A weekend topic starting with Real Clear Markets. “Arthur Burns, Chair of the Federal Reserve from 1970 to 1978, publicly regretted afterward that he had lacked the spine to do what was necessary to get the Great Inflation of the 1970s under control. When his predecessor William McChesney Martin’s term ended in 1970, he openly declared, ‘I’ve been a failure.’ What are the regrets, if any, that weigh on Ben Bernanke’s memory when he looks back on his time as Fed Chair from 2006 until 2014? After a reading of his latest book 21st Century Monetary Policy I would say that — at this time — his most notable regret, one made repeatedly, is that he hadn’t made his experimental monetary operations even larger.”
“It was Bernanke’s implementation of inflation targeting and the quantitative easing programs that have pivoted modern central banking to conducting monetary policy as a guessing game. This is what makes him exceptional. Throwing a monetary Hail Mary pass is most apparent in the practice of Bernanke’s quantitative easing (QE) programs, which feature the Fed buying trillions of Treasury and mortgage bonds from Wall Street, and of which we’ve seen four episodes since 2008. Bernanke writes, ‘we had a theory of how QE might work, but there was a lot we didn’t know’ but despite this ‘our main conclusion was that…our purchases would have to be big’ even though ‘uncertainty about the effectiveness of our purchases was matched by our uncertainty about possible side effects.’”
“And QE was executed despite Fed officials having ‘only general ideas about how they could be reversed when the time came,’ and such an operation would require trillions worth of securities now on the central bank’s balance sheet back into private hands. The Fed has tried and failed to reverse QE three times now. (It is currently giving it a fourth go.) The program has proven, like war, to be far easier to get into then out of.”
“Bernanke points to another central banking theorist remembered by history, Walter Bagehot (1826-1877), when he alludes to ‘Bagehot’s Dictum’ — that in times of financial crisis central banks should lend freely to solvent banks though only against solid collateral and at high rates of interest. Bernanke, though, inexplicably fails to mention that last part about high rates of interest. Considering that the Fed kept its target rate at zero percent for six years, maybe he had a moment’s pause when he realized just how far he’s swum, of just how distant the shore of traditional central banking now lay. Bernanke is well aware of this and relates that with the implementation of quantitative easing, ‘we were moving well beyond Bagehot’s dictum.’”
“We are living in an age of central bank experimentation, and to have the power to experiment with a people’s monetary system is to hold a sword always above their neck. Numerous historical episodes show it to be an awesome power fraught with immense danger to both individuals and society as a whole. So, the moral imperative to anyone who wields it is to do so using extreme caution and humility, not by using best guesses guided by ‘instant expertise.’”
“Only a mad man would believe there is such a thing as ‘instant expertise,’ or, maybe, a genius would believe it, too, because he’s experienced it. There is a fine line between genius and mad man. And because of the enhanced power the Federal Reserve now has, I’ve no choice but to pray that Bernanke, and all who follow him into that Chair, come down on the genius side of the ledger.”
The Guardian. “Across the world house prices are breaking records – but this time it is because of how fast they are falling. Houses in Stockholm are now selling for 20% less than their peak, Sydney prices are down by almost 14% over the year, while in San Francisco they are down by 15%, in Auckland by almost 22% and in Toronto by 16%. Germany has registered its biggest six-month price fall for two decades, while in France forecasters are expecting declines of 5% to 7% this year, and after a strong year in Spain, the first price declines are being reported in Mallorca and Ibiza.”
“Meanwhile, maybe spare a thought for some homeowners in the South Korean capital of Seoul, where apartment prices are reportedly down by 24% since October 2021. So what is behind the global mini crash, and are there lessons we can learn from what is happening in other countries? At its simplest, it’s about the cost of money. The long era of near-zero interest rates, which made borrowing to buy a home cheaper than at almost any time in history, is over, for now at least.”
“Australia: Among the big cities, Sydney has led the way down, with prices falling 13.8% over the year. Houses in Byron Bay have fallen 25%. New Zealand’s biggest city, Auckland, has taken a battering, too. In a classic boom and bust, Auckland prices soared by more than 40% between early 2020 and early 2022, boosted by interest rates at rock-bottom lows and government measures to protect the economy from Covid. Prices jumped to an average of NZ$1.3m (£675,000). But as interest rates rose, the bubble burst, and prices in the city have now fallen below NZ$1m.”
“A correction in US house prices was inevitable after the Federal Reserve began increasing its base rate, pushing up mortgage costs swiftly. The San Francisco Bay Area, suffering from a double whammy of big tech job losses on top of rising interest rates, price falls are accelerating. The January figures from CAR reveal that average prices in affluent Marin County plummeted by an astonishing $300,000, or 19.9%, in only one month. But the declines come after breathtaking rises in the Bay Area in recent years, and even after hefty falls, average prices are only back to where they were in 2019.”
From USA Today. “The latest Housing Market Index, which checks the pulse of the single-family housing market through a monthly survey of National Association of Home Builders, found that 57% of builders were using incentives to bolster sales, including providing mortgage rate buy-downs and offering price reductions. While new home sales edged higher in January, the recent uptick in mortgage rates would imply continued weakness in the coming months, said Danushka Nanayakkara-Skillington, NAHB’s assistant vice president for forecasting and analysis. ‘In terms of affordability, the median price is down for the third straight month and is down compared to a year ago,’ she said.”
“The median new home sale price declined for the third straight month after peaking in October at $496,800. In January, the median price was $427,500, down 8% from December.”
The New York Post. “Recent findings show the amount of residential real estate supply being scooped up by corporations has dropped precipitously. Year-over-year, businesses bought 46% fewer homes in the fourth quarter of 2022 than they did in 2021, Redfin reported. The recent decline set a new record, putting the subprime mortgage crisis of 2008 — during which time investor purchases slumped 45% — in second place for the largest fall since 2000.”
“The shift was felt most significantly in pandemic boomtowns, with Las Vegas and Phoenix seeing the largest slip in investor investment — more than 60% — of any metro area. Single-family homes and high-priced properties, Redfin found, also saw much steeper declines in investor interest than condos, townhomes and low-priced properties. As for the cause of investors’ lost interest, Redfin blames the current high cost of borrowing money — as the Fed raised interest rates to combat ongoing inflation — and the looming prospect of home values going down appreciably.”
“‘A lot of investors are on hold because they still see home prices declining,’ said Florida-based Redfin agent Elena Fleck in the report. ‘The investors who are in the market are selective and aggressive. Many of them are only offering around [60%] of the asking price since it’s so difficult to make a profit when flipping homes right now.’”
The Union Tribune in California. “Developers told the Union-Tribune that less than 1,000 new single-family homes will be built in 2023. Guesses at the start of the year are typically much lower than what ends up being built because developers will increase their production based on how well sales are doing. San Diego County home prices have dropped seven months in a row as of December, so Nathan Moeder, San Diego real estate analyst, said builders — who prefer prices to be as stable as possible when they release new supply — aren’t willing to ramp up building until things calm down.”
“Sellers also might not be very eager to put their homes on the market as prices continue to drop. San Diego County’s resale single-family home price ended 2022 at $825,000 — down more than $100,000 from a peak reached in April.”
The Ventura County Star in California. “Ventura County doesn’t appear headed for a recession, but economic growth will be slow and inflation ‘stubbornly high’ for the next few years, according to the latest projections by economists at California Lutheran University. CLU CERF Executive Director Matthew Fienup said current CLU CERF report is ‘a low-confidence forecast’ compared to its past work, because this is ‘perhaps the most uncertain forecasting environment’ in recent history. As evidence, he pointed to days when the stock market soared on bad news about the economy, and other days when stocks crashed after a strong report on job growth.”
“‘Price signals have been broken,’ he said. ‘Things like stock prices, home prices, bitcoin and other assets, the prices seem to be disconnected from underlying fundamentals.’”
From the Pundit. “Speculative bubbles are common. The Global Financial Crisis of 2008 was an example, as was the New Zealand finance companies’ crash about the same time. The 1987 share market crash was another example, as was the 1929 Wall St Crash. There are at least two major bubbles going on at the moment – one in the crypto-currency market and one in the Chinese Financial System.”
“Hyman Minsky provided one of the best ways to analyse such bubbles: ‘the financial system swings between robustness and fragility and these swings are an integral part of the process that generates the business cycle’. He thought that such financial instability – and the booms and busts which accompanies it – was inevitable in a so-called ‘free’ market economy, unless government steps in to control through regulation, central bank action and other tools.”
“His key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. There are three types of borrowers that contribute to this debt: The hedge borrower can make debt payments which cover interest and principal from current cash flows from investments. For the speculative borrower, the cash flow from investments can cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal.”
“The Ponzi borrower – named after Charles Ponzi who ran the famous ‘Ponzi scheme’ in 1920 – believes that the appreciation of the value of the asset will be sufficient to refinance the debt because insufficient cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat. And so the bubble pops at the ‘Minsky Moment’ after which everyone tries to get out of their investment commitments, turning them back into cash. Ponzi borrowers are forced to, because they have no cash; speculative borrowers can no longer refinance the principal even if they are able to cover interest payments. The prices of assets fall, with innocent lenders suffering as well as guilty borrowers. New Zealand’s housing market fits Minsky’s model reasonably well. By the end of 2021 house prices were falling everywhere. How far they will fall one cannot tell, especially as the stock of housing is ramping up.”
From News.com.au. “It’s dramatic. It’s spectacular. But a viral social media video claiming to show the widespread demolition of failed Chinese building projects is more than what it seems. Chinese property developer Evergrande defaulted on repayments for its $455 billion debt in 2021, triggering fears of a new global financial crisis. But its woes also exposed a nation filled with unwanted, unapproved and substandard building projects.”
“In this context, Communist Party officials ordered the company to demolish 39 high-rise buildings early last year. Permits for that part of an $18 billion Ocean Flower Island resort project on Hainan Island had reportedly been ‘illegally obtained.’ It’s reckless waste on an enormous scale. But the viral video isn’t about Evergrande. Not all of the high-rise demolitions are unfinished. Nor are they all part of a sudden demolition spree. What the viral video exploits is the fallout from China’s explosive building boom over the past two decades. And the industry’s ongoing struggle with corruption and incompetence. And the Evergrande crisis isn’t over yet.”
“Another dramatic clip shows the destruction of 15 unfinished towers in Kunming, Yunnan Province, in 2021. The $1.3 billion development was part of the Liyang Star City Community development – one of many similar projects in the area that had failed to attract buyers for up to a decade. But China’s still struggling to come to grips with the fallout of the most dramatic building bust in history. And that means more demolitions are likely to come.”
“‘When property prices seem only to rise year after year, businesses that overinvest in real estate outperform and eventually displace those that don’t, while the banks that lend directly or indirectly against real estate tolerate excessively risky loans on the assumption that their risks will be mitigated by continually rising prices,’ warns Carnegie Endowment for International Peace analyst Michael Pettis. ‘This happened in China.’”
“In the 1970s, Beijing realised it desperately needed new infrastructure on a grand scale to house, feed and employ its rapidly growing population. Meeting this generated an economic boom on a historic scale. ‘This began to change ten to fifteen years ago, by which time China had largely closed the gap between the investment it had and the investment that the economy could productively absorb,’ Pettis adds. But the need to rebalance the economy away from investment (billionaires and institutions) and towards consumption (household incomes) proved unpopular in the halls of power.”
“So Beijing doubled down on driving investment by any means necessary. And the easiest option appeared to be real estate. ‘Like nearly every other country that has followed this model – China began to overinvest systematically in projects that contributed less to the economy than they cost,’ says Pettis. Beijing, he says, has reacted quickly to address liquidity problems. But it is yet to tackle ‘fundamental solvency concerns.’ ‘The various solutions and proposed solutions have merely transferred the problem from the local banks onto either local governments’ balance sheets or … onto the balance sheets of larger banks. But even if this works temporarily, it cannot go on forever.’”