Tuesday, November 10, 2009

How Closely Aligned are Government Policies and the Banking System?

It is now getting dark here at about 4:30pm. I think I run on solar power because when the Sun goes down my energy level plummets. Makes me think of the villain in Superman IV.

Things Always Change and People move On
I ran across a thoughtful post over at Housing Doom today that I wanted to spend a minute on:
Where Have All the Bubble Bloggers Gone?
It’s been nearly three and a half years since I put up Doom’s first, rather uninspiring post. [In my defense, it was only a test.] We were joining the ranks of a number of "bubble bloggers".

Bubble bloggers were for the most part, regular folks who saw an insane real estate market and said, "It’s going to crash, and someone should say something". Some, like HousingPanic, Ben Jones and Patrick had inspired a national audience, others were smaller and more local. There was a lot of comradery in those days. We’d check each others posts, and add each other to the blogroll. We had fun taking potshots at the likes of Lereah and Mozillo and watched the data in our local markets.

This morning I read Chuck Ponzi’s Top 10 signs you’ve been following the housing bubble too long. Chuck, we’re you writing about me?

10. You kinda miss the days when everyone was still on blogspot. Uh… except for that Ritholtz guy.
9. Everything looks like a bubble now. Even bubbles.
8. Oompa Loompas and “The Tan Man” evoke feelings of intense disgust.
7. You know who Tanta and the Mortgage Pig are and you miss them.
6. You KNOW Neil has got popcorn.
5. The inflation vs. deflation argument was sooo 2007.
4. You wonder if Schiller has a time machine.
3. You know the rental multiplier for your neighborhood.
2. You think the Flying Monkey Warriors vs. Greg Swann battle was epic and you totally know who won.
1. Hoodoodanode?

I can add another to Chuck’s list- you realize that nearly half your blogroll has disappeared. Bloggers have logged off, cease to post, or have sold their name to RE interests or online casinos.

As for John and myself, I don’t think of us as "bubble bloggers" these days. Housing bubble is nearly an outdated term now. Real estate and economic commentators? Nah, that sounds like talking heads from CNBC. I guess we’re just bloggers- and for some amazing reason we’re still here.

In the comments section I chimed in with:
Twist,
Great observations. I think plenty of writers have given up because everything is the same now day in and day out. I know I started my site about 2 years ago hoping to influence the credit bubble and bring more attention to it. Of course everything went as many of us thought, until the government stepped in.
Instead of reform we get bailouts. Instead of a banking system overhaul we get permanent support for failed management. Instead of economic security we get the FED leveraging the entire country to keep Citi in business.
I have a hard time finding things to write about now that any notion of moral hazard was thrown away. Of course the next collapse should be the final one, so there will not be anything to blog about then either.
I appreciate the work this site does and check every day.

It has become a challenge to find writing topics. Every day is the same since about May 2009. Forget anything being changed at the structural level, the plan is clear that permanent support for the banking system is standard policy and there will not be any more thinking about it.

It is discouraging as well to see story after story remarking that this market is clearly a bubble driven by banking liquidity, low volume pump jobs, and a falling dollar as if these things are an acceptable way to operate.

As such, leave topic ideas in the comments section as I have had problems finding much worthy to write about at all.

How Closely Aligned are Government Policies and the Banking System?
I had wanted to spend some time covering an opinion piece by former FED Governor Frederic Mishkin, but once again I am front run before I can get home to write!

There are two excellent articles on this, and if you are so inclined check out Naked Capitalism's takedown as well as Jesse's Cafe walk through.

Still, this story directly confirms a long held belief of this writer so I will cover the Mishkin commentary anyway. I will break the article up into pieces and look at what is relevant.

Not all bubbles present a risk to the economy
There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.
You did not think there would be any circumstances that would require the FED to raise rates ever again did you? Good. Moving on..

Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.

Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. Loans go sour, the deleveraging begins, demand for the assets declines further and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The resulting deleveraging depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. Indeed, this is what the recent crisis has been all about.
And here we get the first piece of the puzzle. Mishkin thinks a credit driven bubble is dangerous because when it goes bad, the financial institutions take a hit. This will be important in a moment, but back to the article:
The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.
Here the translation is that any bubble that does not harm the banking system is really ok, creative destruction and all that. Who cares about bagholders of Pets.com, the banks unloaded all their shares and scooped a huge fee for the IPO. If Pets.com goes bust only retail traders will be hit, and at last check they are unable to deploy "tanks in the street" in financial Armageddon. Moving on:
Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.
This guy is a gem in the rough I tell you. The old "how could we have known?" defense. Add to this Mishkins own statement that if economic heads at the FED were smart at all they would be rich. I think they are all indeed filthy rich, but what's the point? As for doing no harm, what US institution did the following:
-goosed the money supply before the Y2K hoax which led to a spectacular blow off top in the stock indices?
-goosed the money supply in response to said blow up in an attempt to mop up their own mess
-goosed the money supply in such a way that has never been seen before in the history of the USA in order to mop up the mess from the goosing from the last time

The answer is the US FED, so it is clear they tend to do a bit of damage. I will gladly accept the dissolution of the FED so that they in fact "do no harm". More from the piece:
Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.

Tightening monetary policy in the US or Europe to restrain a possible bubble makes no sense at the current juncture. The Fed decision to retain the language that the funds rate will be kept “exceptionally low” for an “extended period” makes sense given the tentativeness of the recovery, the enormous slack in the economy, current low inflation rates and stable inflation expectations. At this critical juncture, the Fed must not take its eye off the ball by focusing on possible asset-price bubbles that are not of the dangerous, credit boom variety.
So should the FED target asset bubbles? Mishkin says maybe they should, but then again plenty of people in the halls of universities say no, so we will just leave it at that. Cannot argue with that logic!

I have written before that the technology stock bust focused it's losses on the individual by wiping out their stock portfolios. The banks made cash on the way up and down raking in transaction fees and IPO floats. The banks were not impacted by the bust to any major degree. In response, the FED lowered rates to try and put a floor under the stock market, and then lowered rates again after 9/11 to support markets even more.

But the stock games were done. Nobody wanted to replay that ride. And it is here that things get interesting. Banks went crazy with real estate loans and engineered whole new ways to expand residential lending to never before seen levels.

Of course we already know what has happened. The difference this time is that the banks themselves are sitting on the losses, not your average retail stock holder. It was almost as if the average joe wanted to get back at Wall Street for selling them RedHat at $500! The only problem is that the banks will not have to sustain these losses like regular people, on the contrary, the regular taxpayer will now pay for the banking losses via bailouts and backstops.

It truly is a case where the banks cannot lose. If nobody can see the embedded problem of such an arrangement, then they need help.

So Mishkin can speak about things in the abstract all he likes, as if there are no real world examples he could gleam some facts from. The FED is filled with others that think just like him. This is what passes for government leadership these days.

Mishkins entire opinion piece is wrong. This equates to defense of the FED's inability to get anything right for over 15 years and running instead of a serious look in the mirror and thoughts about change.

Have a good night.

9 comments:

watchtower said...

It seems like every time I lead the comment section off it dies, but here goes:

GYSC this is an excellent post IMO.
I did not see the "Top 10 signs you've been following the housing bubble too long" and would have missed it if it wasn't for you.
Just reading "Flying Monkey Warriors" made my day, but also the name Tanta brought a little sadness.
On the same note I remember picking up your blog because I had read a comment that you had made over at Housing Panic and liked what you had to say.
I'd bet that was close to 2 years ago and some mind blowing things have happened since then.
Unlike most of the sleeping masses I watched it all unfold mostly here.
Your take on things always seemed level-headed and insightful, not to mention the high quality posters you've attracted (myself excluded, but hey I tried from time to time).
Another thing about this site is that a neophyte can comment here without being flamed, truly amazing in this day and age.
I've been on some car and finance forums that can only be described as shameful.
Haven't said it in awhile but always thinking it...thanks.
Watchtower

Lisa said...

I know it's hard to write about this mess, but I'm glad you do :) And, a lot of finance people who are acting as if this were "an acceptable way to operate" are actually scared out of their minds. They don't really know what to do, and they are acting like cattle in a stampede.
Watchtower, didn't want you to get a complex lol :)

CT-Hilltopper said...

BTW...loved the cartoons from the Depression Era. I haven't been around much lately, and haven't had much time to post when I have been around, but I did love them and wanted to let you know.

GYSC, whenever you are having "expert overload", in wading through all of the manure that the experts are throwing out there to pump the markets up right now, just keep this in mind. 98% of the so-called experts completely missed the market drop last year. Didn't see it coming.

I guess that says something about their level of "expertise", doesn't it? ;)

I sent you an e-mail...did you happen to get it? I sent it to the contact information listed at your blog.

Thanks, and talk to you soon.

Stagflationary Mark said...

GYSC,

"Not all bubbles present a risk to the economy"

I was just telling my girlfriend earlier that somebody really need to heckle that and heckle it big.

I didn't have the energy to heckle the obvious though. Perhaps that's where the bubble bloggers have gone.

It's like being trapped in a wet paper bag with nothing but a Star Wars light saber to cut your way out. What's the point? Where's the fun?

It's like spending your whole life preparing for the big gladiator match and finding out your opponent will be a freshly hatched baby chick. Could you really take a swing?

It's like being on the bomb squad in all of your gear and attempting to defuse a nuclear device made out of cardboard toilet paper tubes and crayon drawn radiation symbols within the local school's 1st grade classroom. You know it is just some 6 year old's fantasy. The parents know it is. The crowd knows it is. Yet the zero-tolerance policy is in effect and no risk is acceptable.

GawainsGhost said...

Bubbles, bubbles everywhere, rising to the top
Bubbles, bubbles everywhere,
and all of them to pop

Yeah, it has been an interesting last few years. I got into real estate around 2002, right when the market started to go insane. By 2006, I was saying this is a credit bubble inflated by questionable financing.

When you got NINJA (no income, no job or assets) loans, stated income loans, interest only loans, adjustable rate mortgages, and the like, you got a real problem. But almost everyone went along with the party and drank the punch.

"Does have a little wang in it." (Great line from the Hollywood Knights.)

I don't drink Kool Aid. Never have liked it really, too sweet. I drink whiskey. It's pretty hard to spike a shot of Jack Daniel's neat.

This fiasco has been decades in the making, through every administration going back to Carter. And it's only going to get worse.

We no longer have a capitalistic economy. What we have is coporatism--privatize the gains, socialize the losses. In such a system, you're right, GYC, the banks cannot lose. They just pass the costs of their monumental mismanagement onto the taxpayers, who had nothing to do with the situation other than electing the politicians which enabled it.

The whole thing is a mess. And the US FED is at the heart of the problem. All it does is blow bubbles and blow them up.

I blame the Baby Boomers. Or the Bubble Children, as it were.

Ted said...

Twist's problem is that she has outlived her usefulness. 1/2 of the early bubble bloggers have slowly but surely turned bullish and bought. Its the natural order of things - prices drop - bears become bullish - they buy - cycle complete.

Twist will never do this - she has revealed herself to be the penultimate permabear. She wont even mention any housing data that is positive - and if she does, its only to say "we arent even close to being at the bottom".

As a permabear, she will be the last one standing. All the other bears will slowly turn bullish - yet she will insist we have "miles to go". She and a few of her permabear friends (igor censors bullish comments) will be there for all time in an echo chamber of denial.

She very much reminds me of "Bearmaster" down in L.A. She started looking to buy in 1988 - rode out the bubble bursing and didnt buy at the 1995 bottom because she thought we were "nowhere near" the bottom. She is still on the sidelines today - 20 years later - waiting for beach properties to hit 1986 values that will never ever come...

getyourselfconnected said...

Watchtower,
You are the old standby!
I agree that the discourse here is high end (NFL bragging/whining aside, mostly my whining) and this forum is open and nobody will be torn up, I will not allow it. Thank you for the thanks, I really thrive on the feedback I get here.

Lisa,
always a treat for you to visit. I hope your new endeavor is looking good. I still find this mess amazing and I try to offer up something most of the time.

C-T,
glad you liked the Depression era cartoons, it took me a LONG time to compile them. I did get your note and sent you a return today. In regards to the experts, I have no idea how any level headed person thinking rationally can read the Mishkin opinion piece and not think the guy is out to lunch.

Gawains,
Kool aid sucks indeed.

Ted,
Twist had always presented hard data with a clear analysis. Of course any blogger offers their take on what that means, and bearish still seems about right (to me). I will have a comedy/sad piece up tonight on this very line of thought.

Thanks to all for stopping in, I enjoyed the comments.

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Mike Morgan is transitioning his business this week:

http://www.floridahomes.pro/Business+Transition+from+Mike+Morgan+to+Julie+Gaumond

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