The Brothers Austrian

From 1987 up until the end of Greenspan’s rein in 2006, there was a period of easy money and what Barry Ritholtz called “ultra easy money” which was created by Greenspan flooding the market with easy cash.

Ritholtz points out that yet another ingredient to the crisis pie might have been that there were too few banks and too many giants. You had super mergers in which smaller banks were snatched by the larger banks. One argument is that banking should be done on smaller scale. A scale where the bank manager as a more personal relationship with person he is lending to.

The principal of banking has always been the same throughout history, borrow money cheaply (deposits) and lend it out to someone who will pay as much interest as possible. What we saw develop through the use of technology was a man (or computer software) lend money to man in on Long Island to buy his house without personally verifying the financial standing of the borrower.

Sweet plan, right? The lender is now executive somewhere else and the taxpayer is left holding the ball, the proverbial “Moral Hazard” at its best.

The easy money policy that allowed for super mergers to occur is another example of how Federal Reserve policies often limits competition and encourages malinvestment.

Wendall Wilkie Federal Reserve, Real Estate banking, barry ritholz, Federal Reserve, greenspan, moral hazard, taxpayer

A co-worker of mine recently put me on to a great op-ed that was in WSJ Monday morning by on Bubble economics by Steven Gjerstad and Nobel Laurelate Vernon Smith. The whole article is fantastic but I want to focus on one small part of it that really baffled me:

“In 1983, the Bureau of Labor Statistics began to use [for CPI] rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since “owners’ equivalent rent” is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.”

So what does owners equivalent rent really mean according to the BLS?

“(The) BLS asks each homeowner for their estimate of the house’s implicit rent and what occupants would get for their rent (how many rooms, etc.) if the owner did rent their home.”

When the Bureau of Labor and Statistics do their surveying for shelter index portion of CPI they ask the following question (verbatim):

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Man I would love to get one of these calls.

If you ask someone about their home value, that is something they probably know about, but if you ask someone about their house’s implicit rental equivalent is, now that is a different story. Most people do not understand the economics of rental properties well enough to give such an opinion. Furthermore, how many people living in Mc-Mansions can even contemplate what their monthly rent would even be when they live in a neighborhood that may not even have on housing unit that charges on a monthly rent basis?

I think Gjerstad and Vernon know what Hazlitt knew decades ago: inflation numbers are blatantly cherry picked and scrubbed to make it seem like the COLA estimates are much lower then they really are.

Furthermore the BLS states that, “Because rents are not volatile, the CPI can use a longer interval between pricing observations than it uses for other consumer items.” I guess we will have take that statement about volatility at face value.

Click here for more information regarding the housing index and CPI

Wendall Wilkie Inflation, Real Estate, Uncategorized cpi, Hazlitt, housing bubble, Inflation

“The chains of habit are too weak to be felt until they are too strong to be broken.”
–Samuel Johnson

U.S. consumption has driven global growth for years. South Pacific countries sold us their spare capacity which drove and modernized their economies at a seemingly unrealistic pace. Foreigners have been building dollar reserves for decades. Many of those countries have rightly realized that perhaps they should use those dollars to buy U.S. assets rather than hold treasuries. It is one thing to exploit foreign labor, but now foreigners have put their surpluses (their money/capital) to work buying up U.S. assets, thus exploiting us. Touché. Now, profits generated from the selling to the U.S. consumer go oversees rather than staying here.

The consumer was being squeezed on all sides entering into 2008. Higher fuel prices, falling housing prices, stagnant wages, higher unemployment, and rising food costs.

Household debt as a percentage of GDP is almost 100% as the below chart illustrates.

Pundits argued that rising household net worth would allow spending to continue forever and ever as net worth continued it climb in 2004, 2005 and 2006. Now household net worth is falling at an unprecedented rate. In 2008 household net worth declined an astounding to $11.2 trillion to $51.5 trillion (Random Factoid $trillion in household net worth vs. 600 trillion in outstanding derivatives in the U.S.).  In 2007, residential mortgages outstanding, in percentage terms   were equivalent to 78% of US GDP. In 2006 residential mortgages made up an outstanding 36% of total U.S. debt outstanding. When this crisis started in 2007 Gary Shilling said that we would need vacant supply to fall below 600k homes now he estimates that there currently are 2.1 million in excess supply. Shilling estimates that housing prices could fall anther 20% (ughh what’s that going to do to household net worth?).

A sad fact now apparent to most of us, the U.S. consumer is tapped and they are not coming back for years … not months. I am now realizing why the Fed has chosen to monetize this debt, clearly the people who have burrowed(or should I say lent…ah what the hell…both) can’t afford for the Fed not to.

Now let me get this straight…the Fed is going to buy back these mortgages via Fannie and Freddie, an issue treasuries to do so? Now the Fed is going to buy back treasuries (monetizing: printing money) to keep rates down so lenders can then make more loans to people who are insolvent? Meanwhile oil is walking its way back up the ladder towards $100 (granted I believe will break $40 once more) because oil is finite and fiat dollars are not. Food costs are not slowing the way they should if an economy is truly productive, wages are declining, productivity(…well is there such thing as productivity in Never Never land?) is declining and the government is scaring the entrepreneur back into his/her shell with taxes.

Jefferson is rolling over in grave as we speak.

Wendall Wilkie Federal Reserve, Free trade, General, Real Estate consumer, dollar, foreign labor, trade, treasuries

Have you ever stopped to think about how much efficiently you could have learned something? Or what about when you realize everything you thought you knew was wrong? I am sure some very smart people were convinced the world was flat and were quite perturbed when learned the world was actually round. Well I would say I just realized everything that I had been taught/thought about the history of the U.S. was dead wrong.

At Syracuse University, as a history major, I was taught that it was Roosevelt’s quarterbacking in the 30’s that helped the U.S. recovery from the depression. I was essentially taught, like the rest of us, that fiat monetary system created by the Federal Reserve was necessary to provide the economy the “flexibility” to soften the blows that were supposedly considered a natural occurrence of the market (this is painful to think about). If you are reading the blog, you probably have had the experience that I had when I discovered the plethora of readings that come from what is known as the “Austrian” school of economic thought. My first reading was Economic Policy: Thoughts for today and Tomorrow. From there it all just snowballed for me. Hayek, Hazlitt, Rothbard. But honestly it really only took me about the first 25 pages of that first Von Mises book and I was hooked. Like I had discovered a new religion and that I was saved….and then I immediately felt as if I had been robbed.

I thought to myself, “How could I not have heard of this school thought…I was a double major.” One would think that if you majored in both political science and history that I would have come across this “Austrian” school of thought. This just did not make sense.

What I do realize is that history is written by the victors. America came out of the WWII the strongest nation which had seemingly won WWII (no one really won, everyone lost in my opinion). We had amassed an enormous amount of wealth throughout the 19th and early 20th century. Subsequently although Roosevelt was in charge during the majority of America’s most prolonged down turn he and his “brain trust” are viewed as saviors.

What’s my point? I honestly believe that Mr. Obama and Mr. Bernanke are two of America’s best and brightest, however their current “humanactions” are a mold/consequence  of their life experiences. Obama happened to attend a college that teaches its students to believe that they know better than the collective. They believe can smooth out market upheaval with their policies rather than recognizing its their policy  their school of thought that caused the problems.   What if Mr. Bernanke was scientist that could have cured cancer but he was instead taught that cancer can’t be cured but merely slowed down and then at very end of his life he realizes he could have cured cancer all along but he was taught it can only be slowed down.

This is my glass have full post. I will try not to succomb to the idea (at least not tonight) that this mess came about because politicians and other self interested individuals were/are trying retain their power through inflation and wealth redistribution.

Wendall Wilkie Entrepreneurship, Federal Reserve, Free trade, General, History, Real Estate austrian, education, Federal Reserve, hayek, Hazlitt, syracuse university

Say you want to buy a house, town home, or condo right now, should you?  For all the ‘benefits’ of purchasing real estate right now, buyers are walking into a virtual unknown.

The problem is that our federal government, in trying to ’save’, the housing industry, has actually perpetuated its decline: the new stimulus package is offering an $8,000 tax credit for home purchases this year; the Federal Reserve is artificially keeping interest rates low; Obama’s housing plan wants to help homeowners drowning in bad mortgages.  You get the point.

The problem is that for someone relatively young without any real ‘roots’ purchasing a home right now is incredibly risky.  I may decide to get up and move in the next three to five years.  So each of these so called government ’saving graces’ is injecting a big dose of the unknown into my plans.  Let’s say government sells me on buying a new home.  Then, a year after I purchase, the government removes the floor and my property value instantly drops to the corrective market price.  All the government has done is punish me, the good American, who is doing his best to save the economy.

Get out there and spend, right?

Better idea: Government, give us a chance to buy, let the market correct, flush out the misallocated resources, and move on.

Teacherman Real Estate condo, Federal Reserve, misallocated resources, mortgages, property, Real Estate, stimulus, tax credit