What Conundrum?

Mohamed A. El-Erian of the Harvard Business School and Nobel laureate in economics Michael Spence say there's nothing puzzling or hard to understand about global imbalances, declining risk spreads, flattened yield curves, and declining market volatility. However, their analysis of these changes leads them to conclude that global imbalances raise "considerable challenges, as does the ability to maintain an orderly global reconciliation process over time":

Capital Currents, by Mohamed A. El-Erian and Michael Spence, Commentary, WSJ: For the past few years, the U.S. has generated insufficient domestic savings to cover its investment needs. The difference has been covered by large capital inflows from abroad, the counterpart of which is the much-discussed current account deficit, which has been running at unprecedented rates of 6%-7% of GDP. ...

This has raised concerns about its sustainability, including whether it will end in a sudden and disorganized manner that sharply reduces growth in the global economy and causes problems in global capital markets. And underlying the concern is a kind of puzzlement about the configuration of global savings -- one that runs counter to virtually every text book description: The world's richest country appears to be saving at a low rate and has to borrow from poorer, developing countries to maintain its consumption and investment.

Let's analyze this puzzle, beginning with the U.S. The financial assets of U.S. households have risen rapidly in the past 10 years, at rates well above inflation. The most dramatic increase occurred in household real estate, principally housing. At least some of these increases in asset values were not anticipated, relative to ... long-term ... savings and consumption plans... [I]t ... seems reasonable that U.S. households would consume a portion of their windfall ... over time.

The recent shakiness in the subprime mortgage market has created uncertainty as to whether this dynamic will be sustained. ... More generally, the potential pressure on house prices could also reduce household's propensity to consume out of their accumulated equity windfall. And ... there is concern in ... capital markets that global growth could be negatively impacted.

These concerns are worth monitoring carefully -- and they highlight a more general issue...: While individual consumption and savings decisions may have been largely rational, that does not mean that the decisions of individual households "add up" properly in the aggregate... In fact they easily might not have. ...

[W]e can consume and invest more than output by importing more than we export -- and we did. Hence the trade deficit. However, this ability is dependent on the ability and willingness of the rest of the global economy to accommodate the US desire for higher consumption by investing in the US. That accommodation has been forthcoming from emerging economies generally, including OPEC and China, as well as from Japan.

Their initial reaction to their improved external trade balances has been primarily to recycle the funds to the "risk free assets," U.S. Treasuries and Agencies. By financing U.S. consumption, many surplus countries are also meeting their domestic objectives, to promote exports, increase employment and build up significant reserve cushions to deal with the possibility of sudden disruptions in global capital markets.

This constellation of conditions was largely unanticipated by both markets and policy makers, and as a result it has been reflected in a host of unusual economic and market outcomes -- referred to as conundrums, aberrations, puzzles, etc. The most visible is ... global "imbalances"; also of note is the excessive compression in risk spreads, the unusual collapse in market volatility, the inverted shape of the U.S. yield curve...

Now to the future. Over time, emerging markets will inevitably divert more of their assets to more sophisticated investments abroad. ... One effect will surely be to put upward pressure ... on the cost of capital in the U.S., as the incremental demand for treasuries declines.

While the shift is inevitable, it would be unlikely that the emerging economies as a group would deliberately ... undermine global economic markets. There will also be domestic pressure on policy makers in emerging countries to gradually shift their emphasis away from the producer and towards the consumer. That will mean lowering the savings rate relative to investment, increasing consumption and letting it assume a more important role (relative to exports...) in driving growth.

Under this state of the world, domestic consumption in the rest of the world picks up over time, facilitating the needed adjustment in the U.S. The result is a gradual journey to a more normal relationship between assets and income returns, with savings moving to a more normal long-run pattern.

But this process is not automatic and faces significant disruption risks; and it is particularly sensitive to "policy mistakes." Among these policy mistakes, protectionism measures in the U.S. would derail the global adjustment So, too, would the inability of emerging economies to navigate their complex policy challenges.

Geopolitical shocks would also be a problem... Finally, significant "market accidents" ... associated with excessive leverage and ... sudden and large portfolio changes and credit rationing, would add to the policy complexity.

So where does all this leave us? The current configuration of global imbalances, while highly unusual is not a real puzzle. It is the result of a series of individual decisions in both advanced and emerging economies that were largely rational when considered at the micro level. ...

The aggregation of these decisions at the national and international levels raises considerable challenges, as does the ability to maintain an orderly global reconciliation process over time. The fundamental question, therefore, is whether these global considerations will be sufficient to minimize the risk of "policy mistakes" in a world that is subject to geo-political risk and bouts of excessive leverage.

One thing that bothers me about this story is that it begins with a run-up in asset prices as the source of global imbalances:

Let's analyze this puzzle, beginning with the U.S. The financial assets of U.S. households have risen rapidly in the past 10 years, at rates well above inflation. The most dramatic increase occurred in household real estate, principally housing.

However, prices are endogenous variables, and therefore this explanation leaves the primary driving force behind the run-up in asset prices unexplained. Jim Hamilton looks at the housing market in "Bubble, bubble, toil, and trouble." His analysis is concerned with whether or not housing prices have departed from underlying fundamentals, and he doesn't believe that they have. He concludes:

Low interest rates and rapid population and employment growth relative to the supply of available housing were the main factors driving house prices up...

To that, Jim adds:

The one thing to which I think I was not paying enough attention two years ago was the role of lax credit standards and even fraud ([1], [2]) in addition to low interest rates as factors fueling the boom. I have been coming around to the view that there may have been some significant market failures behind that. My first worry here is about Fannie Mae and Freddie Mac, and the second concerns whether some of our institutions have the right incentives for fund managers to properly value lower-tail risks. This ready availability of credit, over and above the low interest rates themselves, I now believe was an important factor contributing to the real estate boom.

I would also mention regulatory restrictions as an important factor, e.g. see Edward Glaeser's on zoning regulations or Krugman on Flatlands and Zoned Zones. But many people blame (or thank) the Fed for driving interest rates so low.

Which opens the door to "Did the Fed Do It?" from David Altig. David isn't so sure that the Fed is to blame for the escalation in housing prices:

Did The Fed Do It?, macroblog: The ISI Group's Andy Laperriere, writing on the opinion page of yesterday's Wall Street Journal, says the answer is yes (at least in part):

Federal Reserve officials and most economists believe the problems in the subprime mortgage market will remain relatively contained, but there is compelling evidence that the failure of subprime loans may be the start of a painful unwinding of a housing bubble that was fueled by easy money and loose lending practices...

The ... fallout from the second major asset price bubble in the last decade should prompt some broader questions. For example, what role did the Fed's loose monetary policy from 2002-2004 play in fueling the housing bubble? Should the Federal Reserve reexamine its policy of ignoring asset bubbles?

I know that the easy money claim has become something of a meme, but I often find myself pondering this picture:

What's the story here?  That the long string of federal funds rate cuts beginning in January 2001 caused the decline in long-term interest rates -- including mortgage rates -- that commenced a full half-year (at least) before the first move by the FOMC?  That low levels of short-term interest rates have kept long-term rates well below their pre-recession peaks?  Then what to make of the fact that rates at the longer end of the yield curve have barely budged in the face of a 425 basis point rise in the funds rate target?  Maybe it's "long and variable lags"? Should we then be expecting that big jump in long-term rates any day now?  I guess it's still a conundrum. But maybe, then, we should be a little circumspect about the finger pointing?

OK, here's part of the Laperriere article I can get behind:

It's not the size of foreclosure losses as a share of the economy that matters, it is the effect those losses have on the availability of credit.

Like I said.

In a recent speech, Fed Chair Ben Bernanke says the Fed still has the ability to affect long-term rates:

The empirical literature supports the view that U.S. monetary policy retains its ability to influence longer-term rates and other asset prices. Indeed, research on U.S. bond yields across the whole spectrum of maturities finds that all yields respond significantly to unanticipated changes in the Fed’s short-term interest-rate target and that the size and pattern of these responses has not changed much over time (Kuttner, 2001; Andersen and others, 2005; and Faust and others, 2006). ...

[G]lobalization of financial markets has not materially reduced the ability of the Federal Reserve to influence financial conditions in the United States. But, ... globalization has added a dimension of complexity to the analysis of financial conditions and their determinants, which monetary policy makers must take into account.

I'm also intrigued by David's suggestion, and hopefully more evidence can settle whether previous research has this wrong. But for now, my policy recommendations will still account for the possibility that the Fed can affect long-term rates.

Comments

[Bruce Webb]

Where to start?

Well snark is always good. I don't doubt Spence's nobility or worthiness to have a laurel crown for economic prowess but I would think Alfred Nobel would be wondering about that "Noble laureate" thing.

On a more serious note economists need to get a grip and decide whether markets and market participants are rational or not. You got one camp arguing that all prices clear at the point of maximum efficiency and another arguing that the market is at risk of "market accidents" and "policy mistakes". Well as a matter of logical necessity it is pretty hard to maintain both. How anyone could maintain one second of faith in the Invisible Glove and entertain the following is close to madness:

"to deal with the possibility of sudden disruptions in global capital markets.

This constellation of conditions was largely unanticipated by both markets and policy makers, and as a result it has been reflected in a host of unusual economic and market outcomes -- referred to as conundrums, aberrations, puzzles, etc."

Ah yes. That is a conundrum AND a puzzle. It also puts some traditional conceptions of Neo-Classical Economics to a pretty severe test. Because a model that relies on all participants being fully informed actors doesn't fare well in a world that has whole constellations of unanticipated conditions.

"Who knew?" and "Markets clear" are uneasy bedfellows at best.

You can make this work. You can probably argue that economic decisions become more subject to pure market considerations as you move from the general to the granular level. But you need to remove that Invisible Glove and start talking mechanics. Because from where I am sitting I don't see that anything about economics is in any way automatic. Too many cooks stirring the pot for my taste.

[Tapen]

Small point: Nobel Prize NOT Noble.

Tapen

[Bruce Webb]

"The recent shakiness in the subprime mortgage market has created uncertainty as to whether this dynamic will be sustained. ... More generally, the potential pressure on house prices could also reduce household's propensity to consume out of their accumulated equity windfall."

Well it wasn't my ellipsis and I don't know what came in between but a lot of things are being blurred here.

People in sub-prime loans don't have equity. At least initially and in the loans that go south never. That is why these loans are written sub-prime to start with, the borrowers can't come up with a conventional down payment.

On the other hand the mortgage industry has made it extraordinarily easy for people who actually do have equity to take out HELOCs (Home Equity Line of Credit). I have one, its physical manifestation is as a credit card and a check book. I could take my entire home equity to Vegas tomorrow and be asset free by Monday. But that has nothing to do with sub-prime, at least directly.

The mortgage industry collectively decided or discovered that you could take residential real estate totally liquid. On one front this manifested itself as sub-prime lending, if assets appreciate endlessly why not lend on them? On another front this manifested as a willingness to lend on equity because (wait for it) if assets appreciate endlessly why not lend on them?

But for the most part you are talking about two separate markets here, one that is leveraging themselves into a home, another that is extracting equity to support consumption. Sure the former will blend into the latter, at least that is what they hope but I don't know that HELOCs really fall into the category of 'sub-prime' by definition. I mean I can see somebody with substantial equity getting greedy and taking out a HELOC instead of refinancing out of their sub-prime to take advantage of that equity. Then again you can't legislate for stupidity.

Certainly a lot of this runs together but it is a mistake to blend MEW (mortgage equity withdrawal) with sub-prime lending. They draw from the same well of assuming that this asset class will appreciate without end, that in the end the rising tide of housing prices floats everybody's boat, but the markets and mechanisms are generally separated.

Until you get to speculators. Because you can jam MEW, HELOCs, 100% LTV and sub-prime into a stew and leverage yourself until Hell wouldn't have it. And make a lot of money. Or end up so underwater that you can't even see the surface. Which is what I am worried about. Some people made some bad choices, some people were victimized, yep they are out there. But some people suited up, put on the weight belt and dived into the deep blue sea intent on making a killing in real estate. And lots did. But we have no obligation to bail out divers who misjudged the depth of the water in their plunge.

Drawing the lines between innocent drowning victims and reckless divers is going to be tough. But necessary.

[robertdfeinman]

At the risk of seeming immodest I'm going to proclaim Feinman's first law:

"The thing that gets you is never the thing you have been worrying about."

There has been so much focus on the sub-prime market that I'm willing to bet that the next crash won't be triggered by this sector. In fact the cause may not even be directly financial.

For example, the US (and now Germany) is in the midst of a huge die off of bees. This may cause billions of damage to agriculture as crops don't get pollinated and fail to mature. We can get along without peaches, but what happens if more vital crops fail?

Another scenario is that one of the current droughts in China will become so severe that civil unrest breaks out, the military is called in and foreign investors get scared off. Supply chains dry up and the US becomes short of imported goods. Since we don't make this stuff here anymore the impact could be widespread. Imagine Walmart with empty shelves...

[mrrunangun]

The propensity of the subprime lenders to engage in imprudent lending reminds me of the S&L crisis of the eighties. Both resulted from policy decisions that penalized prudence and rewarded the lucky winners in the casino. S&L regulation did not account for the surge in interest rates imposed by the Vocker regime and they were stuck with long-term 6% mortgages they had financed with short-term 5 1/4% money. When that money threatened to leave for greener pastures, the S&L managers could close or gamble on high-risk high-reward investments in hopes of staying in business. The lucky survived in business and the unlucky sometimes went to jail. Recently low rates and the consequent rapidly rising home prices created a consumer buying panic and invited lenders to lend more money to some people than they could reasonably be expected to pay back unless home prices continued skyward indefinitely. There are no doubt people who knew what they were doing here, but there was probably plenty of stupidity and ineptitude as well. Here again the lucky will survive in business and some of the unlucky will go to jail.

[bullbust]

JD Hamilton defines the word "bubble" differently, and then goes on to say there is no bubble. What else is new?

Lot of economists have so much invested in the Fed policies that even to admit the possibility of Fed mistakes is sacrilege.

[Appukkuttan]

Are Nobel laureates really Noble?

[Fullcarry]

bullbust why don't you give us your definition of bubble.

[anne]

Robert, please do reference the dying of bees in Germany if possible. I was not aware of such a problem elsewhere, though I am sure there must be such worries everywhere.

[anne]

http://www.nytimes.com/2007/02/22/opinion/22notebook.html?ex=1329800400&en=9937978729f63151&ei=5090&partner=rssuserland&emc=rss

February 22, 2007

Keeping Bees Among Us
By VERLYN KLINKENBORG

Mention honeybees, and most people think two things: stinging and industriousness. A beekeeper thinks: jubilation, harmony, the civilization of insects. Nothing in nature is more vibrant — literally — than a strong hive on the increase in late spring and early summer. And few things are more depressing than opening the lid on a hive and pulling apart the supers, the boxes where bees raise young and store honey, and finding that the colony inside has died.

It is far more than the death of individual bees. It is the death of prosperity itself....

[Bruce Webb]

Ah Anne it is a fortuitous world.

Who knew that a query on "bees einstein" could return a relevant response to your question. Yet a chance reference yesterday led me to this:

http://www.mindfully.org/Pesticide/2004/Fipronil-Kills-Bees4mar04.htm

You know? I think these internet tubes may pay off someday.

[Mark Thoma]

Typo fixed.

[anne]

Thank you, Bruce. There have been sporatic American problems in sustaining bees over a number of years, though I was only aware of mites as a problem, and was not aware of problems internationally. Evidently though the cause of the latest losses are simply unknown, and it is not even clear that the latest European losses described parallel the American losses.

[Lafayette]

BW: "On a more serious note economists need to get a grip and decide whether markets and market participants are rational or not."

Very serious indeed.

Economists study data for "interpretations", in the assumption that with full knowledge of all market factors people make the "informed choices" that the data represent.

They have no way of knowing, however, if that is true. The data simply represent an historical evolution of an event or events.

Which is why a closer working with sociologists might seem appropriate. The problem is that sociologist don't like necessarily obtaining "behaviour" from data as observed. They prefer to have it expressed in terms of group phenomenon and seek the impulses that could lead a group to behave in a certain way. For instance the herd instinct of animals that makes humans band together to form communities - the basis for which is thought to be self-protection.

In fact, philosophy has always strived to distinguish mankind from the animal kingdom due to innate intelligence. That's fine, but it's also a bit self-centered. We aren't all that intelligent as we might think.

[Bruce Wilder]

Very interesting about the bees.

More and more, I expect, all the problems of life on this planet will be human problems of inadvertance, of unintended or unexpected consequences of human action. We are responsible for the bees and for the orchards, and both suffer in our arrogant and uncertain care.

Economic "conundrums" often amount to the same thing.

It is all very well to wonder "what causes recessions", but we live in a world in which the central bank and the government are responsible, regardless.

I find the kind of narrative analysis in which Spence and El-Erian have engaged to be highly irritating. How easy and facile they are, slipping into the passive voice and hiding behind meaningless abstractions, whenever it suits them. So, smoothly, that we scarcely notice when "emerging economies" start "deliberating".

Just look at this peroration:

Under this state of the world, domestic consumption in the rest of the world picks up over time, facilitating the needed adjustment in the U.S. The result is a gradual journey to a more normal relationship between assets and income returns, with savings moving to a more normal long-run pattern.

So soothing, to know that our journey toward normalcy will be preceded by "needed adjustment" of an undefined character and nature.

It is no wonder that professional economists insist on mathematical expression; these geniuses so abuse the language as to make themselves indistinguishable from morons! But, one good thing is that we don't have to adjust any of our economic theories, because our economic theory tells us that the world will soon be closer to "normal" and more like what our theories describe. Yeah, that makes sense.

It is really past time for these guys to grow up.

Does the Fed affect long-term rates? Are we killing the bees? Well, duh.

It is simply not sensible to suppose that the present "constellation" is not the consequence of policy, simply because the power of the policy makers exceeded their capacity for anticipation or intention.

Nor is it fair to take a potshot at "protectionism" as a potentially disruptive "policy mistake" when you are unable to honestly face and account for how the present state of the world resulted from "policy".

How much do you want to bet that that "needed adjustment" referred to by the authors will be very painful, indeed, for people not reading the Wall St. Journal editorial page?

It all seems less like trying to understand the world, than trying to obfuscate the choices we are making, or that institutions are making on our behalf.

[robertdfeinman]

Re German Bees:
I'm a bit reluctant to cite the article since the featured pundit sounds a bit extreme, but the underlying phenomena seems to be correct:

Are GM Crops Killing Bees?

[Mark Thoma]

On bees:

http://www.ag-econ.ncsu.edu/VIRTUAL_LIBRARY/ECONOMIST/julyaug03.pdf

[anne]

Thank you, Robert, and I understand and agree with your caution which is why I asked for your thinking rather than simply look.

A few summers ago, I was running when the sky darkened quickly and it began to rain. I ran through the short rain and began to walk along rows of bushes while drying. By chance, I suddenly saw a leafy bush that was simply covered with bees. The bees were under the leaves, many hanging upside down, and as it turned out were waiting for warmth and drying. I watched for more than 30 minutes as they became active slowly and flew away. Oh my.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5778&u=11942|16|...

Monarchs and Bee
New York City--Central Park, Wildflower Meadow.

The bee bush was like this, with similar narrow leaves.

[john c. halasz]

Good comment, Bruce Wilder. Now if we could only get you and the other Bruce together in a cage match, I'd pay to see that!

[anne]

http://www.nytimes.com/2006/08/15/science/15observ.html

August 15, 2006

Bees Like a Warm Drink Now and Again, Too
By HENRY FOUNTAIN

Shivering works to warm the body up on a cold day. But a hot drink can help, too — the more heat from the drink, the less shivering necessary.

What works for people works for bees as well, researchers in England have found. Given a choice, bumblebees will choose a warmer flower, with its warmer nectar, over a cooler one. What's more, the bees learn to identify warmer flowers by their color.

Bumblebees need to warm themselves up in order to fly, said Lars Chittka of Queen Mary College at the University of London, an author of a brief paper describing the research in the Aug. 3 issue of Nature.

Typically, bumblebees need a body temperature of close to 100 degrees Fahrenheit. To reach that temperature in cold weather takes a lot of energy.

Like people, bees warm up by shivering, but they'll take help when they can get it.

Dr. Chittka said many plant species have an adaptation in the surfaces of their flowers: conelike cells that focus sunlight on the floral pigments underneath. This makes them warmer than species without the adaptation. "We were interested in the question of whether bees take this into account," he said. "Whether they opt for warmer flowers or nectar."

The researchers experimented using artificial flowers of various temperatures (artificial flowers enabled them to eliminate other possible factors, like petal texture, that might influence bee behavior). They found that bees preferred to feed at warmer flowers, even if they were as little as 7 degrees warmer than those at ambient temperature.

In another experiment with artificial flowers of different colors and different temperatures, the researchers found that bees quickly learned to associate warmth with color.

"They needed to land on the flower and experience the warmer temperature," Dr. Chittka said, but once they did, they regularly chose flowers of that color.

The bees benefit, of course, but so do the flowers, by having more bees pollinate them. The adaptation that makes the flowers warmer is another example of evolution at work, Dr. Chittka said.

"Flower species are engaged in a competitive race with other flower species," he said, and do many things to attract and keep pollinators, like making big showy flowers. "But also in this competitive race, they might benefit by offering them warmer drinks."

[Thank you, Mark....]

[dale]

When I was young, playing in fields near my home, I noticed that Bumble Bees were most often found in blue-purple flowers (I live in NW Oregon). Now I just need to know if those color flowers are warmer in my climate zone.

[Bruce Wilder]

jch: "Now if we could only get you and the other Bruce together in a cage match"

I agree we would be a great tag team -- "2Bruce is 2 much" -- but who would we fight?

[Winslow R.]

"But for now, my policy recommendations will still account for the possibility that the Fed can affect long-term rates."

Only in the upward direction if real/potential deficit spending is sufficient for investors to be worried about inflation. Otherwise the Fed can only push rates down. Pretty weak if they follow the 'rules'.

[robertdfeinman]

I wasn't trying to hijack this topic and make it about bees. This was just an example that has been in the news lately.

However, for another example from the news:
Millions face drought in SW China

My point being that economists seem to focus on money issues, but that the things which may have the largest effect on society are unforeseeable and beyond our control in many cases.

The military has done contingency planning on what they may be expected to do when various scenarios play out in the future. This includes things like which countries will they have to dominate when a specific raw material becomes scarce. Or what actions will they need to take if wholesale civil unrest breaks out because of famine or other conditions.

It would useful if economists engaged in such efforts as well. We don't even see projections for simple things like currency revaluations or changes in trade patterns.

[anne]

Robert, you have done well in giving us pause to think from a properly broad perspective even in responding to narrow questions. Because of the reminder, I am reading Edward Wilson yet again and remembering that Wilson could focus intently on ants on a leaf while being open to the sorts of metaphors, broadening metaphors, that allowed even more remarkable vision.

While I am thoroughly excited about the development of China, I do not forget the potentially self-defeating ecological possibilities China must deal with.

[anne]

What we need to know, by the way, is how to take the temperature of a flower, but when we notice bumble bees seemingly favoring blue-purple flowers asking why always is in order. Noticing is artful when we properly remember context.

[paine]

b wilder
"who would we fight ??"

paine the giant

i'll take you both on ....

texas bull rope rules

[anne]

Paine, your complaints about detachment reflected in Federal Reserve statments are worth while.

[paine]

anne will you be my manager in the steel cage last man standing match
between me and those two pencil necked geeks named wimper and weep ??

i must warn you
it may involve
hitting a guy named bruce over the head with a folding chair....from behind

[PEmberton]

Anne has misread the calendar, I think. April 1st is a
few days away

[outtanames999]

The savings rate in the U.S. may be underestimated or hidden in other categories. Are IRA and 401K balances considered savings? If not, then the savings rate is vastly under reported.

In addition, the economic impact of the boomlet generation, with millions in that generation forming new households every year and thereby increasing housing demand, especially at the low end which has driven up prices in many markets and resulted in prices pushed higher across the board.

Fueling by easy money clearly did exacerbate this phenomenon to the point where college students with no visible means of support other than their parents could qualify for a mortgage - an absurdity of course, and like all anamolies, self-correcting.

Regardless, the demographics will continue to create housing demand sufficient to sop up any foreclosure inventory from the subprime market.

As to imbalances, they are bound to occur as we move more fully to a free flow of capital on a global basis. What is considered acceptable level of imbalance may have to be adjusted. Perhaps there is a capacity and tolerance for wider swings of the pendulum than in the past.

[bullbust]

>bullbust why don't you give us your definition of bubble.

Oh, I define bubbles as JDH defines it at the beginning of his post. "price rises for no reason other than the fact that everybody expects prices to keep going up".

You have to muck around in the comments to see that JDH really does not meant what that means in plain language.

His reasons for there being no bubble?

>we should now be seeing a calamitous price collapse rather than the slow fizzle that's unfolding.

Yes. He indeed said that. Housing is sooo liquid.

>there was substantial variation across U.S. communities in the amount by which real estate prices went up...These differences in realized price appreciation were at least weekly correlated with such fundamentals as population and employment growth

A bubble always has fundamentals at its origin - even the tulip bubble started because tulips were rare, and a status symbol, and expensive after their introduction to Netherlands. Bubble are created because of the belief that the price rises caused by fundamentals will continue forever, even beyond the prices that are dictated by those fundamentals.

>Third, if this was all a bubble, then what we should be seeing now is a reversal of that process, with the states that are brightest purple in the graph above now taking the hardest hit.

Here JDH is using highest mortgage delinquency rates - to prove what?. It is prices that matter. Houses are not stock. There are no margin calls. There are still people who hold YHOO (not pets.com)bought at $100+, now worth $30. For them there never was a bubble, as long as they don't sell. So says JDH.

[real person from the real world]

Both Bruces were ineresting. Unusual, but Layfette did not have much to say. I hadn't heard that the bee problem was international, but that is interesting and a worry, whatever is causing it, and it should get the environmental hobbists all worked up.

Webb is right, the subprime market is not necessarily getting the money to hit the mall. On the other hand, most people I know, got home equity for the reasons people get home equity. To pay down medical bills and credit card debt (which might be previous shopping mall debt, but it sure ain't now).

The problem is that salaries and costs in the US are high HERE, and low overseas/elsewhere. It's nice to talk of "leveling off" but as someone else said, these guys hide behind abstractions. If you are, like I am, facing declining years and bad health, and rising living costs, while earning less and less on my bank savings and job, the leveling off is pretty painful.

All these economist say we do not save enough, but how can you save? Go to a bank, and what kind of interest do you get on your money? 2-3%? a money market may pay more. Meanwhile, credit card interest (as documented in USA Today article I cited in previous blogs) can range as high as 32%. You can only save if you are making the bucks to start with and can invest in the stock market (aka Investment Gambling Casino), or you can keep your costs low enough to put some money aside, and if it is too small, you sure don't get much return on it. Companies don't even invest in R&D anymore. At least not in the USA. Microsoft opened a campus in India, and probably does it's research there, not in the US. We don't have the entry level jobs for IT in the US, we just import guys vetted thru entry level in their home countries. Education, Inc. is now a business that puts huge burdens on the US Citizen, while critics complain about how stupid we all are, while importing more students from overseas that get generous help from the US Tax Payer via the US Gov't. (Just go to any local college and see the foreign students lined up at the financial aid offices at the start of the quarter/semester).

US citizens are now commodities, unless they are part of the lucky few overpaid managers. With prices often market based, the only way a commodity can survive is finding cheaper and cheaper goods (hence the rise of Walmart), and those things are usually made somewhere else cheaper, so they are imported.

Personally, to solve the "conundrum" I say we should lower those guys making $80K and up, to half that, and make it illegal for companies to give anyone making over $40k benefits, especially HEALTH and DENTAL. IF this was done, I bet we would have some RATIONAL changes done quick!

[Bruce Webb]

First I have to congratulate outtanames999 on his or her screen name. That is an only too funny commentary. Though the thousands of "Anonymous"'s and "NoName"'s out there may not get the joke.

But to the point. Traditional measures of savings have broken down as housing equity liquidized. And that remains true whether housing heads up or down. Because there is an oddity to a HELOC (Home Equity Line of Credit). Because unless I missed something in the fine print they don't get to reset the limit. Did I take out my HELOC at the top of the market? Well probably not. But if I had, or even better had extracted that equity in advance of a local market collapse I don't think the line is by that fact alone cancellable. And even if it were it wouldn't matter if I had already maxed it out.

It's a variant on the old "If you owe the bank a thousand the bank owns you, if you owe the bank a million you own the bank".

The market is resetting to this new reality. MEW (Mortgage Equity Withdrawal) is light years faster than judicial foreclosure. The new mortgage products have enabled people to simply isolate their equity from the underlying security. "I'll take your house!" loses a lot of its force if your first mortgage was 100% LTV and you subsequently took all of the appreciation out in the form of a HELOC. Particularly in a down market.

And I suspect that a lot of the hysteria out there is a result of end investors waking up to the fact that they have lent $600,000 on an asset now reselable at only $500,000 and that at a substantial cost to foreclose, and are at the mercy of people who only have to compare the cost of the mortgages to equivalent rent.

LTV: Loan to Value. A hammer in the hands of the lender in an up market. Who wants to walk away from equity? Unless of course you already extracted every penny of that equity and carry it in your wallet. Me I am sitting on my equity. Quite literally. And if Boeing announced tomorrow that they were shutting down believe me every bit of that Line of Credit would be some form of cash by the end of the business day. And the investor who ultimately was securing the loan would be feeling kind of ill.

Will lenders crack down? Will they limit HELOCs? Stop lending money 100% LTV? Maybe. But until they de-liquidize housing equity traditional measures of savings are out the window.

I don't have a job. My last paycheck was Friday. Yet by one of the weirdnesses of the new economy I can make a solid financial case for taking every penny I have in checking and pre-paying principal on my first mortgage. You have to work the numbers pretty hard, it all depends on the differential in interest rates between your first and the HELOC and the amount you have in the bank. And the ratio between your unemployment check and your monthly expenses. Nobody said math was easy. But the numbers work, for a precisely calculable period of time. Take out a HELOC and don't use it. You just bought yourself a bank.

(Kids don't try this at home. Unless you have spending discipline. And solid prospects for a new job within the defined time frame. Because once you eat the seed corn you starve to death. But you can profit by borrowing from it. The fact is that these new instruments shifted mortgage risk in a whole different direction and the markets are just now waking up to that. Little to none of this is concern about the poor being victimized by cruel lenders, as always 'economic crisis' is defined as 'rich people losing money').

[real person from the real world]

Just read some of the Bee articles. One thing that hits me, is that perhaps by humans insisting on micromanaging eveything to work in predictable ways (genetically modified crops that repel pests, to up production or economists managing the economy using mathematical models that miss human complexity) we are killing ourselves off.

[Bruce Webb]

Smarter BW:

"I agree we would be a great tag team -- "2Bruce is 2 much" -- but who would we fight?"

I'll take Kudlow and you can have Mankiw. (I don't want to try to punch above my weight, and I know I can take Larry out, and I am pretty confident about your ability to deck Greg.)

[Bruce Webb]

Apropos of something. Before Frank Herbert wrote Dune (and introduced the word 'Ecology' to audiences that had never heard of the concept, still less having an appointed 'Planetary Ecologist) he wrote perhaps the oddest science fiction work ever, (and I am including Runaway Skyscraper in the mix here).

It is titled The Green Brain

It depicts a world roughly projected forward from the 50's where society had simply decided to exterminate all insects and replace their functionality with science. In other words you could subtitle the work "Who needs bees".

The way that insects strike back and negotiate with humans is so extraordinarily weird that you have to wonder what Frank was on at the time and why wasn't he sharing it ('spice' doesn't begin to touch it). But he was making a hugely important point at a time in history when conventional wisdom was that nothing couldn't be solved if you just threw enough DDT at it.

"Better living through Chemistry" You kinda had to be there, but there really was a time when the answer to global problems was for humans to shove back hard against nature.

(Oh wait a minute. That was last week. In the Bush Administration Interior Department. But snark aside environmental awareness was nowhere before Rachel Carson's Silent Spring which I now just realized was titled to evoke the absence of bees buzzing.)

says...

I grew up ready Frank Herbert, and I have all the books and even the newer 'prequels.' But I am changing my thinking on this. Every year, I have to limp into a station to get my emissions tested on my 120K+ miles car. I can barely live, let alone buy a new one. Those $80k or more a year people, with generous health benefits and multimillion dallar homes and driving the latest cars (green or not), rant and rant about environmental problems. I also read about downer animals being used for animal feed consumption, and now suddenly, we have mad cow disease appearing in our food animals. There are massive pig farms created to lower costs in pork production, and they create cess pools with fumes no one wants to live near, and pollute grown water. Clearly, lowering costs to be as cheap and low as possible had it's downsides.