Identifying stock bubbles

Columbia University economics professor Rajiv Sethi discusses identifying stock market bubbles in real time.

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.

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.

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.

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.

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.

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.

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.

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?