking for the smoke and mirror of catching terrorists, the new national ID fraud passed as a rider on Baby Bush's $80+ billion additional funding to keep our boys and girls in the Middle East, hello Houston - is anyone there?
Deregulation of the GSEs, 4-to1 Reverse Splits, Foxes and Henhouses
There's also talk and rhetoric about the new re-regulation [deregulation is more like it] of the GSEs since OFHEO hasn't been powerful enough to foil these accounting tricksters. Now you have to understand that the GSEs operate as second tier central banks anyway, being able to create money and loans out of thin air by selling bonds to Wall Street Money Market Mutual Funds giving these supposed cash accounts a general 40 to 60% exposure to a GSE default should the housing market implode. This process is called mutual fund money market intermediation, and should folks wake up one morning to find their $1 NAVs went for a 4-to-1 reverse split, there will be a long of angry folks running around the planet. There's big talk on Capitol Hill about putting the GSE step-children under the US Treasury to keep them from getting into any financial trouble. This is the same thing as putting them directly under the control the Federal Reserve, and further deregulating the second tier central banks. Hello, Houston, pick up the phone! If you think we have a conundrum of frothy irrational exuberance now, should that happen, we will all be zillionaires with our real estate in just a few short years. This is the same thing as the fox guarding the hen house, when you get right down to it.
The Three Monkeys and Blackmail's No See, No Hear, Fed$peak
So the Fed Boys have been raising the Fed Funds rate up, and tell us that they are going to do it some more since the economy is so great. Yet real estate mortgage rates actually went down a blimp or two still holding near 50 year lows. Fed$peak Greenspan uses the word conundrum to indicate he's in the dark here. And guess what? The press and every brother and their dog are buying the conundrum theory of frothy irrational exuberance! Hello, Houston we ehhh... have another problem!
Well, gee whiz, somebody has to be buying those 10-year treasury bonds depressing the yield raising the price of the bonds to keep mortgage interest rates fictitiously low. Somebody has to be pumping money to our bond market from someplace, hello! Could it be blackmail? Could it be some nice folks in Asia, perhaps? Could it possibly be the Japanese and the Chinese? We know Fed$peak Greenspan is one sharp cookie, and what he says to Wall Street and what he really knows are two different things in our view. I am certain that the Top Kat at the FED knows and reads Dr. Fekete up there in Canada, who is another smart cookie. Hey, Easy Al, how is that Supply of Oxen at the Federal Reserve? Of course in central banking financial and economic give us your cheap cars and TV blackmail, it is all in a day's work. By the way "Day's Work" is a chewing tobacco, but we all know that central bankers, all good ole boys as they all are, probably don't dip snuff, chew tobacco, or smoke those nasty cigarettes - but I hear they all love a good $20 Cuban cigar sitting around the walnut FOMC table.
Nehemiah Was a Bull-Frog Who Spoke Spanish, or Three Dog Night's Conundrum?
What gets all the more interesting is the very dangerous new mortgage loan products the banking cartel has dreamed up to entice people to take on more debt and more real estate than they probably deserve, and more risk to the financial system than is prudent for Austrians, economically speaking. We also have many give away programs [The Nehemiah Program] that provide the supposed poor folks to jump into the real estate market as first timers. These folks and their associates, and others at this audition, even loan and give away money in Spanish. 69% homeownership was the last statistic I think I saw - that's where we are. The goal of the GSEs and the Fed Boys is 100%. Hello, Houston, we have another problem! If we achieve the FED Boys target it will tear the UN-HOLY HECK out of the duplex and apartment business in quite a few micro and macro realty markets. Gee, Whiz, is that why that commercial real estate guru loan officer here at Boone County National Bank was quizzing the heck out of me last week about the residential rental market here in Columbia? You can see the problem, Houston, if you just pick up the phone!
For years FHA and the VA made 100% to 110%+ loans to the entry level realty buyers in this country, with the VA program geared toward our boys and girls who have been militarily oriented as a benefit. 100% loans are nothing new, but now the rest of the nice mortgage lending folks are into the fray with all sorts of gimmicks to make the deal, and after we make you a 100% loan on that $200,000 house, these crazy folks will set up a home equity line of credit for another 25% to 50% on the overall loan to value. Hello, Houston wake up - we have a big problemo, Dudes!
Surreal Real Estate Gone with the Wind?
Then we have this Kool Kat Bovard, a best selling author, who smells a rat in the housing market. Previously Kool Kitten Fitts figgered out what's going on at HUD and Fannie Mae, our favorite fudge candy. At the same time we have flying condos in Florida and New York that aren't even built yet, and the pre-construction buyers of these flying condo pigs in the air are already flipping 'em to another sucker. Now how in the heck can these flipped deals get a mortgage loan from a lender is beyond me. If they [the lenders] are getting a realty appraisal from some realty appraiser on these inflating flips of condos in the sky, where the heck is the support in the micro realty market? Oh, sure, you have contracts on pie in the sky and things are going up and getting really hot! On stuff that is surreal real estate at the moment. If that is the appraiser's mentality appraising pie in the sky, I am Donald Trump [alias Donald Duck] in Drag, and I will swap you a peanut for a watermelon! Condo fever flipping is nothing but re-arranging the deck chairs until the music stops, and folks realize that, "Frankly, my dear, I don't give a damn!" about tulips. Thank you Rhett Butler! Thank you Margaret Mitchell!
DOW 20,000, Handing Poor Richard His Head, and Perpetual Motion Machines Printing Money
Hummm... I love Richard Russell, the DOW theory letter guru, whom I have great admiration and respect for. He has been around a long time and called some pretty market moves in 80 odd years. As a former subscriber, I love his wit and charm explaining markets, and his overall take on life. I read his free stuff now, since I am pretty busy. Knowing the current Kondratievian Winter Wave Cycle that we are currently in, coupled with Austrian Economics, the fact that the DOW above 10,000 composed of 30 stocks, which include ABS [asset backed securities] companies of Ford, GM, and GE, which makes all their money for 'em as financial companies instead of manufacturers of Lincolns, Buicks, and Microwave Ovens' absolutely defies reason. That which should be at 3,000 is above 10,000. If you look at histories of markets and the real follow the money PE [Price to Earnings Ratio] of these 30 stocks, who is the Huckleberry here? The nice Folks on Main Street America? That is the power of Big Brother and its Federal Reserve holding up the smoke and mirrors of Wall Street and financial markets. Hello, Houston, we have another problem!
There are some other guys and dolls who think Wall Street should be lower, and the FED has basically handed these folks their heads back to 'em on a silver platter, somewhat like John the Baptist. It is kind of slick how the Working Group on Financial Markets [aka, The Plunge Protection Team] does it moving money around and the repurchase agreements injecting the taxpayers� free money into markets as the smoke and mirror to attract nearly $2 Billion in foreign capital a day into our financial system. That is the power of centralization and control of a central banking system. That's why I don't play options much anymore. You cannot win! For all I know, the DOW will be at 20,000 next year, and my house will be worth $1,000,000+ Federal Reserve Notes [legal tender fiat paper funnie monie]. Houston, ehhh... we have another dang problem! Anybody there?
Budlong and I were talking the other day about how long real estate can keep inflating. Lady Budlong is a MAI [Appraisal Institute, commercial realty valuation professional designation] and lives in the Peoples' Republic of California where real estate is really hot. I sent her a copy of my buddy Ed Griffin's Creature from Jekyll Island - a second look at the federal reserve, which she's nearly finished. Miss Leigh posed the question - "When does it stop? When does it all implode?" It is a great question, but I am afraid I cannot answer it. I am human. The Federal Reserve is not human. This economic tapeworm is in complete control of the financial system using real estate [commercial and residential] as a secondary money base to support a fraudulent legal tender money system of Federal Reserve Notes, unbacked by specie, and in our view an Un-Constitutional Fraud on the American Body Politic - the nice folks on Main Street America. I suspect that the FED Boys under Greenspan or its probable new Top Kat, Bernanke with the printing press running 24/7 as a perpetual motion machine, can keep this Ponzi shell con game going for years. In the meantime they, with their propaganda machine, will dumb down the last vestiges of economic and financial sanity in America before the whole thing implodes. In turn, folks that really know what is going on and how to follow the money in this corrupt financial system, will be handed their heads on a silver platter, since no one will believe that the day of reckoning lies in the future. But I can tell you that if and when real estate implodes, the folks at the Federal Reserve will duck for cover from the angry folks. Real estate is perhaps the last play the FED can make, before becoming the lender of last resort in a financial meltdown. The financial meltdown? Derivative bailout of the GSE counterparties on Wall Street, perhaps? [just a guess, who really knows!]. The central bank protects Wall Street and the financial system. Gee, Folks! Don't you read John Dizard? Prozac, Anyone?
Voting with Your Money in the Marketplace
Houston, are you there? No one is answering!
Yeah, this is all spooky stuff, but the sky isn't gonna fall anytime soon, God [or your Deity of Choice] is still in Heaven [or wherever they are] and the world will go on for another day. Scarlet O’Hara's famous line is - "Tomorrow is another day." Well, Scarlet is right! But there are things one, or a family, can do to protect your assets and vote with your money in the marketplace.
So how do you vote in the marketplace?
Simple really. Use your head! I buy Sinclair gasoline even though it is a little more expensive than British Petroleum. Why? Sinclair buys only North American Crude from the USA and Canada. It doesn't mess with OPEC and the Middle East. Acquire some heavy metal music, aka gold and silver bullion. The FED and Big Brother have unrealistically capped the price on precious metals documented by Bill Murphy's work at gata.org and lemetropolecafe.com. Reading the Gold Derivative Banking Crisis is not for the light-hearted. Yeah, the Powers that Be have been rigging this market since 1995 or thereabouts.
Take your money out of the Big Boy Banks and put it in local or regional banks, credit unions, and savings and loans that don't cater to the Big Boys and the Federal Reserve Fraud. Or Start your own bank and go to cash and low interest credit cards. Transfer those rip-off 17-25% interest credit card balances to low or 0% interest rate credit cards, but they have to be another company. For instance you cannot transfer a high interest rate balance to a lower interest rate balance at the same credit card company. Want a real estate loan? Stop shopping the Internet and go down to Main Street and use a local lender, or start your own Solari, which can operate as a bank.
Live within your means!
Who the heck wants to keep up with the Jones'? They are in hock over their head. So drive an old Ford or Chevy a few years longer. So you have an OK home or apartment, but want something nicer? Live with it! Rearrange the furniture. Clean out the clutter! Clear out the garage. Have a garage sale to get rid of the junk. Downsize right now, and get rid of the fluff you don't need! In hock over your head already in debt? Get a good local credit counselor to help you get on a firm footing of debt repayment to clear up your credit report and credit history so you can make a move later.
Need more room for a growing lifestyle or family and just have to make to make a move someplace. Great! Take your time and find a great Realtor to help you make the transition! Don't buy more house than you can afford if you get laid off for a year. Liquidate all your real estate holdings waiting for the sky to fall? Liquidation of some commercial assets is prudent in my view in the current financial system, especially if you are top heavy in one realty investment form. Owning 50 duplexes in Columbia, Missouri is dancing with the Devil on the RMS Titanic in my view in such an overbuilt investor driven market. Get rid of 'em! Owning investment property in prime rental locations that can weather any financial storm? - hold onto 'em. Sell your adobe hut and rent an apartment or another house waiting for a crash? - why do something silly like that? A growing family cannot do that economically speaking. See how this common sense on real estate and voting with your money works? It is your money, use it and vote with it wisely in your purchasing decisions.
Everyone on the planet has to live some place, that some place is some form of realty or real estate that is not surreal! Doesn't matter if it is a mobile home in a rental lot trailer park, a modular factory home on an acreage, a retirement community, an apartment, condo, loft apartment/condo or rental duplex, or a detached single family 2 BR bungalow worth $20,000 or a mansion worth over a $Million$. It just does not matter. Folks just gotta live someplace they can afford - and more importantly - a place called home that they like, as most folks have been sucked into a mortgage to the banking cartel. [Real estate is all about debt unless you pay cash for it!]
Denouement and Conclusion - In Come the Waves
When we observe how the Powers That Be can control the decline of stocks and mutuals on Wall Street, which appears to be in suspended animation, and correlate this type of economic power that a central banking systems has, we can easily conclude that the real estate con game of perpetually inflating realty prices can continue for a long time. The Evil Kneivel Daredevils out there can make a heap of pocket change playing the risky real estate con game, as long as they find the next sucker to take their property off their hands at a higher price using the greater fool theory. Just remember Evil Kneivel has probably broken every bone in his body at least once. However, in our view, real estate is a manipulated market serving as secondary money base for the Federal Reserve to keep a fraudulent paper money system alive and well. Realistically, if you know your economic history - all legal tender fiat paper money systems ultimately fail. Whether the current financial system implodes from real estate or monetary collapse is like trying to figure out which came first - the chicken or the egg? If folks learn to vote wisely now with their money, they will not have to worry about silly riddles.
Ole Bear, Editor
© 2005 Gale Bullock
Editor for Realty Reality
by Rob Kirby
In the United States, monetary policy is conducted by the Federal Reserve and more specifically it is set by the omnipotent FOMC [Fed Open Market Committee]. In an admittedly simplistic sense, the FOMC's raising and lowering of interest rates ultimately determines the supply and demand of credit and hence the expansion and/or contraction of the money supply. Put another way, all new money created in the economy comes through the "loan spigot" - interest rates simply control the rate of flow [i]. Few, if any, would argue that interest rates and monetary policy have a direct bearing on the real estate market. I would like to now explain how, but it's going to take me a minute or two to get there, so bear with me - ehhh?
Many pundits agree that the Dot Com boom of the late 1990's was the result of loose or accommodative monetary policy on the part of the Fed. Graphically, in table 1, we can see a clear shift or acceleration in the money supply [m3] at or about late 1995. The white line marks the spot when government began
Table 1 compliments of Jesse: http://www.jesse-livermore.com/market-manipulation.html
borrowing money from the social security trust funds. This action was arguably the equivalent of the government printing money. Had the Fed responded at this time by dramatically hiking rates, showing displeasure at this repugnant profligacy and largess, the dramatic financial asset inflation of the late 90's may have been somewhat lessened or subdued. Remember folks, one of the primary fiduciary duties of the Fed is to defend the integrity of the currency [dollar]. So, while the dollar looked strong relative to other currencies and gold, it suffered terribly in terms of how many financial assets it bought. By utterly failing in this regard, at this critical juncture - and instead adopting easy money [low and in fact negative real interest rate] policy - I would argue that the Fed abdicated their primary responsibility. Oh sure, they committed this and other acts under the cover of a strong dollar policy, fears relating to Y2K, doctored or neutered gauges [CPI, PPI, GOLD] of inflation and at times alleged to be responding to international monetary and currency turmoil. I would still argue that this time period definitively marked the period when the Fed completely and utterly crawled into bed with [or perhaps I have erred in my articulation and should redress this relationship the other way around] their political masters. This all occurred with little more than the infamous "irrational exuberance" utterance [I prefer whimper] from Sir Alan of Greenspan's pulpit.
The upshot of this critical failure cited above, was highly inflationary. There was excess "new" money in the system and I would argue that whenever this occurs, it manifests itself by producing what is affectionately referred to as an asset "bubble". In the mid 90's, the S & L bailout and associated real estate collapse was still fresh in many people's mind. Besides, transacting real estate took time and was cumbersome. Instead, the internet was emerging as the "next big thing" and online brokerages were popping up like dandelions on a warm summer's day. Capital had never been so mobile and in essence - this was the equivalent of the Casino opening its doors, and we experienced the serious run up in financial asset prices we now refer to as the Dot Com boom/bubble.
By the time Y2K had come and gone, things [that would be financial things] were clearly on an unstable footing in the manic equity markets - with technology startups [mostly NASDAQ listed] that were little more than "ideas" with no earnings or discernable prospects for earnings customarily being granted market caps measured in billions [that would be billions with a "B"]; even the Fed realized this situation was unsustainable recognizing that something had to be done - but what?
Swiping the Punch Bowl and Putting Back A Bigger One!
The Fed began raising interest rates in the aftermath of Y2k in a vain attempt to reign in the asset inflation they were so instrumental in creating. The result was a recession which had all the earmarks of getting worse – but then something happened – the Fed reversed course. Yes, the Fed reversed its course and instead began lowering interest rates once again – dramatically. Investors with short memories [read everyone] who were recently "burned" in the technology collapse once again found credit conditions too irresistible not to borrow money and began surveying the horizon for something else to buy. Savings were out of the question, real interest rates were negative and increasingly becoming more so. Remember folks, once the act of inflating the money supply occurs, the excess simply seeks a convenient place to manifest itself.
So investors finally came around to buying, well... just about everything else. Interestingly, the business community seems to have not been largely "fooled" by these machinations of the Fed since Cap-Ex has been lethargic and slow to respond and outsourcing [to further reduce costs] seems like it is here to stay. It seems that only the "gullible" and punch drunk Jane and Joe Six Pack really took the bait. They started with oil [prices have risen from 20 to 55], they moved on to the other commodities [like copper, steel, or anything else tangible] and finally moved on and got around to buying REAL ESTATE. After all, buying real estate has become so much easier in recent years. Virtually anyone with a pulse seems to qualify for a mortgage these days. Realty valuation metrics have been turned upside down with the likes of AVM's and drive by appraisals. Real estate is typically bought with mortgage finance – implying leverage. In many areas of the country, homes typically trade at valuations that those living in them "cannot afford" based on current incomes. Many new home buyers are literally "created" out of thin air - only qualifying for their purchases as the result of financial engineering - like ARMs or negative amortization loans. Inflating real estate prices in many parts of the U.S. are now serving to provide consumers with the means to "extract" this illusory wealth through refis brought on by absurdly low interest rates - all compliments of the Fed. This has allowed many to continue to make ends meet with the general rise in price levels or in many cases allow them to spend above their means. So the logical question becomes - How long can this keep going on? Good question!
Now, dear reader, I would like you all to go back to table 1 [above] again and ask yourself if what you see. Does it look anything like the side of a mountain? Where I come from, mountains have tops as well as other sides. It's the other side of the mountain that we all need to be wary of folks because it's a long way down from these lofty heights.
[i] Actually, interest rates along with reserve requirements [percentage of deposits that banks are mandated by the Federal Reserve to keep on hand in a liquid form] are ultimately used to regulate credit creation. The altering of reserve requirements occurs much less frequently than targets for interest rates [ie. The fed funds target rate or the discount rate].
by Ben Jones
Proprietor, The Housing Bubble Blog
"The global surge in house prices is a boom by design, largely manufactured by the world's central banks, led by the Federal Reserve. Other central banks, like the European Central Bank, quickly followed the Fed's lead." - Real Estate, the Global Obsession by STEVE LOHR. Published: June 12, 2005 The New York Times.
The Austrian School of economics tells us that deflation can be the death-knell for a central bank. The Federal Reserve fears deflation so much that it rarely uses the word, preferring "dis-inflation" and "lack of pricing power" when describing the phenomenon. The Fed created this speculative bubble in housing prices in a desperate bid to defeat deflation, and therefore maintain its power.
The discussion around the time of late 2001 and 2002 was that the exceptionally low interest rates were needed until business spending picked up. Housing prices began to skyrocket. As the prime borrower segment became exhausted in 2003, the mortgage industry launched a bid to fund sub-prime loans on a large scale. Refinancing was heavily encouraged and home equity lending was grown by hundreds of billions of dollars.
As even these high-risk loans were not enough to pump the required trillions into the system, adjustable rate and interest only loans became the majority product in many markets. Finally, they threw away the rule-book and made zero-down, no document, "stated" loans available to "anyone with a pulse".
We all know that the result was astronomical home prices in dozens of the largest US metropolitan areas. The foreign central banks had equal success in producing unsustainable bubbles in Spain, the UK, Australia and even China, to name a few.
The Federal Reserve must have "requested" the lending industry to resort to these lax lending methods. How can I be so certain? To believe otherwise is to think that such a dangerous gamble could be initiated by the likes of Countrywide Financial and GMAC or was an economic accident. That, I submit, is not possible.
With government-backed Fannie Mae and Freddie Mac ready to put the US taxpayer behind the mortgage backed securities, all the lenders had to do was rake in the loot. The wild price appreciation drew in more speculators, who were encouraged by the easier money and a cheerleading financial media who told them real estate never goes down.
That is why the appraisers were brushed aside when they petitioned congress and polled members about coercion. The matter at hand for the central bank was to pump trillions of dollars into the system. It had nothing to do with housing, indeed that home markets might be devastated was considered insignificant in the attempt to retain their sway. It must be maddening for appraisal professionals to see their standards cast aside, but true value stood in the way of the massive debt creation and that's why we see the industry in shambles.
Of course, the global over-capacity prevented the hoped-for business spending. Eventually home prices rose so much that the Fed began to pretend to put the brake on. Tiny rate increases are meaningless when you consider the interest-only frenzy that accompanied them. Now the Fed stands looking into the abyss of deflation again, this time with a housing bubble and the accompanying debt. Perhaps the Fed faces the true end-game that comes to destroy all fiat currency regimes.
"We knew...addressing the consequence of a very severe deflation of a bubble carried with it potential side effects. As best we can judge ... the positive effects of the policy far exceeded the negative ones. And while it's too soon to judge the final conclusions of how all of this comes out, I think that given the same facts under the same conditions, we would have implemented the same policy."
Alan Greenspan, June 9, 2005 from:
"Fed Chief Signals Rates Still to Rise Greenspan Says Economy Has Left Soft Spot Behind, But Notes Housing Risk" By GREG IP, Staff Reporter of THE WALL STREET JOURNAL, June 10, 2005; Page A4
by C. Robert Bell, PhD
Chairman, Economics Dept., Brooklyn College
Some persons are determined not to take the fall when the real estate boom turns into the real estate bust. Among them is a commercial real estate appraiser I interviewed a few weeks ago. Although he works in one of the hottest of the boom markets, he is only getting a moderate amount of appraisal work, perhaps because he gives honest appraisals. His work comes mainly from out-of- state banks that want honest appraisals because they don't want to get stuck with the property after the fall.
He includes in all of his appraisals a disclaimer he drafted himself. He gave me permission to reprint it provided I didn't identify him, since he still hopes to get some work from local banks. The disclaimer specifies how the real estate bubble came about and at least one way it could pop. It may be of interest to readers of Realty Reality, so here it is in full:
-- extraordinary assumptions directly affecting the appraisal of the subject property and value estimates are as follows:
- According to published accounts, 1) the U.S. trade deficit exceeded $600 billion, or about 6% of Gross Domestic Product (GDP) in 2004, a record that is expected by some experts to grow to 8%of GDP; 2) roughly $2 trillion in U.S. Treasury debt instruments are held by foreigners, 3) the value of the U.S. dollar has fallen by more than 50% against the euro in the three years ending December 31, 2004 (30% alone over the past two years), and 4) interest rates (bank prime, federal discount, five- and ten-year treasury, and conventional fixed-rate mortgage) have remained at or slightly above 40-year lows over the past two to three years and the federal discount rate has been, in real terms, near or below zero for more than two years. Other things being equal, a weakening national currency combined with very low interest rates are precursors to general price inflation, and the central bank's traditional response to a collapsing currency (or to persuade foreigners to continue purchasing dollar-denominated debt instruments) and general price inflation is to raise interest rates.
- However, the historically low interest rates have been a primary factor in the steady rise in most real estate values and construction activity in most major markets and here in Any County, Any Town, Any State USA, as well. Although the central bank has been making modest increases in interest rates, market forces can move independently of the central bank and a significant rise in real estate mortgage rates, for example to levels such as seen throughout most of the 1980s would probably have a substantial adverse effect on the market value of the subject property. Indeed, a published summary of the minutes of the Federal Reserve's December 14, 2004, policy meeting indicated that some policy makers worried that the prolonged strategy of low rates might be fostering "excessive risk-taking" in financial markets and in the market for houses and condominiums.
"Accordingly, the client is hereby forewarned that the potential exists for a substantial drop in local market prices (i.e., a correction) for property such as the subject at some point in the foreseeable future and the client is advised that the value estimates contained herein are based upon current market conditions, anticipated short-term supply and demand factors, and a continued stable economy. Therefore, these estimates are subject to changes in future conditions."
Commercial real estate appraisers could be particularly at risk when the real estate market turns down, just as some sell-side stock market analysts were after the stock market bubble started to lose air in early 2000. So those who think there is no real estate bubble or that it is a long way from popping might want to reflect on the words of this commercial real estate appraiser. He clearly thinks there is a bubble and that it could explode or start to hiss air at any time.
Robert Bell, Ph.D., Chairman of the Economics Department, Brooklyn College, N.Y., is the author of seven books, including: Beursbedrog (The Stock Market Sting), De Arbeiderspers, Amsterdam, 2003; Les peches capitaux de la haute technologie (The Capital Sins of High Technology), Seuil, Paris, 1998; Impure Science, Wiley, N.Y., 1992. This is his third article to appear on Realty Reality.
© 2005 Robert Bell
by Sol Palha
Proprietor, Tactical Investor
Why is it that reality, when set down untransposed in a book, sounds false?
Simone Weil 1910-1943, French Philosopher, Mystic
Since I basically only had 3 days to come up with my essay (I was out of the country in Costa Rica and Nicaragua evaluating the real estate market and several other investment opportunities) I decided that it would be best if I answered some of the corollary questions Gale bullock offered.
How long can it last?
The feds are masters at this game and they have managed to convince the world that everything is just fine and dandy; this game will last till the consumer is completely broken and destroyed. Only when he has nothing left will he snap out of his drunken stupor and realize that everything was just smoke and mirrors. Nothing short of extreme pain is going to bring about change.
What are the prospects for real estate investment?
This question is slightly ambiguous in the sense that not all areas have experienced a wild boom in real estate. I am going to attach a chart below that was sent to me by one of our subscribers. It clearly illustrates the 5 hottest markets and illustrates historically how they have moved up and down together.
Real estate markets will not crash across the nation in one shot. You will have localized crashes that will slowly spread; the hottest markets will be the ones that will be affected the most. Factors such as job growth, future prospects and overall appreciation in the value of the real estate in the last 5 years will also play a vital role in determining the extent of the pull back. Areas that have good job prospects but have not experienced a wild increases in the price of real estate should remain relatively unscathed, while those areas that have gone ballistic such as Las Vegas, New York, Miami and California will experience huge pull backs as prices regress towards the mean; the current prices in most of these areas are simply unsustainable.
I can add a bit of a global perspective here. I just returned after having spent approx 3 weeks in Costa Rica and Nicaragua. Costa Rica and especially Nicaragua should offer some great real estate values; well that's what conventional wisdom would say. Luxury condos in Costa Rica that were selling for 400K several years ago are now going for as much as 1.2 million. When one takes the local salaries into consideration these prices seem even more obscene then those here in the US. The situation is worse in Nicaragua; one would have thought that one could find great bargains here. For example a small hostel business, which is actually run out of home (it has about 6 bedrooms) in a not so good a part of town was being sold for upwards of 80K. It might sound cheap when you compare it to the US but one has to make this comparison based on the average salary in Nicaragua. The average salary is about 135 dollars a month.
I also spent sometime in Asia this year and can say that for the most part certain parts off Asia offer a far better bang for your buck ( we cannot reveal this info right now as its for subscribers but will do so on a delayed basis at some later date).
Another interesting tit bit; Australian real estate took off much earlier then the US real estate markets and currently housing prices are down roughly 20% in Sydney. Hmm, I wonder what lies in store for us.
Coming back to the question at hand, rural areas that have not seen much of a price appreciation will not be affected that much when prices pull back. However those that have seen huge price increases will experience huge corrections which depending on where you got in could end feeling like a crash. One should avoid investing in any of the super hot markets because when they correct the corrections will be just as powerful if not even stronger. The smartest thing to do right now if you own no real estate is to rent and wait for another buying opportunity to present itself. Those that own several homes should look to sell most of them and make sure you have a fixed mortgage and not one of those adjustable mortgages; should rates ever rise significantly you will be roasted alive.
What are the mechanisms of manipulation for real estate markets?
There are so many here that one could write over 3 pages on this topic. However I will just summarize some of them below.
One way is to have property falsely appraised or promote the concept of inflated appraisals. Banks want to lend money and if the property appraisers do not play ball suddenly they find themselves with a lot less work. Since they have to put bread on the table sooner or later they will switch sides. Eventually this becomes the norm and prices slowly get pushed up even higher based on fraudulent valuations and not true valuations.
The other mechanisms are to provide easy financing to anyone who has a pulse regardless of credit. To heat up things even more offer Zero down programs and to truly set the stage for insanity even offer to add the closing costs to the mortgage so it appears that they are no out of pocket expenses till the idiot moves into the house; once in he gets whacked too death and it becomes a struggle to just make those monthly payments.
Offer mortgages where one only has to pay the interest for a set number of years thereby providing the illusion that the payments are actually manageable.
Offer absurdly low rates via ARMS and once again the consumer is fooled into thinking that the payments are manageable. Should condition change slightly this chap could find himself on the street and with his credit completely destroyed.
Use the mass media to create the impression that real estate is one of the fastest ways to create wealth. By the way this has already been done and that's why everyone and his grandma think that real estate is the investment of a lifetime.
All of the above end up having a direct impact on the price of homes as they tend to drive them up by creating demand; the means to create this demand is questionable to somewhat illegal to say the least, but then again who cares right its all about living the American Dream.
Are there any similarities in previous histories of the markets?
They definitely are one of the best ones is the Tulip mania where individuals were paying huge sums of money to own these tulips; when the market crashed the transition from riches to rags was rather rapid. A more recent one is the dot.com mania where trillions of dollars were lost. You would think that such a huge loss would be a lesson that would last for at least 50 years but this generation is so brain dead that it hardly lasted 2 years. By the way they are creating another market (subtle signs are slowly being given as they were for the real estate market years ago) in anticipation of the real estate crash that will occur sooner or later and based on the data it seems that the masses will jump into that one and learn nothing from the real estate crash when it does finally occur.
Why is or is not real estate investment, the greatest thing since sliced Wonder Bread?
Actually it is the greatest thing since sliced wonder bread and at the same time it's one of the most dangerous arenas to enter. The rules are simple buy when nobody is buying and sell when everyone is buying. Another simple measure is that if the rental rates are lower then your monthly mortgage payments the market is now overvalued and therefore buying no longer is a wise option.
Two markets have created more millionaires in the world then any other area, or sector, real estate and the stock market. But both of them are laden with mines and so one has to know when to play and when to fold. Most players don't even know how to hold the cards up let alone play the game and as result most will be slaughtered. Just remember the dot.com era; everyone appeared to be making money but when the dust settled almost 90% had lost it all.
How should the consumer for real estate vote with their money in the marketplace?
It would be interesting if for once in their lives they could use their brains instead of you know what. Instead of spending so much time listening to the gurus out there they should spend more time evaluating the facts. You don't need a guru to tell you that jumping off a sky scrapper is going to kill you; on the same token you don't need to be told that for the most part real estate is not the place to invest in right now. So think before you leap or leap before you think and get fried alive.
The reality of life is that your perceptions -- right or wrong -- influence everything else you do. When you get a proper perspective of your perceptions, you may be surprised how many other things fall into place.
Roger Birkman American Publisher
by Doug Wakefield
Best Minds, Inc.
Solomon once wrote, "A rich man's wealth is his strong city, and like a high wall in his own imagination," and surely he was right.
Like many, I had a perfunctory understanding of Keynesian economics for years from my college days. However, in reading his landmark work, The General Theory of Employment, Interest, and Money, it became clear that Keynes, though in a much different way, also well understood the human condition. After reading his work and several books by Dr. Murray Rothbard, a prominent economist from the Austrian school of thought, it has become increasingly apparent that much of what has been taught regarding economics is built on an illusion. While this may sound offensive to some, I ask that the reader allow me to explain.
Inflation has been around for decades. We have come to accept it as a natural outgrowth of our capitalistic society. We even believe that asset price increases are a good thing. But is this growth of the money supply, for that is what inflation is, a byproduct to hard work, innovation, and free enterprise, or is it attributable to expanding government programs, higher taxes, and greater debt?
In order to understand how we got to our current circumstances of rampant (though understated) inflation and a credit and real estate bubble, we must look back and understand the role of the consumer in the Keynesian system.
Keynes believed that it would be boon to the economy to break away from the prior generations' thinking on savings. He saw savings as a hindrance to consumption and therefore a hindrance to economic growth. "The excess of income over consumption, which we call saving, is a mere residual." He held that if we were to grow and prosper as a country, the emphasis would need to be on consumption. "In accordance with this principle, the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save."
To Keynes, consumption was the highest moral good in that it was an investment in the economy. In fact, making sure people continued to consume was so important, he believed the state must ultimately exercise control of consumption for the benefit of the people. �In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of the investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot be safely left in the private hands.� (Italics mine) I can sum his views no better than the cover of the book. "For Keynes, enlightened government intervention in a nation's economic life was essential to curbing what he saw as the inherent inequalities and instabilities of unregulated capitalism."
Of course central banking had gone on years prior to Keynes 1936 work and had played a major role in inflating our money supply (as discussed in my article titled, "When the Big Boys Buy"), but here was the academic mouthpiece to help the failed policies of central bankers rise from the ash heap of the depression. In 1944, Keynes expanded his influence and eventually the supply of money worldwide as he formulated most of the Bretton-Woods Agreement, doing away with the obstacles that the gold standard presented. In many ways the government followed his tenets well in not leaving consumption to the whims of the private sector. Bureaucracy begets bureaucracy, and bureaucracies always need more money.
Over the last 60 years the role of government and bureaucracies has continuously grown. The following charts courtesy of Michael Hodges of The Grandfather's Economic Report shows the incredible extent of government expansion.
Source: The Grandfather Economic Report
How did we let it go this far? Subtly, while Americans were busy raising our families, working hard, and saving, we began a multi-generational shift towards an "entitlement" mentality. As each successive generation experienced a higher standard of living, our baseline expectations grew as well. The mentality goes something like this, "You deserve a 'comfortable' retirement, the best medical care, a 'safe' bank for your money, a good airline system for travel, and, of course, your own home." We began to place more and more reliance on the state to provide rather than each other, the free markets, and the God who created us. While we certainly enjoy having these things, we must stop and think, "So how do we pay for all of these things that are 'our right'"?
The government can cut benefits, raise our taxes, or print more money. The first two options are quite unlikely for a public who votes for the politician who promises to deliver the most. So we are left with the last option, paying for today's debt with tomorrow's promises. Yet history teaches that this game of printing money, backed by nothing except a government's promise to always pay its bills, has been tried since the early 1700's and John Law's Mississippi Scheme, and that it ultimately breaks down.
If all of this makes sense, your next question is, "when will this major change in the money game take place?"
To answer this, we need to leave our discussion of history and turn to science for a moment and the market. We need to understand a term in trading known as a parabolic spike. This trading term means that a line, representing price, is picking up speed and is moving more vertically than horizontally. This is a terminal sign of a change of direction. Often, the movement in the opposite direction is rapid.
For example, if a pilot flies a plane horizontally and then starts climbing vertically, eventually he will stall the plane and start to free fall.
If a government entity were to speak to a group of pilots and told them that they had overcome the laws of nature, the pilots would laugh in their face. However, when it comes to printing unlimited amounts of money and stacking debt on debt, the public plays along thinking the plane can fly straight up indefinitely.
Having watched the cost of money, as measured by the Feds Funds rate, fall from 19% in 1980 to 9% in 1990 to 3% in 2005, how can anyone say the movement of markets is just some random set of events? After reviewing these parabolic spikes, that appear to have unlimited upside, review the past parabolic spikes below, noting their outcome once gravity finally caught up with them.
Source: Elliott Wave International
Complacency has crept in. Many of us, content to enjoy our "expanded inalienable rights", do not even consider how all of these benefits the government provides for us will be paid for. Believing that all of these perks can go on forever, we've grown comfortable with our nation's debts. If there are any problems, we depend on the Federal Reserve to step in and add "liquidity" to the system to solve them. This moral hazard has allowed the central bank to print more money to pay for past liabilities with ever burgeoning, and increasingly burdening, debt loads.
As Michael Hodges' charts reveal, we have slowly moved away from our capitalistic roots to a more socialistic society. Ironically, in the same year that Keynes came to the center of the financial world with his socialistic views, history records these words from a well-known Austrian economist. Ludwig Von Mises, Rothbard's mentor, penned the following in 1944. "Government control of business, it is claimed by the advocates of authoritarian management, looks after the nation's well-being, while free enterprise, driven by the sole aim of making profits, jeopardizes national interest." How different might our circumstances be if the two had changed places?
So, does cutting interest rates and making credit ultra-accessible in the desperate pursuit of keeping the consumer spending, sound like a story that ends well? Every investor should be learning as much as possible and preparing for the downside of these parabolic spikes. If you are interested in learning some of the questions investors should be asking, visit our website at bestmindsinc.com. Without preparation, no high wall in our imagination is going to help us escape the impact of what lies ahead.
Sources: Books and Websites
The General Theory of Employment, Interest, and Money, (1936); John Maynard Keynes, pgs 64, 65, & 320.
Bureaucracy, (1944); Ludwig Von Mises, pg 27.