Bubbles, Not in the Abstract

Tim Duy uses an analysis of local conditions as a lead-in to a more general discussion of "The Scars of Losing a Home," bubbles, and Fed policy:

Bubbles, Not in the Abstract, by Tim Duy: I am working on a presentation for an audience in the Bend, OR area next week, and thought I would share some charts that I thought interesting. They touched a nerve as well. Using Census data from the American Community Surveys, I looked at relative income profiles in Bend and Eugene in 2000:

Roughly comparable communities – the median family income in Bend in 2000 was $49,387, compared to $48,527 in Eugene. Housing values were also roughly comparable:

In both cases, median home values were about three times median family incomes. Flash forward to 2006. For income:

Income distributions are not as evenly spread, but median incomes are once again similar, $58,225 for Bend and $57,361 for Eugene. But look at housing values:

In both cases, the distribution of home values shifted to the right, but the magnitude of the shift in Bend is quite stunning. The median home value in Eugene in 2006 was $224,900, about four times median family income. The median home value in Bend was $345,400 – just under six times the median family income.

The local story is that the Bend area will always attract a steady stream of wealthy California retirees with plenty of wealth. If this were true, I cannot understand why so many of these recent migrants are desperate to leave. Consider the 55 price changes on just one day, Friday May 16:

[Update: Apparently I misunderstood the price change data. From the Bend Economy Bulletin Board: 

They write "Consider the 55 price changes on just one day, Friday May 16", which is incorrect. The price changes posted on this bulletin board don't happen "on just one day", they typically happen over a period of two days to a week before they're posted here.

I stand corrected.  Still bad, but not quite as bad.]

While there is truth to the underlying story that Bend is attractive to retirees, and is a very pleasant place to live, work, and play, that story clearly does not justify median home prices at six times median incomes. Bubble, plain and simple, and now there is a rush for the exit.

What strikes me most in these charts is the massive misallocation of capital during the last six years. The housing stock in Bend was twisted in a direction that is fundamentally misaligned with the community income profile. True, this happened in many places – I would argue that home prices in Eugene are also misaligned, although to a lesser degree. But the magnitude of the misalignment in Bend is quite remarkable, and in my mind represents a complete failure of social policy. This is especially the case when policy has turned homeownership into a moral imperative, creating a culture that equates renting with failure and granite countertops with success.

In these charts I see the immense damage done to everyday Americans by allowing an asset bubble to propagate unchecked. And while there is some chatter that the Fed is moving toward a more serious look at the wisdom of ignoring bubbles, I remain underwhelmed. I believe the Fed views asset bubbles as primarily an academic puzzle, a problem in the abstract that conveniently allows them to ignore the very real impact on average citizens, whose paths they rarely cross. I see little in the current discussion that is new (see also Naked Capitalism); New York Fed President Timothy Geithner offered the dominate view back in early March:

I don’t believe that asset price and credit booms are preventable. They cannot be effectively diffused preemptively. There is no reliable early warning system for financial shocks. And yet policy plays an important role in determining the dimensions of financial booms, and policy helps determine the ability of the financial system and the economy to adjust to its aftermath. We need to undertake a broad set of changes to address the vulnerabilities in our financial system revealed by this crisis. Just as a long list of factors contributed to the trauma, there is no single reform that offers the promise of sufficient change.

This implies we need to accept that capital formation will be a random event. This doesn’t sound like a good way to run an economy to me. Almost reckless. From Keynes:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism….

And finally, I find the Fed’s appeal to regulation to be almost laughable if it were not so sad. Fox. Henhouse. The Fed abdicated their regulatory responsibilities long ago. One example from the WSJ blog:

Although it has been gotten little attention, this was made possible in part thanks to an explicit decision by federal bank regulators in 2003, then finalized in 2004 to exempt banks from holding full capital against such vehicles, which post-Enron accounting changes could potentially have required. (To be sure, regulators did require additional capital to be held against some entities to which banks had short-term funding commitments. And banks eventually found ways around the accounting standard anyway.) The ruling reflected the prevailing belief that as long as the entities were legally separate, the sponsoring banks had limited exposure. “There’s always been this mentality that if it’s somehow legally separate they’re not liable for it anymore and that ignores the reputational risk and the de facto obligation,” says Robert Eisenbeis, a former research director at the Federal Reserve Bank of Atlanta and now chief monetary economist at Cumberland Advisors. Sure enough, when some of the vehicles were locked out of the commercial paper market last year, some banks, fearing the damage to their own reputations had the entities failed, took them back onto their balance sheets, straining their capital

I will be surprised to see real, effective regulation emerge until the Fed is divorced from the very unfortunate marriage to the fetish of liquidity that allows policymakers to turn a blind eye to the unquestionably damaging bubbles spawned by that marriage.

Comments

[a]

Yup the West's housing bubble is turning out to be the greatest misallocation in capital the world has witnessed since the Soviet Union.

[wcw]

Pfft, six time? I think it's ~8x around here. Healthy, no, but 6x doesn't automagically make prices a bubble. Given the amount by which residential property is subsidized by the government, I think there is a strong argument that 3x in any vaguely desirable area is itself the mispricing.

[Lafayette]

The blameless society

Article: (From Keynes) The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism….

First of all, Keynes should have been more careful about the word "social". This has never been and quite likely never will be part of Wall Street's charter. Still, Keynes wrote this in 1935 (?), so we can forgive him the usage; which, at that time, quite possibly was construed as social.

Most importantly, his focus on Wall Street and the way it functioned was very precise. Let's not forget that Keynes was a heavy player, and winner, in equity markets. He knew VERY well how they functioned and, given his intelligence, why they functioned.

On the one hand, there must be an element of "laissez-faire" in any market for it to function properly. Otoh, when a market dysfunctions its consequences are stark and fingers need be pointed.

The Fed, comprised of a class of over-paid and under-stressed individuals, refuses to wake up to the fact that "someone was to blame" for the excesses of Investment Bankers in the matter of the sub-prime mess. The "toxic waste" did not bubble up to the surface like escaping natural gas. And, its later explosion was no accident either.

This was, to my mind, a case of premeditated fraud. Let's not leave sight of two facts:
1) Nobody in his right mind could have imagined that repackaging bum credit and reselling it forward as "realty secured" SIVs to the world, was not professional negligence , if not fraud. And,
2) No ratings agency could have blessed Toxic Waste with the green light, unless they had taken collective leave of their senses - or, more likely, simply had not taken the pains to investigate. (Likely out of cahoots with the Investment Bankers.)

And, as said before, had any Joe Blow robbed a bank of one one millionth of the sums involved in this fraud, they would be IN JAIL TODAY. Where are the arrests in the sub-prime mess?

Nowhere to be seen ... in our blameless (but criminal) society.

[Farrar]

The problem is not pure speculation. Remember Elizabeth Warren's speech post here last month :
http://bostonreview.net/BR30.5/warrentyagi.html

[Lafayette]

a: Yup the West's housing bubble is turning out to be the greatest misallocation in capital the world has witnessed since the Soviet Union.

Explain further. Is the above tonque-in-cheek?

If so, why?

[Farrar]

Laf: "Explain further. Is the above tonque-in-cheek?"

I think it's been explained often enough. I guess it doesn't hurt to repeat to make sure the message gets thru, and it gives us pleasure to read it again.

For me, everytime I've returned to the USA during the last 10 or maybe 15 years, I've been struck by the extreme wastefulness and especially the extreme UGLINESS of new housing development in the USA. One often finds a bizarre resemblance to the ugly houses built during the 1920's, perhaps an era of similar misallocation.

But then I'm a terrible conservative in this regard. For me the ideal house is still the Eichler Atrium (perhaps with reinforced insulation)
www.eichlernetwork.com/ENStry26.html

[ken melvin]

Lafayette - good stuff. Fraud, No doubt. But, I think, there's the context of why all the investment money into housing. Truth be they can't give the damned stuff away when it comes to increasing productive capacity and infrastructure. Not enough return? And, again, it's this ownership, everyone's going to live off investment, thingee. The same that's throttling small business everywhere. WCW asks, "what's wrong with it." When less than 1 in 10 can afford a house America has lost it.

[JRossi]

Bend is way over-rated.I could have told you that--been going there on and off for 20 years and have seen considerable deterioration. Sure, the mountains and deserts are beautiful, but the people--wow. The locals are Oregon-nice, but the metastatic Californians are intolerable, both the wealthy, condescending, gated-community-loving Bay Area fancy-pants and the brain-dead motor-head Sacramento transplants stuck in the Fifties. Pity poor Oregon--so far from God, so close to California. And forget about Boise ID too. It's history. Don't get me going.

[AJ]

Interesting question is why was there more of a bubble in Bend than Eugene? Was there more construction growth in Eugene? A small increase in demand in Bend that set off a home price spiral? A run to 'positional' goods?

Duy's mini-rant on the joys of renting and evils of stone countertops doesn't explain the difference home price change between the two cities at all, which is the more interesting economic and social story, I think.

[Tim Duy]

AJ:

One possible/likely explanation is the growth restrictions were a greater contraint in Eugene than Bend, giving rise to more speculative developments in Bend (and Southern Oregon as well). Plenty of easily developable land.

Tim

[Kerry Kirpes]

I agree with Lafayette and I suspect fraud was rampant in many areas. I recently took a look at 8 houses being auctioned to see if might get a bargain. There is no way these houses could have been worth close to the last price paid. Lafayette points out the fraud being by perpetrated those packaging, rating, and selling investment vehicles. My experience suggests the fraud was also perpetuated by lenders, borrowers, and appraisers.

The environment seems similar to a "mob" enterprise. Either a cultural dog eat dog attitude became pervasive encouraging fraud at many levels or there were some organized efforts to ensure this happened.

[Jas Jain]

--
"I will be surprised to see real, effective regulation emerge until the Fed is divorced from the very unfortunate marriage to the fetish of liquidity that allows policymakers to turn a blind eye to the unquestionably damaging bubbles spawned by that marriage."

Thank you, Prof Thoma. But you must understand that Fed is a slave to Bankrupters and Fraudsters of New York City (BFNYC). The US economy has been fully criminalized by the interventions, including lack of proper regulation, by the Fed and the USG. The simple question to ask, in all cases, is: Who benefits the most and who losses out, both short and long term? I have never seen economists discuss, in-depth, who all lose out, no?

I recommend that you, or someone, do a thorough research into who all won and who lost out in the tech bubble (fraudulent accounting by my ex-employer Cisco, while I was employed, and many others, for example) and the housing bubble (fraudulent lending). The Criminalization of the US economy would become clear.

Jas

[Central Planning versus Market Based Allocation]

Central planning tends to produce mis-allocation of capital. Republics do not seem to be any better at central planning than the defunct dictatorship of the vanguards were.

[dale]

Bend used to be just the gateway to the 3 Sisters wilderness and the fishing lakes off of Century Drive. Just an honest working town on the way to paradise. Now it has become a destination itself.

25 years ago Outside magazine labeled Bend one of the best places to live. Perhaps it used to be.

[dale]

I have a friend who had two sons graduate, 2-3 years apart, with civil engineering degrees from Oregon State. The first one got a good job in Bend and was able to buy a home his first year there. The second son got a job with the same firm in Bend, at the same salary level. But the 2-3 years difference in the housing market made all the difference. He could not afford the market he moved into. Same good salary- just a couple of years of housing bubble inflation kept him from being able to afford to buy.

[Lafayette]

Farrar: The environment seems similar to a "mob" enterprise. Either a cultural dog eat dog attitude became pervasive encouraging fraud at many levels or there were some organized efforts to ensure this happened

Giuliani was right about NYC crime. He installed a Zero Tolerance pursuit of crime very small, small, medium and large. Well, maybe it was Spitzer who took care of the Large Stuff.

Looks like that's what we need on a national level in Finance. When the fraud is Vertically Integrated, beyond a local boundary, then the FBI has jurisdiction.

Where are they? Focused on recovering lost persons in less that 24 hours.

We've got a democracy with feet of clay.

[RW]

"We've got a democracy with feet of clay."

Possibly true but what society and what system does not? With the exception of Utopians who believe perfectibility is possible and typically have a good idea what form that should take -- unless the system actually lurches to that form and inevitably fails to work of course in which case it must not have really been that form after all ;-> -- the best we can probably do is strive for transparency and continue to afford protection to the minority when the majority becomes oppressive.

PS: Just out of curiosity is there anyone else out there who sees what happened in Bend as an exemplar of central planning?

[Winslow R.]

"I will be surprised to see real, effective regulation emerge until the Fed is divorced from the very unfortunate marriage to the fetish of liquidity that allows policymakers to turn a blind eye to the unquestionably damaging bubbles spawned by that marriage."

Sorry I don't have the time to read the comments yet, I'll do it later.

I am a strong supporter of liquidity.

Damaging bubbles are spawned by the marriage of intermediation to monopoly. Not liquidity.

If liquidity was accessible to everyone with solid equity (more than the gov/Fed were willing to destroy), overleverage would not have been required to pull us out of the 2001 downturn.

I surprised Ives and Tim have not thought this through.

[Mario Sikorski]

Research at People for Mathematically Perfected Economy argues that any purported, i.e., to have or present the appearance - often false - of being or intending, economy subject to interest ultimately terminates, i.e., comes to an end, itself under insoluble, i.e., incapable of being dissolved or solved or explained, debt, just because merely to maintain a circulation - the participants of economic activities - must perpetually re-borrow what those participants pay against already loaned principle and interest obligation as subsequent debts, thus perpetually increasing so much as periodic interest.

In case of Dr Ron Paul, how will competing currencies idea or United States return to the gold standard, or any other proposition offered arrest or stop perpetually compounding multiplication of debt and sorrow by instrument called interest?
There is one solution to inflation, deflation, stagnation and stagflation, but are We the People ready for it?

[Spectator]

Glad to see the dots get connected. There is one culprit, the Fed, and one policy, ignoring and promoting asset bubbles, that is to blame. Everyone is just starting to see how damaging that was. We've peeled very little of this onion.

All this on account of spineless bureaucrats that could not take the punchbowl away.

[Lafayette]

RW: Possibly true but what society and what system does not? With the exception of Utopians who believe perfectibility is possible

Granted, no such society exists on earth. But, if it did, it would be called Paradise wouldn't it?

Still, in terms of perfectibility, I can show a great many countries, with higher levels of Social Capital Expenditures, that provide a good deal more well-being to a larger proportion of their population than does America.

Try some, you'll like it! ;^) Rather than slamming the door on it with a cry that it is the devil's handiwork. Until you do, you really don't know what you are missing.

[ken melvin]

Take a $400 k house, sell it for an $800 mortgage (doesn't matter who you sell it to), sell the paper for $800 real dollars ... What a deal.

says...

So let me close these remarks with what Professor Minsky had to say (my emphasis):

"Commercial bank reserves mainly result from the ownership of government securities by the Federal Reserve. The government security/open market technique of supplying reserves to the banking system is not the only way reserves can be furnished. Prior to the Great Depression, a major part of reserves that were not based on gold were based on borrowings by banks at the discount window. The resurrection of the discount window as a normal source of bank reserves is a way of tightening Federal Reserve control over commercial banks. If commercial banks normally borrow at the Federal Reserve discount window, they will necessarily accept and be responsive to guidance by the Federal Reserve.

As long as bank reserves are mainly the result of open-market purchases of government securities, the giant banks are virtually immune to Federal Reserve pressures. If normal functioning requires banks to borrow at the discount window, then the capital adequacy and asset structure of banks will be under Federal Reserve supervision. A shift to a greater use of the discount window as a normal source of bank reserves should diminish the destabilizing influences in our economy that are the result of too rapid an expansion of bank financing of business and asset holdings.”

The Fed addressed the Minsky Moment of the last year exceedingly well. Now is the time to adopt the Minsky Solution.

Paul McCulley

http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/2008/Global+Central+Bank+Focus+5-08+Monetary+Policy+Conducts+Fiscal+Policy.htm

[Lafayette]

A dead man's handle

km: Take a $400 k house, sell it for an $800 mortgage (doesn't matter who you sell it to), sell the paper for $800 real dollars ... What a deal.

What a fraud.

But, such is the essence of a bubble ... prices rise inexorably without any bearing to reality. People are motivated to think, "Well, if I don't profit from the price rise, someone else will".

This is metaphorically called "Lemming Logic", after those furry little animals in Norway who rush off a cliff every four years because "everybody else is doing it!"

[NB: What they are effectively doing is responding to a population bubble, where, some think, food scarcity is brought about by excessive numbers of the rodents. Suddenly the population bubble bursts and the lemmings attempt to migrate massively and some propel themselves psychotically over a cliff into the sea, which reestablishes a basis for procreation. Or, something like that.]

Nobody cares to prevent the lemmings from leaping off a cliff. After all, they are only rodents. But, when Central Bankers take the same non-interventionist attitude towards a speculative frenzy of fellow citizens, motivated in much the same manner, then societal consequences are far more drastic.

The Social Distortion of a bubble's bursting, the purpose of which is, again, to reestablish a floor for realty value maintenance, is much too drastic a corrective remedy for a society to incur. It is evidently far, far better to have applied preventive medicine.

Central Bankers everywhere have a lot to learn. We've imputed them with a great deal of latitude in the use of their means. But, they still fight with the riddle of "What is right to do? When is it right?" -- because it is rarely apparent beforehand, until hindsight tells them that they "should have done something". Nice excuse, but no reason for dereliction of responsibility.

Let's hope that the housing bubble has taught Bernanke and his minions that a bubble is a bubble, even if only sectoral. When that sector morphs mechanically from realty to finance, under the machinations of Wall Street Investment Bankers, they had better get their mental wheels in gear.

Any mechanism, mechanical or political, should have a "dead man's handle". Some aspects of finance, prone to blowing bubbles, apparently need one as well.

NB: Dead Man's Handle refers to an old train device, still found in some subways. It was typically some form of switch that the driver would keep closed by hand. Should the driver suffer a calamity - such as a heart attack - their hand would loosen and the switch would open, stopping the train automatically. The aim of the dead man's handle was to protect the passengers, even in the worst possible case.

[ken melvin]

I'm sure Prof. Duy's seen:

http://www.oregonlive.com/business/oregonian/index.ssf?/base/business/1210987521306830.xml&coll=7&thispage=1

says...

mario s

"Research at People for Mathematically Perfected Economy "

worthy of jonathan swift

says...

miss allocation of capital ???

a house used as a residence
is a consumer durable

too much house
wrong type house
too fuel intensive
too lot intensive
too many up scale pads in the mix ???

whatr ??

these houses as built
were they a case
like our over large suv fleet
now
wacking into
an era of rapidly rising fuel prices ??

i think not

i think the bubble was in
lot values not house values

and if we're talking
an over investment in lots
this means nothing in itself that's "real "

is tim finding
a density externality ground rent effect type meme
behind any parting of ways between eugene and bend
lot values

this must in the long run rely on what ??

freer to build more and closer together
can kick off a higher "central " lots pricing spiral

even if region wide pop stays uneffected
then this means lower lot values on the outer margin

but if the region sucks in extra boom movers
from outside the region....
and if eugene's restrictions run opposite
then
hey....
get bad ass model fired up
and a big fast machine calculator
to run it on

this gets to have too many moving parts
real fast
at least for one meat calculator
using a simple vickrey type model

[Bruce Wilder]

Calculated Risk points to this article about a Bend, Oregon developer.

Whether fraud and malfeasance simply feed like parasites on fantasy-thinking in a "bubble", or whether fraud and malfeasance actually drive the bubble, is a debate worth having. But, not-in-the-abstract, criminality plays a large part.

Whenever any one from Bernanke on down claims they cannot be addressing asset bubbles, what they are really saying is that they are not willing to prevent or prosecute criminal behavior. The criminals are their friends and fellow Republicans.

The article I point to above ends with this telling paragraph:

"Meanwhile, Desert Sun hasn't gone out of business, but Fitzsimons is attempting to move on. He formed a new company, TFMH LLC., in January. A month later, eight lots in Sisters were transferred to that company from a Desert Sun affiliate. In February, according to Deschutes County property records, Columbia River Bank gave the new company a $3.4 million line of credit."

When you've read the article and you know the role of Fitzsimmons and Columbia River Bank in ruining people's lives with fraud and deceit, you will know what I am talking about. This is not going to end.

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