I just came across a 2005 Economist article, with the subtitle: "The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops " In the first paragraph, it notes: "Rising property prices helped to prop up the world economy after the stock market bubble burst in 2000."
This is another idea that maybe we should reconsider. I guess the idea is that rising property prices create credit expansion. I think Scott Sumner's notion of monetary offset of fiscal policy should also apply here - monetary offset of credit expansion. And, in fact, I think in both cases, there is good evidence that the Federal Reserve has overcompensated for fiscal or credit expansion.
But, even worse, if those higher levels of credit are only being taken out to fund higher payments to real estate in Closed Access cities, then the idea that a housing bubble props up an economy is especially outrageous. Did Barbary pirates prop up the economy of Mediterranean traders?
From that same article:
Interest-only mortgages are all the rage, along with so-called “negative amortisation loans” (the buyer pays less than the interest due and the unpaid principal and interest is added on to the loan). After an initial period, payments surge as principal repayment kicks in. In California, over 60% of all new mortgages this year are interest-only or negative-amortisation, up from 8% in 2002. The national figure is one-third.This seems to confirm my suspicions. Interest only and negative amortization loans were concentrated in places like California where homebuyers were hedging against rising rents. They weren't engaging in speculative over-consumption. They were trying to get out from under the relentlessly grinding cost of living in Closed Access cities. An interest only loan is a lot more sustainable than rent that is rising 5% or more per year.
Also from the article:
Even the Federal Reserve is at last starting to fret about what is happening. Prices are being driven by speculative demand. A study by the National Association of Realtors (NAR) found that 23% of all American houses bought in 2004 were for investment, not owner-occupation. Another 13% were bought as second homes.Isn't it strange how usurious loan terms, investors, and wealthy multiple-unit owners are all taken as signs of excessive speculative demand? Wouldn't we expect to see more usurious loan terms and concentrated ownership in places with limited access and constricted supply and rising rents, too? And, wasn't less concentrated ownership also taken as a sign of excessive speculative demand, when more of the buyers were new owner-occupiers? Some of this is pieces of evidence that were taken to be evidence of excess demand, but really were just evidence of prices that were high for any reason. And some of it just seems to be collectively assuming the conclusion. Think about it, rising homeownership was a sign of excess until it peaked in 2004, then rising homebuying for investment was a sign of excess until the collapse in 2006, and now that homeownership is collapsing and institutional buying is ascendant, institutional buyers are a sign of excess. We have now cycled through all the major buyer segments, and they have all confirmed the excess demand story.
If we think about it, imagine any credit-dependent market. Imagine some supply-based cause for a price spike. Wouldn't we expect that price spike to lead to more credit expansion, realization of capital gains, and an expansion of marginal credit or questionable credit terms?
Given the rise in home prices, can we imagine any set of facts that wouldn't have been interpreted as signs of excessive speculative demand? Surely we should be able to think of something. I can think of something. It happens to be the set of facts that roughly describe this period. How will others react to my story if there is no pre-existing set of potential facts that they will accept as a means of falsification? How many observers will even accept, in practical terms, the possibility that the current consensus is falsifiable?
And, that first sentence is similar to a passage in "All the Devils Are Here" (pg. 255, hardcover) about financial analyst Josh Rosner.
In mid-2005, his sources at the Fed start telling him that rates are going to rise significantly, in no small part to "cure" the excess speculation in housing. He is soon warning clients that the housing market has peaked.This is of a class of statements that appears to be benign or satisfying if the housing market was characterized by excessive demand, but is dark and foreboding if it was characterized by supply constrictions. Think of "The Big Short", but instead of protagonists positioning for the inevitable collapse, the story's protagonists are villains in the shadows that are becoming wildly wealthy because the Federal Reserve and banking regulators are conspiring to destroy the value of every family's home. It's basically the same script. You just have to change the musical cues. In either case, the villains would be generally accidental villains, inasmuch as they weren't attempting to create a macro-crisis.
Here is another passage from "All the Devils Are Here" (pg. 268, hardcover):
On another level, synthetic CDOs were a classic example of how things never really changed on Wall Street. The sellers of synthetic CDOs had a huge informational advantage over the buyers, just as bond sellers have historically had an advantage over bond buyers. Buying a synthetic CDO was like playing poker with an opponent who knew every card in your hand. Conflicts abounded. Those..."dumb guys"...weren't necessarily less intelligent; they were simply less plugged in...Stretching to get the extra yield that synthetic CDOs seemed to offer, lacking the clear understanding of what they were buying, they were the perfect willing dupes.
What's remarkable, in hindsight, is that despite their many advantages, so many Wall Street firms, blinded by the rich fees and huge bonuses the CDO machine made possible, duped themselves as well. As one close observer says, "There was plenty of dumb smart money."I think this is a great example of how we have populated the conventional narrative with stock characters who operate in the service of a predestined conclusion. From within the fever of collective righteous indignation, the second paragraph here says, "This episode was so out of control, the insiders that did this to us even ended up cutting off their own noses to spite their faces. Whereas the characters serving as their victims were 'dupes', the Wall Street insiders, nonetheless, took the same losing positions, because of greed, fees, and bonuses."
But, stepping out from this fever, the second paragraph is a refutation of the first paragraph. One might imagine an author writing the first paragraph, and a skeptical reviewer responding with the second paragraph, as evidence that the first paragraph was false. But these characters and the conclusions of the narrative cannot be refuted. The rest of the chapter that these paragraphs are a part of is about how Goldman Sachs is culpable because they were taking the other side of some of these deals. In fact, the case against Goldman is that sometimes they were neutral, sometimes they were aligned with clients, and sometimes they had the opposite position, and so their interests were complicated, and sometimes at odds with their clients. But, all of these conditions are presented as evidence that Wall Street insiders were greedy and that their positions caused the collapse.
I try to imagine what outcome would be seen as a falsification of the "bankers did this to us" conclusion. I think the answer to that is that we wouldn't blame the bankers if home prices had never spiked up. The only falsification would be the lack of the event itself.
So, I happened upon this story that maybe the housing problem was a supply problem. And, after I make that case, I look at this vast literature about the role of the banks, and I think, well there is a lot here. I have to address this. But, is there any statement anywhere in the literature where someone has said, "This evidence would convince me that demand-side excesses weren't a significant cause." One would think that the fact that mortgage originators were keeping the most vulnerable tranches of the securitization cash flows, that the market for most of the AAA rated securities was the banks themselves, that sophisticated Wall Street firms were competing with "dumb money" for the synthetic CDO securities, would serve as sharp pieces of evidence against the demand-side, insider-imposed, heads-they-win-tails-we-lose version of events. But, the demand-side versions spit these facts out as part of the story without even missing a step. They just keep barreling along, as if these facts strengthen their case. Is this a reader base that I should try to engage, or that I should ignore. If I ignore it, I am speaking to an empty room. If I engage it, it seems as though I am committing the classic error of trying to reason people out of something they were never reasoned into.
Every e-mail sent by an investment banker convinced that some buyer is taking on an ill-advised position is taken as proof that they knew, as if any complex capital markets are characterized by traders who are all in one accord, who only have strong opinions when they have complete certainty. As if newspaper archives aren't littered with opinionated rants from powerful insiders who were fundamentally wrong. And, every piece of evidence of actual fraud is treated as proof of the demand-side bubble story, as if the counter-narrative has to deny that fraud ever exists, or even that it would increase during a boom. But, the point of the counter-narrative is that all of these things could be as bad as they seem. They just weren't causal. After a decade of living in an echo chamber blaring "They did this to us." can a distinction that subtle be heard?
So far, I have simply written my story, with little regard for the audience. But, to the extent that I engage with the demand-side narrative, the narrative seems to be saturated with the presumptions of its audience. The engagement would be with those presumptions. I think it is a fool's errand to engage in that way. People must be willing to self-direct toward the evidence for there to be fruitful conversation. But to not engage them will look careless and aloof.
One purpose this blog has served, for me, is a sort of public record of my thinking process, so that I can go back and uncover careless thinking or unconsciously shifting goalposts. I guess, as this housing project becomes something that might reach a broader audience, I am naturally sharing this writing process, too. Maybe, like those traders e-mailing their opinions, if I am honest enough, I can eventually provide fodder to be discredited. That was the original intention of this blog, to discredit my thinking behind poor trades in time to reverse them when readers might convince me that I was mistaken. But, now that I am engaging in public policy conversations, the motives and consequences of being discredited are more complicated. Until this record becomes grist for ad hominem, maybe it can at least help to make my story as honest and effective as possible. Advice and criticism is welcome (at least for now ;-) ).