The Housing Boom Will End
By Duru
August 30,
2005
I did not take
Hurricane Katrina seriously after both my southeastern-dwelling brothers dismissed
its impact. Sure enough, the storm
whizzed right by them, but now, hundreds of thousands of people in Mississippi
and Louisiana are wishing they never met the thing. Similarly, when Greenspan
made his annual comments at Jackson Hole, Wyoming, I yawned. I expected more econo-babble
that reiterated more of the same that we always hear from good ol' Greenie. Now, as
scores of headlines continue to pour in announcing that Greenspan made his most
stern warnings yet about
But now, and finally,
Greenspan has spoken loud and clear and in no uncertain terms that he is going
after the boom in housing. It seems that
the psycho-babble back in late May set the stage for this big hammer. While the main speech makes for good reading,
I paste here the
comments he made in closing out the confab in Jackson Hole because
Greenspan makes his claims clearer than ever - (you can even detect some hints
of plain English!):
"Nearer term, the
housing boom will inevitably simmer down. As part of that process, house
turnover will decline from currently historic levels, while home price increases will
slow and prices could even decrease. As a consequence, home equity
extraction will ease and with it some of the strength in personal consumption
expenditures. The estimates of how much differ widely.
The surprisingly high
correlation between increases in home equity extraction and the current account
deficit suggests that an end to the housing boom could induce a significant
rise in the personal saving rate, a decline in imports, and a corresponding
improvement in the current account deficit. Whether those adjustments are
wrenching will depend, as I suggested yesterday, on the degree of economic
flexibility that we and our trading partners maintain, and I hope enhance, in
the years ahead."
The emphasis
is mine…. when did Greenspan ever admit that housing prices could actually go
down in such plain talk?! This claim
violates the very tenet underlying the current bubble in housing - that housing
prices never decline in the
Folks, even I
cannot say it plainer than Greenspan now:
the housing boom will end. And given the Fed is now actively targeting
the demise of this boom, this party will end sooner than we can imagine right
now. Long-term rates remain the wildcard
piece of the puzzle. As long as they
stay low, it will still make sense for a lot of folks to continue buying up
real estate for all types of reasons and purposes. The subsequent pain of the most speculative
of activity in real estate will depend on just how fast these rates rise after
they finally decide to pay attention to the Fed's aggression. The yield curve is almost flat right now, and
it seems the Fed will now continue charging ahead even if they force an
inversion of the yield curve. The
ultimate irony of such an event would be an economic recession that brings all
rates right back down…and then the housing boom might be broken because incomes
contract too much to maintain all the debt that the post-bubble economy has
accumulated.
We have a dangerous game of chicken going
on, and you and I may be the ultimate losers.
As a final
note, for those folks who were surprised to hear Greenspan "admit"
that the Fed now considers asset prices in determining Federal Reserve policy,
you need not look far to find the Fed already admitting to such activity. For example, Governor
Gramlich made a speech in France in 2001 where he
tried to clarify the Fed's approach to stock prices:
"Now let me turn to the influence of these movements in asset
prices on the conduct of monetary policy. The fundamental goal of our policy is
to achieve maximum sustainable output and employment, which can be reached best
in an environment of price stability. Therefore, the Federal Reserve must take
an active interest in all the factors that affect economic performance,
including business and consumer confidence, economic growth abroad, the foreign
exchange value of the dollar, fiscal policy, and, of course, asset prices. We
take the level of the stock market into account when we consider the economic
outlook and monetary policy. But let me be clear: We do not target a particular
level of equity prices. We attempt simply to judge the likely influence of the
stock market as well as other important factors on the level of aggregate
demand and aggregate supply and, hence, on the economy’s ability to achieve
price stability and maximum sustainable employment. In this respect, the stock
market plays the same role in our analysis as does any other influence on our
outlook. While our goal of price stability can foster a favorable environment
for business investment, we make no pretense to being able to control how that
plays out in the stock market. We cannot avoid gauging the effect of the stock
market on economic performance, but we do not target stock prices."
Next, Governor
Bernake made it clear in a lecture in Pennsylvania in
2003 that the Fed has spent considerable time researching the interplay of
monetary policy and stock prices.
The implication here is that if monetary policy can encourage asset
inflation, it can also cause asset deflation by acting in reverse:
"It is true, as I
have discussed, that an easier monetary policy raises stock prices, whereas a
tighter policy lowers them. However, easier monetary policy not only raises
stock prices; as we have seen, it also lowers risk premiums, presumably
reflecting both a reduction in economic and financial volatility and an
increase in the capacity of financial investors to bear risk. Thus, our results
suggest that easier monetary policy not only allows consumers to enjoy a
capital gain in their stock portfolios today, but it also reduces the effective
amount of economic and financial risk they must face. This reduction in risk may
cause consumers to trim their precautionary saving, that is, to reduce the
amount of income that they put aside to protect themselves against unforeseen
contingencies. Reduced precautionary saving in turn implies more spending by
households. Thus, the reduction in risk associated with an easing of monetary
policy and the resulting reduction in precautionary saving may amplify the
short-run impact of policy operating through the traditional channel based on
increased asset values. Likewise, reduced risk and volatility may provide an
extra kick to capital expenditure in the short run, as firms are more likely to
undertake investments in new structures or equipment in a more stable
macroeconomic environment."
Certainly, Greenspan
has often implied that the Fed could not care less about stock and asset prices
when he was questioned about this topic.
The astute watcher could see between the lines and understand the real
story. The two quotes above provide
additional points of proof that the Fed has always cared about asset price
levels. Until now, the Fed never seemed
to do much about these asset prices. This
time, they seem to mean business. Be
careful out there!