Friday, January 29, 2010

The effects of easy money on mortgage lending

Simon Constable of Dow Jones Newswires points out the harmful side-effects of easy money on mortgage lending:
When Bernanke says low interest rates weren't the cause of the housing bubble, he is at best being disingenuous. Instead, he points to lax lending standards as the key fuel for inflating home prices.

But the truth is rather different.

His assertion is similar to claiming that it isn't the fall from a skyscraper that breaks your bones, but the sharp stop when your body reaches the street.

Low interest rates and lax lending standards are also closely related. They are just two symptoms of loose money. Lax lending standards were the response to healthy banks being awash with cash and most creditworthy borrowers already fat with debt.

So to put more money to work, bankers lent to increasingly dodgy borrowers. Indeed, that is what you would expect during a period of loose monetary policy.
Actually, Bernanke's position is that the loose money was coming from a global savings glut, a position I agree with. The effect on lending would be the same, though. My complaint is that the Fed's low interest rates exacerbated the problem when the Fed should have been trying to counteract the problem.

By the way, Bernanke's reappointment has been confirmed by the senate.

Thursday, January 28, 2010

Yes, Virginia, there is still a housing bubble

Dean Baker, the first economist I'm aware of to spot the housing bubble (although he was still a year-and-a-half behind me), says we've still got a housing bubble and the government isn't helping people by encouraging mortgage lending:
Housing economist Dean Baker, the co-director of the Center for Economic and Policy Research, laid out his case at a risk conference last week for why we still have a housing bubble. Adjusted for inflation, home prices are still 15-20% higher than they were in the mid-1990s. “There’s no plausible fundamental explanation for that,” he says.

Why? Simple, he says: Economic fundamentals are all going in the other direction. Rental apartment vacancies are reaching record highs. Many segments of the housing market are still oversupplied. And the core demographic in the country—the baby boomers—are reaching the age where they’re more likely to downsize, buying less house in the years to come. ...

“As a matter of policy I can’t see that we want people to buy a house in 2009 that’s 10-20% higher than it would sell for in 2011,” he says. “In so far as the FHA was encouraging people to buy homes in bubble markets that were not deflated, that’s not good for the FHA and you didn’t help the homeowner. We didn’t do those people a favor.”
Again, encouraging people to buy houses at inflated prices is harmful to home buyers. It's harmful when banks do it and it's harmful when the government does it. When it's done with low down payments (such as the FHA's 3.5%), it's risky to the entire economy because many people can easily end up underwater.

Tuesday, January 26, 2010

CNN cheerleads the home buyer tax credit

CNN staff writer Les Christie acts as a cheerleader for the home buyer tax credit:
There is some hope that this good thing could live on after June 30. If the housing market and the economy is not in full recovery mode by late spring, there is already discussion about Congress extending the tax credit again, according to Jaret Seiberg of Concept Capital, a Washington-based research group.
In the article, CNN tells happy stories about people who receive the money, but completely ignores the fact that other people have to pay for it eventually, plus interest.

All our problems would go away if everybody just received free money from the government, wouldn't they?

I support stimulus spending. All I ask is that the spending add to our country's physical or human capital stock (i.e. useful infrastructure or knowledge), because those contribute to economic growth. Spending taxpayer money to transfer pre-existing houses from one person to another doesn't do that.

More bubbles?

Fortune magazine sees four new asset bubbles. Also, the European Central Bank sees bubbles in emerging markets and some commodities. Jim Chanos sees a bubble in Chinese real estate.

Saturday, January 23, 2010

Paul Volcker for Fed chairman!

I keep hearing people arguing for the renomination of Ben Bernanke by claiming that there's no one else who can do the job. That's status quo bias taken to an extreme. (Four years ago, many people thought no one could replace the Maestro.)

Ben Bernanke was on the Federal Reserve Board of Governors from 2002-2005, when it willfully ignored the growth of the housing bubble. Thus Bernanke is like an arsonist firefighter, who creates a crisis and then gets treated like a hero because he resolved it. We need a Fed chairman who will act to prevent problems in the first place.

The truth is that there are many good economists who could take Bernanke's place. Although old, Paul Volcker is in good health and is widely considered to have been the best Fed chairman. He could do the job again. Another option would be Stanford economics professor John B. Taylor, inventor of the Taylor Rule. Got any suggestions? Leave them in the comments.

Update: Calculated Risk suggests Janet Yellen for the job. Also, Paul Krugman says appointing himself to the job would be crazy. I oppose Krugman because he favors a version of the Taylor Rule that mimics the bubble-blowing Greenspan Fed's interest rate policies.

Friday, January 22, 2010

Bernanke out as Fed chairman?

The New York Times reports bad news for Ben Bernanke. He may not have the votes to be confirmed:
The confirmation of Ben S. Bernanke to a second four-year term as chairman of the Federal Reserve ran into further trouble on Friday, as two more Democratic senators said they would vote against him.

The White House came to Mr. Bernanke’s defense Friday, but the Senate majority leader, Harry Reid, is believed to be struggling to come up with the 60 votes necessary to confirm Mr. Bernanke before his term as chairman expires on Jan. 31.

In a statement Friday morning, Senator Barbara Boxer, Democrat of California, came out against Mr. Bernanke, who was named to his post during the Bush administration. She said she had “a lot of respect” for him and praised him for preventing the economic crisis from getting even worse. “However, it is time for a change,” she said. “It is time for Main Street to have a champion at the Fed.”

“Our next Federal Reserve chairman must represent a clean break from the failed policies of the past,” Ms. Boxer said.

Another Democratic senator, Russell D. Feingold of Wisconsin, also announced Friday that he would vote against Mr. Bernanke.

“Under the watch of Ben Bernanke, the Federal Reserve permitted grossly irresponsible financial activities that led to the worst financial crisis since the Great Depression,” Mr. Feingold said in a statement.

Because several senators are using procedural methods to try to block Mr. Bernanke from serving another term, it will require 60 votes for him to be confirmed. Congressional Democrats said they do not have a firm sense of how many votes Mr. Bernanke can count on, and Mr. Reid has not scheduled a vote.
Russ Feingold's reasoning is far better than Barbara Boxer's. Her reasoning is populist and naive. I am glad they both oppose Bernanke's reappointment, however.

If President Obama needs a last minute replacement, I hear former Fed chairman Paul Volcker is still alive and kicking.

Wednesday, January 20, 2010

Mortgage terms in plain English

New rules this year clarifies mortgage terms for borrowers:
Shopping for a mortgage has just gotten simpler.

Lenders are now required to use easy-to-understand forms providing basic loan terms and good-faith estimates of closing costs. And closing agents are required to provide a settlement statement that clearly compares borrowers' final and estimated closing costs, according to the U.S. Department of Housing and Urban Development.

The new rules, added to the Real Estate Settlement Procedures Act, went into effect Jan. 1.

The new, simplified documentation is aimed at helping consumers fully understand the terms of a mortgage and more easily compare loans from different lenders. It also reminds consumers that they can shop around for the various required closing services, instead of simply accepting their lender's suggestions.

Tuesday, January 19, 2010

The fed funds rate: Too low for too long?

Here's an interesting graph. It shows the fraction of the time in each decade that the real fed funds rate was negative, i.e. the nominal fed funds rate was below the inflation rate. In the 1970s, we had significant consumer price inflation. In the 2000s, we had a credit bubble.

Monday, January 18, 2010

Option ARM resets

Looking at this graph, it looks like Option ARM resets begin to become a problem in about the mid-point of this year, and really shoot up around mid-2011. According to Calculated Risk, most Option ARMs are negative equity. The prevailing interest rate will not likely be a problem, since mortgage interest rates are lower now than they were five years ago. The problem is that many Option ARM borrowers have probably not been paying much of their principal yet.

Notice that at its peak, the Option ARM wave will be slightly smaller than the subprime wave of 2007-2008. The subprime problem has past.

CNBC discusses the problem:
Thousands of American homeowners are starting to see their monthly mortgage payments skyrocket, dealing a fresh blow to the already shaky housing recovery.

The widely feared reset of thousands of option adjustable-rate mortgages—where both interest and principal payments rise sharply—is already leaving many homeowners struggling to keep a roof over their head. ...

Terms of the loan usually allowed the borrower to make low monthly payments initially—sometimes by just paying interest only.

But as the terms of those mortgages now readjust, homeowners are facing much higher mortgage payments at a time when the value of their house has plummeted and many are out of work. In some cases, homeowners who chose a very low starting interest rate have actually seen the overall amount of their mortgage increase—known as negative amoritization—putting them even deeper in debt.
The question is how many of these Option ARM mortgages have already defaulted?

Friday, January 15, 2010

Sixty years of residential fixed investment

Here's a look at six decades of real private residential fixed investment. Notice that it has fallen by more than half since the peak. Also notice that it appears to have bottomed.

Note that, in economics, building new housing is considered investment but purchasing existing housing is not. Thus, a real estate "investor" who buys an existing condo as a rental property does not directly contribute to residential fixed investment.

Thursday, January 14, 2010

Mortgage defaults hit record in 2009

RealtyTrac reports that mortgage defaults rose 21% in 2009 compared to 2008:
Almost 3 million homeowners received at least one foreclosure filing during 2009, setting a new record for the number of people falling behind on their mortgage payments.

RealtyTrac, the online marketer of foreclosed homes, reported that one in 45 households — or 2,824,674 properties nationwide — were in default last year. That's 21% more than in 2008, and more than double 2007's total.

Wednesday, January 13, 2010

U6 not the real unemployment rate

Cato says U6 is not the "real" unemployment rate.

I think U6 is attractive to permabears and "progressives" because it fits their pessimistic view of the world.

I don't think it matters whether you use U1, U2, U3, U4, U5, or U6, because they move in lock step with each other. Just pick one and stick with it. U3 is the official unemployment rate and is most widely reported.

What matters is not the unemployment rate per se, but the unemployment rate compared to the natural rate of unemployment (i.e. NAIRU, "full employment"). For U3, the natural rate of unemployment is about 5%, so when it's above that we know things are bad. If U3 falls much below 5%, inflation cometh. I don't know what the natural rate of unemployment is for U6, and I bet most people who insist on using it don't know either.

Adam Smith's "invisible hand" in context

Princeton University economics professor Alan Blinder puts Adam Smith's concept of the "invisible hand" in context:
When economists first heard Gekko's now-famous dictum, "Greed is good," they thought it a crude expression of Adam Smith's "Invisible Hand"—which is one of history's great ideas. But in Smith's vision, greed is socially beneficial only when properly harnessed and channeled. The necessary conditions include, among other things: appropriate incentives (for risk taking, etc.), effective competition, safeguards against exploitation of what economists call "asymmetric information" (as when a deceitful seller unloads junk on an unsuspecting buyer), regulators to enforce the rules and keep participants honest, and—when relevant—protection of taxpayers against pilferage or malfeasance by others. When these conditions fail to hold, greed is not good.
Greed is a natural human vice, just like aggression. As much as we may try, we cannot get rid of them because they are part of human nature. But just as sport channels aggression into productive use, free enterprise does the same for greed. Free enterprise is only productive when its goal is to benefit consumers. When it becomes acceptable to screw consumers (or taxpayers) in the quest for wealth, the benefit is entirely lost.

Greed is not good. It is the productive work and investment we do as a result of our greed that is good.

Tuesday, January 12, 2010

Fed economist: housing is a bad investment

Federal Reserve economist Karen Pence says housing is a poor investment compared to other asset classes for several reasons:
  1. It is an indivisible asset. If you own stocks and bonds and suddenly need a little cash, you can sell some of your stocks or bonds but not all. With a home, on the other hand, “you can’t just slice off your bathroom and sell it on the market.”
  2. It is undiversified. You can buy stocks or bonds in industries or countries all over the world. A home is a bet on one single neighborhood.
  3. Transaction costs are very high when you buy or sell a home because of real estate agent fees, mortgage fees and moving costs.
  4. It is asymmetrically liquid, meaning it’s easy to get money out when home prices are going up. (You just take out a bigger mortgage.) But it’s hard to take money out when prices are going down because refinancing becomes more difficult. ...
  5. It is highly correlated to the job market, meaning that home prices in a neighborhood tend to rise when the job market is improving in the area and fall when the job market is worsening. This means that your main financial asset provides the smallest cushion to you when you might need it most.

Monday, January 11, 2010

How to lose money in real estate

12008 Thornbrooke Ct., Bristow, VA 20136

June 12, 2006 purchase price: $619,000
Current list price: $324,900

That's a loss of almost $300,000 in 3½ years!

If the house is in good shape, it may be a good deal.

Sunday, January 10, 2010

December 2009 employment data

Pundits are making a fuss about the fact that official December job losses increased from November's unbelievable numbers. Monthly job losses still show a longer-term gradual decline. (Source.)

Perhaps looking at ADP's private job loss numbers does a better job of putting the trend in perspective:

The official unemployment rate remained unchanged at 10.0% in December:

The year-over-year percent change in aggregate weekly hours worked shows an upward trend, although it's still below zero:

The year-over-year percent change in initial unemployment claims is below zero and continuing to improve:

So, while the widely-reported official data didn't look so good in December, other data shows the recovery is continuing.

A reminder for conspiracy theorists: The ADP data (i.e. the second graph) does not come from the government.

Saturday, January 09, 2010

Did predatory lending cause the housing bubble?

Or, for that matter, did the Community Reinvestment Act? Paul Krugman compares housing prices to commercial real estate prices and draws a conclusion I agree with:
From my perspective, the CRE bubble is highly significant; it gives the lie both to those who blame Fannie/Freddie/Community Reinvestment for the housing bubble, and those who blame predatory lending. This was a broad-based bubble.
This doesn't mean that predatory lending didn't exist. It simply means that predatory lending was a result of the housing bubble, not a cause of it.

Friday, January 08, 2010

My DC housing predictions for the new decade

Unless the Feds succeed in sparking a new bubble, I suspect the long-term housing trend inside the beltway will be stagnant nominal home prices and slowly declining real home prices. In fact, according to that's basically what's been happening over the past five years (except that there was no inflation in 2009).

These graphs show nominal prices per square foot:

I predict that a decade from now, DC and Arlington nominal home prices will be roughly the same as today, perhaps with slight declines. Real prices, however, will have declined significantly.

I'm no Nostradamus, so my prediction could easily be wrong, but my prediction is based on two key factors. First, DC and Arlington home prices are still substantially overpriced compared to their historic norms (relative to rents, incomes, inflation, etc.). Second, the usual tendency during a housing slowdown is for nominal home prices to stagnate, rather than to fall. This housing downturn has certainly been unusual, but inside the beltway home prices have been following the usual pattern since the peak.

I also predict that a decade from now Bubble Meter won't be around to be held accountable for faulty predictions. :-)

Thursday, January 07, 2010

Home prices forecasted to fall in 2010

From CNN Money:
After four months of gains, home prices flattened in October. Worse yet, industry insiders think that they'll soon start to fall.

Prices have risen more than 3% since May, according to S&P/Case-Shiller.

But most forecasts predict price declines in 2010, with possible losses ranging from anywhere from 3% on up. Fiserv Lending Solutions, a financial analytics firm, forecasts that prices will fall in all but 39 of the 381 markets it covers, with an average drop of 11.3%. ...

There are three main reasons for the reversal: a coming flood of foreclosures, rising interest rates and the eventual end of the tax credits.

Wednesday, January 06, 2010

The case for renting

James Altucher argues in favor of renting.

Senator Dodd to retire

Good news:
Leading Democratic Senator Christopher J. Dodd, chairman of the Banking Committee, will announce Wednesday that he is retiring, NBC News has learned.

Dodd is a centrist and his popularity fell as the economy was gripped by a long recession brought on by the financial crisis.

Over the years, the Connecticut senator has raised millions of dollars from employees of Wall Street firms.
Senator Chris Dodd is a buffoon. He's the chairman of the Senate Banking Committee, yet has little understanding of the economy. He has been a leading advocate of homeowner bailouts. It's good to see him go.

His retirement probably reflects the fact that he has little chance of getting re-elected anyhow.

Monday, January 04, 2010

5 housing issues to watch in the new year

From The Wall Street Journal:
The housing market, which brought the economy to its knees in 2008, struggled to recover in 2009. The modest gains of the past year can be credited in many ways to federal support that will be removed at some point in 2010. ... That makes for an uncertain outlook for the year ahead...

Here’s our list of five big issues to keep an eye on in 2010:
  • Mortgage rates: The Federal Reserve has kept mortgage rates low for most of 2009.... Whether the private market is ready to fill the gap when the Fed exits is one of the hottest debates between economists, investors and analysts.
  • Fannie, Freddie and the FHA: Nearly nine in 10 mortgages are now being backed by Fannie Mae and Freddie Mac, the mortgage-finance giants taken over by the government, or government agencies such as the Federal Housing Administration. The future of Fannie and Freddie remains nearly as uncertain now as it was one year ago.... The FHA, meanwhile, has suffered from heavy losses that could lead to a taxpayer bailout...
  • Loan modifications: Loan modification efforts have helped to hold back the supply of foreclosures for sale. The number of seriously delinquent loans continues to climb, so it’s reasonable to expect a pick up this year in distressed sales and foreclosures that hit the market.
  • More loan resets: Analysts and pundits have been warning for years about the coming wave of option adjustable-rate mortgages that will jump to sharply higher payments beginning this year. Those loan recasts are concentrated particularly in high-cost housing markets.... Meanwhile, more interest-only loans that allowed borrowers to avoid making principle payments for three, five, or seven years will reset to higher payments.
  • Tax credit and home sales: Sales were fueled in the late summer and early fall in part due to an $8,000 tax credit that had been set to expire in November. Congress has extended that through the first half of next year, but some economists say that the tax credit will steal demand from future months.... There’s still a good deal of debate between housing economists and analysts over whether a “double-dip” could lead home prices to fall below the bottom that was set last April.
As long as mortgage rates remain at historic lows, option ARMs will be a non-issue. If mortgage rates rise toward the historic norm—an unlikely event in the near-term—only then will option ARMs become a problem.

As far as the FHA and GSEs are concerned, the government is continuing the reckless, low down-payment lending that got us into the current mess.