Being the Fed Means Never Having To Say You’re Sorry
Everyone knows who the Federal Reserve Board is. They are the folks who told us that there was no housing bubble. Then they told us that there might be some problems with housing, but it would be restricted to the subprime market, and was no big deal. Last weekend at their annual meeting of central bankers in Jackson Hole, Wyoming, they seemed to agree that the housing market is somewhat of a problem. However, just like President Bush in Iraq, they were nonetheless confident that everything is under control.
Excuse me if I don’t share their confidence. The country is now seeing the beginnings of an unprecedented drop in housing prices. House prices in many formerly hot markets, like Las Vegas, San Diego, and Miami, are now falling at double-digit annual rates. Prices are also falling in many other cities, although at a somewhat less rapid pace. For the first time since the depression the country will be seeing nominal declines in house prices nationwide.
And of course this is just the tip of the iceberg. With record supplies of unsold and vacant homes, and demand suddenly curtailed by a sharp cutback in credit, there is no way that house prices will stop falling anytime soon. Trillions of dollars of housing equity will vanish in the next few years as the bubble deflates and house prices return to trend levels.
The fallout from this drop in housing prices will go well beyond the subprime meltdown. The housing sector is still almost 5 percent of the economy. It has already contracted by close to 20 percent and will likely contract by another 20 percent or more. The loss of trillions of dollars of equity in housing will almost certainly lead to a sharp reduction in consumption through the wealth effect. The basic story is that homeowners can no longer use their homes as ATMs when there is no equity against which to borrow.
And of course as more people end up with negative equity, the greater is the likelihood that they will default on their mortgages. This could ramp up the losses by another magnitude for those suckers holding mortgage backed securities and their various derivatives.
This is not a pretty picture. But the most disturbing aspect to the Jackson Hole gathering is that no one seems to think that they made any mistakes. One paper from the Fed argued that they did absolutely the right thing to push the housing bubble in 2002 and 2003 because the economy was very weak at that point and badly needed some stimulus to get back on track.
While it is true that the economy needed stimulus, the Fed paper ignores the reason that the economy was so weak in 2002 and 2003. The economy was weak because it had been hit by a stock crash induced recession in 2001. It turns out not to be very easy to recover from a stock crash induced recession. This fact is important for two reasons.
First, it was Alan Greenspan’s frequently stated view that the stock bubble was no big deal. He said that it was better to just let it run its course and then deal with the consequences rather than attack the bubble directly and prevent its growth. It now looks like the consequences of the crash of the stock bubble were quite serious.
The second reason that we should be concerned about the difficulties of recovering from a stock crash induced recession is that we are likely to soon be viewing a housing crash induced recession. It will be at least as difficult to restore life to the economy following the crash of the housing bubble as the crash of the stock bubble.
At this point, there is not much that can be done to prevent the crash. In fact, it will probably be best for the economy in the long-run if it happens as soon as possible. But, it would still be nice to hear someone at the Fed acknowledge that they had made a mistake and to apologize to the country: maybe next year.
You wrote this just for the humor, right?
The crash isn't confined to just housing foreclosures but the soon to be crashing employment numbers. Many of the employees in construction are not qualified for other jobs. Over the last few years with the pace of construction these employees have received fairly high wages for their education levels. There will be no alternative employment available that will pay those same wages. Even if the employment numbers don't crash than these employees will assuredly be working for other employers (Wal-Mart) at significantly lower wages.
Lowering interest rates and covering some mortgage risk is not going to lower the supply homes on the market. Demographics show that the number of younger workers expected to enter the housing market will remain low until 2012 (I think that is the year, I’ll look for the figures).
What is needed is a significant investment in infrastructure to pick up these construction employees and at least keep us floating along until the demographics change.
September 3, 2007 6:36 PM | Reply | Permalink
What is needed is a Democratic administration that recognizes that "big government" can do big jobs, and if "big government" doesn't do those jobs they don't get done at all. This, of course, means tax increases to pay for those big jobs. One nice thing about the Bush tax cuts, they were all aimed at people who will now be able to easily afford big tax hikes on their incomes.
Then we can seriously begin the reconstruction of New Orleans and the Gulf Coast, the building of adequate systems for avoiding future Katrina type disasters, ways of ameliorating the effects of global warming, research on alternative energy sources, etc.
That should fill much of the employment shortage very nicely, and it will leave the country in far better shape than building a lot more armaments ever does.
Hoppy in Sacramento
September 3, 2007 6:46 PM | Reply | Permalink
Well not being very fluent in economics I tend to try to wrap my head around what I see going on through analogies that I can understand.
What our economy looks like to me is a large game of Monopoly. It's funded with fake money and in this particular game people roll the dice but then move however many spaces they want to and only pay attention to where they land when it's something good. In the end it's not really even all that fun to play (let alone productive) unless you keep saying to yourself "this money is real and therefore I'm rich!)
I know this isn't necessarily accurate (in fact it probably is not) but it is how I feel. When people know how to game the game then they'll do or say whatever is needed in order to keep the game going. After all what the hell else would they possibly be able to do if the game suddenly ended?
September 3, 2007 7:01 PM | Reply | Permalink
Absolutely. That is the infrastructure investment that I was referring to above.
Unfortunately, since it appears that Iraq will begin winding down the Bush team is already setting up the next need for new massive defense spending by getting Putin to play the next bad guy.
The defense budget will never decrease so we had better hope that somebody takes over willing to tax the rich.
September 3, 2007 7:05 PM | Reply | Permalink
Unfortunately whenever the words government and jobs for the people appear together in even the same paragraph you'll get fanatics screaming "Socialism!"
Whether or not it is in fact Socialism or even if that's a good or bad thing, you'll then have scores of Republicans shoring up their positions before launching their strikes against it. Because they'll feel threatened and need to defend why they've spent the last 60 years destroying what FDR did the last time this nation needed saving.
September 3, 2007 7:06 PM | Reply | Permalink
well, yes, like he said ...
September 3, 2007 7:10 PM | Reply | Permalink
wait until the full effect of pissing away so much wealth in Iraq is really felt by the economy. certainly all the government spending has an inflationary effect on the economy, limiting the ability of the government to aid a slowing economy by lowering interest rates . I would guess this makes it a lot harder to break the stagflation cycle we are in. American dollars held by Asian banks cannot help either. the cost of empire and hegemony is high.
September 3, 2007 7:21 PM | Reply | Permalink
Recession is such an economist word that it has lost its meaning in the reality of day to day living.
Are we really sure that we will stop at recession?
There are so many similarities to the 1920's within the investment world and the artificially ballooned economies tied into new peoblems of massive debt, the concentration of wealth at the top, the lack of real physical product creation and the number of service jobs.
House of cards.
September 3, 2007 7:28 PM | Reply | Permalink
This is more Greenspan's fault than Bernanke's but the Fed has played a dangerous game ever since the currency/Asian/Russian crises for the late 90s. At that point, the Fed started purposefully fueling bubbles. They didn't always know what bubble they would fill. In the late 90s, it was stock buying, often on margin (on the part of individual investors) and via corporate debt that fueled massive share buybacks by corporations (also made worse by a tax code that gives a corporation a break for taking on debt rather than paying dividends, hence they borrowed to buy back shares rather than making dividend payments).
Then, the Fed cut rates, I think, in the hopes that corporations would increase capital expenditures. They didn't. The corporations horded the money. But consumers used the low rates to run up credit card bills and to take out or refinance mortgages. It wasn't the bubble the Fed expected, but it held the economy up. Now, that's gone.
And the Fed seems confused.
thosethingswesay.blogspot.com
September 3, 2007 7:53 PM | Reply | Permalink
I sometimes wonder about when exactly those "full effects" of the Iraq war will be felt and by whom.
Who exactly paid for the Vietnam war? Was it ever paid for at all? Some of the economic pains we are currently feeling may very well trace their roots back to that enormously expensive and bloody war. So I wonder if these Iraq debts will not likewise be rolled further down the road to someone else's driveway to be dealt with.
September 3, 2007 8:01 PM | Reply | Permalink
Good questions. I'd surmise that the bills for these wars are paid for over a longer period of time than the wars warrant news coverage. In financial parlance, that's called "amortizing" where you pay off the bill over the course of decades but recognize it all at a time when it's convenient.
We likely paid for Viet Nam until the mid 1990s. We likely stopped hearing about it before 1980.
thosethingswesay.blogspot.com
September 3, 2007 8:24 PM | Reply | Permalink
This Bush Administration is a mirrored image of the Hoover Administration, whose slow and ideological government inaction, brought us the Great Depression.
Stupidity. According to Bush just as Hoover, they both suggested it would be improper role of government to bail out speculation in the market place.
That's like cutting off your nose to spite you're face.
Just like the Great Depression, the banks and the rich will own everything, since we won't have a steady workforce maybe we all could sell pencils and learn to make tomato soup from catsup. Just as the let them "Eat Cake"Nancy Reagan said, catsup was a vegetable.
America reaped what it sowed, put a Republican in office and watch out.
The Rich will benefit from the impending financial crisis, why would they do otherwise. Lower wages, the poor clamoring for less government Regulations like clean air and clean water, because it interferes with job creation.
Cynical? or Planned Domination?
September 3, 2007 8:54 PM | Reply | Permalink
Of course the US government is and has been reflating with the other hand since 2001. And vastly more so since 2003 with "the war".
Now I can't tell you how much of that money is going towards increased domestic production and consumption, how much is being directly siphoned into the pockets of the connected and/or criminal, or what the net benfits, if any, are, but two things you can't accuse shrub of is frugality or understanding anything about economics.
September 3, 2007 9:25 PM | Reply | Permalink
With $200 billion (1/2 the military budget), we could fully solar power every home in the United states in 8 years.
With $200 billion all of our homeless could own homes.
With $200 billion we could feed the entire world
With $200 billion we could put in high speed rails across the country in a couple of years
but if we did that, we couldn't kill near as many people... and killing people seems to be much more important to us than the other alternatives...
September 3, 2007 9:48 PM | Reply | Permalink
Re: But consumers used the low rates to run up credit card bills and to take out or refinance mortgages.
Mortgages and HELOCs, yes.
But credit card rates have never been low no matter what the Fed does, even for people with very good credit.
September 4, 2007 3:40 AM | Reply | Permalink
. . . Never Having to Say You're Sorry . . .
And why should it when its critics have nothing in their various quivers other than a bunch of narratives the persuasiveness of which is solely dependent upon the strength of their rhetorical skills.
For example; some critics' ridiculous narrative that pretends that stock market crashes cause recessions rather than the correct view that the stock market's mounting recognition or anticipation of the economy's reduced "consumption" of realty, capital goods, and/or durables -- the cause of recessions and lowered profits -- cause investors to decide to sell stocks.
September 4, 2007 7:08 AM | Reply | Permalink
So the stock market is all-seeing. That's great, they saw an absolutely wonderful future in March of 2000 and then it turned real gray the next month -- maybe it was premonitions of 9-11.
September 4, 2007 7:12 AM | Reply | Permalink
And the phrase "liquidity crisis" has been used by more than one writer. Only question is whether it resembles more the 20s or the Gilded Age.
September 4, 2007 7:39 AM | Reply | Permalink
Nope -- "premonitions" of a post-Y2K collapse in IT (capital and software) spending -- and, of course, the market was correct.
Enough of this March 2000 dot.com silliness! The market didn't go down for good until after August 2000 -- beginning, as usual, six months before the start of the recession.
N.B. NYSE Composite hits all time high the week of August 28, 2000. Same week, S&P 500, to its chagrin, artificially overloaded with tech-media-telecom, comes within 1.4% of all time high.
September 4, 2007 8:00 AM | Reply | Permalink
We should get rid of the Fed.
That's why I am so excited about Ron Paul. He's the only candidate who actually has anything to say about monetary policy.
Sorry to be interjecting him here, but come on, the Federal Reserve is the guy's signature issue!
"You say I'm a dreamer. We're two of a kind. Looking for some perfect world that we both know that we'll never find." - Thompson Twins, "Hold Me Now"
September 4, 2007 7:22 PM | Reply | Permalink
Ellen -- "beginning, as usual, six months before the start of the recession"
This must be one of the most stupid statements ever.
Well, then, cause or effect?
And the price of tin crashes 6 months before the demand for tin.
The price of gold crashes 6 months before fears of inflation receed.
The dollar crashed 6 months before the fed reduced interest rates.
This is so brainless and typical of people who think the "market" is predictive, all-seeing and all-knowing.
How old are you?
Ever study the '29 crash? Ever heard about backwardation? Any single "bubble"? Its definition? Tulips, anyone?
Don't think you ever answered about S&Ls!
Go away or get real.
September 4, 2007 8:42 PM | Reply | Permalink
You're blithering again, notthere; go to bed.
September 4, 2007 9:00 PM | Reply | Permalink
Dean, it'd be thread drift for you to reply here, and thus I apologize for the comment, but I wonder if I can use this way of communication to suggest a post topic for you. I found this intriguing from Matt Yglesias today. Perhaps you could comment on it, as it refers to you and to topics discussed here in the past (non-mainstream economics) or simply tell us about your reaction to Chait's book. Thanks!
John
http://www.haberarts.com/
September 5, 2007 7:59 AM | Reply | Permalink
Do you remember Ravi Batra's book, The Great Depression of 1990? He was wrong on the timing, but the issues he raised bear some similarity to what you just said. He compared the economy to an ecology, where the rich and the poor correspond to the wolves and the caribou. When the wolves consume too many caribou, there results a collapse in the population of wolves.
It could be said that the Fed invalidated Batra's prediction by creating successive bubbles, one in stocks and the other in housing, but the underlying imbalances have only gotten more extreme.
September 5, 2007 10:25 AM | Reply | Permalink
I actually have not read Chait's book, but I have seen a few reviews. Based on these reviews, it does seem to be on the mark.
I am not sure of the nature of Matt's criticism of Ezra and Chris (and implicitly Max and me), but speaking only for myself, my main criticisms of mainstream economists stem not from their theory, but their failure to apply it consistently.
For example, I don't really dispute the standard story on trade. It leads to gains for the economy as a whole, but it hurts some segments of the workforce. The key issues are how much are people hurt relative to the size of the total gains and of course who those people are. That is the theory, so I should never have to argue with any honest mainstream economist that people get hurt by trade, the argument should only be about how much. However that is not the way the debate has generally been conducted.
Similarly, economists get very quiet when you talk about creating conditions to allow free trade in highly paid professional services (e.g. doctors, lawyers, accountants and economists). They are all for such free trade abstractly, but when it comes to concrete steps towards removing professional barriers and immigration restrictions that prevent the same sort of competition for physician services as we have for apparel, economists are generally hard to find for some reason.
Tariff barriers that raise the price of steel by 30 percent prompt outrage and charges of Neanderthalism. Professional barriers that allow salaries of doctors in the U.S. to be close to twice the European levels somehow don't garner any interest.
Anyhow, it is these sorts of inconsistencies that are at the center of my complaints against economists, not necessarily the theory itself.
September 5, 2007 12:54 PM | Reply | Permalink
I'm thinking more Gilded Age, as China has not yet passed the US as the largest economy in the world.
And recession simply means what it means ... a downturn in market value of all newly produced goods and services. Of course, if the next recession turns into something like the Great Depression, then it will be the Great Recession, and we will have to come up with a new turn for a downturn in GDP, that doesn't scare the children at night, just as Panic was replaced by Depression and Depression replaced by Recession.
September 5, 2007 3:42 PM | Reply | Permalink
religious sect may degenerate into a political faction,' wrote James Madison, but the new American nation would nevertheless be protected against the ungovernable combination of religious fervor and political power as long as the Constitution prohibited the federal government from establishing any particular creed as preeminent.
Egitim | sohbet
March 7, 2011 5:58 PM | Reply | Permalink