Ingram: One bubble, like new

                   The real engine of the U.S. economy
                   throughout the recent downturn - and to
                   a lesser extent the Canadian one as well
                   - has been the consumer, and by far the
                   biggest sign of that has been the
                   incredible strength of the housing market.
                   Sales of existing homes in the U.S. set a
                   record in January, and a recent report
                   from Royal LePage on the Canadian housing resale market showed
                   that some metropolitan regions have seen similar performance. But
                   can it possibly last, or is it another bubble in the making?

                   If housing sales - both new and existing homes - have been an
                   engine for the economy, the rocket fuel was supplied by Federal
                   Reserve Board chairman Alan Greenspan and his counterparts at the
                   Bank of Canada, who slashed interest rates at an almost
                   unprecedented rate over the past year and a half. That in turn pushed
                   mortgage rates near record lows, and spurred many would-be
                   homeowners to make the leap, not to mention encouraging existing
                   homeowners to sell and use those rates to move up.

                   January's sales in the U.S. market came in 16.2 per cent higher than
                   the previous month, at a record annual rate of 6 million homes -
                   compared with most estimates of 5.2 million - and some expect the
                   market to see 5 million homes sold for the year, close to the record of
                   5.3 million homes set last year. On the construction side, housing
                   starts in January rose by 6.3 per cent to their fastest rate in more
                   than two years.

                   Morgan Stanley economist Dick Berner told The Economist that
                   American house prices have risen by more in real terms over the
                   past five years than during any previous five-year period. It's not just
                   the U.S. either: a recent survey by Royal LePage showed that the
                   average price of a home or condominium in Toronto has climbed by
                   anywhere from 9 per cent to 24 per cent in the past year, and the
                   International Monetary Fund said rising house prices and debt levels
                   in Britain are also a concern.

                   According to some analysts, the weak stock market could be
                   exaggerating the activity in the housing sector, as investors turn to
                   strong house prices to compensate for tumbling stock portfolios.
                   "People want to jump on the housing bandwagon, and the fairly rapid
                   price appreciation... during the past two years has many investors
                   looking for better returns over equities," William Sullivan of Morgan
                   Stanley told Dow Jones.

                   The risk, of course, is that the same thing that happened to
                   technology stocks occurs in the housing market: prices climb beyond
                   a reasonable level, driven by a surge in demand, and then the bubble
                   pops at some point. That's what happened to the housing market in
                   both the U.S. and Canada in the 1980s, when higher interest rates
                   suddenly torpedoed the boom in house prices in many metropolitan
                   markets. In some cases, prices still aren't back to where they were in
                   the 1980s in inflation-adjusted terms.

                   One fear is that homebuyers - both new and those moving up in the
                   market - are being sucked into a purchase by low mortgage rates,
                   and encouraged to take on more debt than they could have afforded a
                   year or two ago. Why settle for a $300,000 house in Toronto when you
                   can now make the same payments and get a house that's worth
                   $350,000 or even $400,000? That's all well and good, until mortgage
                   rates start to rise - as they have already begun to - and take your
                   monthly payments along with them.

                   In a larger sense, a falloff in activity in the housing market could
                   weaken the recovery in both the U.S. and Canadian economies, since
                   the "wealth effect" created by home equity is even more pervasive
                   than that created by owning stock. According to research by several
                   economists - including Yale University professor Robert Shiller, who
                   coined the term "irrational exuberance" to describe the dot-com
                   boom - higher home prices create almost twice as much
                   consumption as high stock prices.

                   Most economy-watchers seem to feel the housing market is not at
                   risk of a major meltdown. It would take a sudden increase in mortgage
                   rates to torpedo the sector, they say, and that doesn't appear likely.
                   The housing market is also more resilient than the stock market
                   because sellers tend not to dump their house if prices weaken - they
                   hang on to them, which keeps a vicious cycle from forming the way it
                   does in stocks. Housing experts also say there isn't as large a glut of
                   supply as in 1980.

                   At the same time, however, levels of household debt are at or near
                   troubling levels - bolstered by the popularity of refinancing at lower
                   rates - and still the housing market continues to soar. The bubble
                   may not burst with a bang, but all it would take is a series of upticks in
                   mortgage rates to put on the brakes, and all of a sudden the
                   consumer-led growth that has looked so rosy in the past might look a
                   lot less so.

I'm glad this guy mentioned The Economist, because there's a much more thorough and enlightening article this month about the same topic. While he's right that higher interest rates sank the housing market in the late 80's, home prices correlated to wages were somewhat higher than they are now, and to boot, there's no sign that inflation is around the corner and that rates will have to jump as they did then. Furthermore, unless alot more people go into adjustable rate mortgages than I think, his point about overbuying is silly. Once the rates are locked in, the payment stays the same.

I think it goes without saying that homes are a different investment altogether than stocks, we all know that. The kicker here is that new homes are not being built at any rate close to what the need is, at least here in N California, and with any kind of demand, limited supply keeps the prices high.

Home builders are as sensitive to interest rates as home buyers. The difference between the two is the year or more it takes the builder to produce, vs. the immediate increase in home sales as the buyers take advantage of the interest rate. In all I would rather have a home buying and building led recovery than a stock market led recovery. Home buying engages not just the real estate market, but appliances, furniture, remodeling, interior and exterior designers, building materials makers, banking, etc... A stock market led recovery? I don't think there is such a thing, it's just an indicator that stock holders are wealthier, not of economic activity.

Re #2

Housing may not go as high as stocks. Nevertheless, the cheaper credit through mortgage adjustment will make people hunt for better existing houses, driving housing price. This will also help them buy other durable goods because money is freed from mortgage payment. The housing bubble is at this point more of an intent than of result at this time. If cheap credits keep coming out, then this could create some noticeable bubble. At the least, this is a way of sustaining market in general through consumer spending.

cut in prime lending rate, increase in credit card issuing, now cheaper mortgage are all devices to inject money into economy, especially on consumer side. The question is how long this will last without affecting dollar values. Is deflation such a menace that Fed and Treasury Dept do everything to flood market with cheaper and cheaper credits as long as possible ?

Re #9

I do not think that they are hyping this time. The way I figure that, during the boom , bulls are right, and, during the bust, bears. If we always discount folks pushing gold, we have to believe that there is no bear market, and crash. The worst is a minor dip. And the market rockets forward in full blast. The market always surges ahead beyond P/E ratio 25, 40, and 60. But we should not believe that these overvaluation will be corrected drastically because doing so will make us gold-bug automatically. This is not the behavior of rational agents in the capitalist market. This kind of irrational behavior made "invisible hand" paralyzed in the financial market.

Is deflation such a menace that Fed and Treasury Dept do everything to flood market with cheaper and cheaper credits as long as possible ?

It's been known since the depression, that deflation is the worst. Deflation seems to be almost uncontrollable once it starts, as it seems to feed on itself. While lite inflation seems to be beneficial to an economy. We all know hyperinflation is bad but many economies have experienced it(Germany,Russia) and sprung back stronger than ever after. A look at Japan which did have a real estate bubble, and is now in a deflationary depression, show how long a deflation lasts, and how hard it is to get out of.

Re #14

Japan's deflation persists due to political problems. Small powerful group of business/government complex do not let bad corporations go under. They are happy surviving on the country's huge reserve of savings. America appears to bias against deflation due to its own past experience. Germany's problem was also political because hyperinflation was triggered by heavy burden of reparation money to Allied powers. I mean that too much credit has been extended that they have to be paid back on way or another. One possibility is a permanent inflation without much income increase. The inflation which goes up and stay there, not coming down. After inflation, you may be 20-40% poorer. And there is no easy way to make up for it soon. That is the most convenient way to go for everybody.

I'm not sure I understand what your saying. All economies have political problems. In fact when an economy goes bad it's always the government's fault. I think what your saying about inflation being good at wringing the debt out of an economy is right, but it also destroys savings at the same time. In other words destroying savings at the expense of an easier debt burden. Inflation therefore preserves jobs, plants and equipment, and real estate. Unlike deflation, which preserves savings(for awhile) and destroys jobs, factories, and real estate. As owners walk away from unpayable debt, bank loans become uncollectable, and savings are destroyed as the banks go belly up.

Japan's real estate and stock market bubble, left the banks with huge non-performing loans, which the owners walked away from. The government has papered over and hidden the problem, and kept the economy stable with government spending. But the savings are gone, the government is $5 trillion in debt and 50% of the budget goes to pay the interest, while 30% of the budget is borrowing. A recent meeting in NY, saw the Japanese speakers laughed at when they suggested they had everything undercontrol, and that the banks only had $200 billion in bad loans.

When the savings and loan problem first began in the 80's, the fed said they had $50 billion in bad loans, that eventually turned out to be $200 billion, and these were people who were trying to find the truth. When all is said and done the Japanese banks are probably hiding $2 trillion in bad loans. If all we did is use the saving a loan experence of a four fold increase, it would still be $800 billion. However the Japanese are very good at ignoring the truth,and I think my figure of $2 trillion is more likely. Durring the real estate bubble, the city of Toyko alone was valued the same as all of the United States($30 trillion).

It's said that the Japanese have an earthquake culture. By that I mean it's static except for brief periods where everything explosively changes. This is in contrast to the US culture, which is in a constant state of minor changes.

Re #16

I tried to say that, in the beginning, the deflation in Japan was not inevitable. It was not built into market dynamics to cause deflation at the time, if bad loans were taken care of, which were manageable, albeit painful process. You are right that Japan has earthquake culture. If you look at Japanese history, there were only a few shattering political/social events which changed the course of country. Otherwise, they did not change much.

I was trying to say that inflation can be as bad as deflation. Inflation may not have a death-grip like deflation. But it may erode sizable chunk of nation's wealth. If debt gets too big in a rush to head off deflation, it could be just as bad. Just like Japan has many hidden debt, US may have its share of hidden debts. It may not be as big as Japan's. We will see.

What America is doing is to intervene before bubble popped. Fed preemtively inject money into market to head off any ill-effects. Japan did it after it is in recession. While America can be more flexible than Japan, if such a flexibility is directed toward delaying the inevitable rather than cleaning up the problem, it may not serve America well.

I worked for Toyota for 8 years, and spent 6 months of that time in Japan in the 90's. So when I say that america is much more transparent than Japan, and therefore unable to hide from problems you will understand. I also read an excellent analysis of the american character recently by an australian, who said americans are the most confident and the most self critical people on the planet. I therefore believe that we are fundimentally incapable of sweeping a problem under the rug as the Japanese do. We faced our savings and loan problem squarely, while the Japanese are still ignoring their banking problem, 10 years after everyone in the world knew they needed to do something about it.

RE #19

America's bubble is not really popped yet. Once it pops, then some actions will be taken sooner than later, unlike Japan. I was merely talking aobut the moment of truth being delayed consciously by policy makers and other big players in the market. They are recognizing the problem alright. They pour in a lot of credits to the markets in order to fend off serious downturn. Once any serious problems develops, the mood of country and those in power will change just like 9/11/01. Some of big players will have a lot to answer for. So it is being delayed at all cost. It also have a big political consequence. Any sitting admin. will be held responsible. That is why Clinton admin hyped it skyhigh and Bush is trying to keep it there as long as possible.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.