Low Chance of Recession--Still

relevant.

Brian is the chief economist for First Trust Advisors and one of my go-to guys on all matters economic. He's a go-to guy because his forecasts are nearly always spot-on.

Here's an article Mr. Wesbury wrote at the very top of the housing/credit bubble. I'll highlight the "spot-on" parts for you.

Mr. Greenspan's Cappuccino

By BRIAN S. WESBURY May 31, 2005 Get out your dictionary and thesaurus: Alan Greenspan is at it again. In 1996, he suggested that stock investors suffered from "irrational exuberance," a few months ago he labeled surprisingly low long-term interest rates a "conundrum" and this month he said that there was "a little froth" in the housing market, calling it an "unsustainable underlying pattern."

In the dictionary, "froth" is described as a mass of bubbles, or foam. It brings to mind a cappuccino, not a realtor's office. Nonetheless, it is obvious what he meant. In some markets, homes are bought and sold before they are even finished. Double-digit annual price increases are common. And in April, both new and existing home sales jumped to all-time record highs, pushing toward the fifth consecutive year of annual records.

Nodding their heads with caffeinated vigor, bubble-believers gathered around the espresso machine and said "I told you so -- even Greenspan thinks the trend is unsustainable." These nattering nabobs expect a housing collapse to take down the U.S. economy. But excessive pessimism is unwarranted: Fears of a housing bubble are overblown.

Housing is a complex market. It is affected by demographics, taxes, wealth, interest rates, regulation, the economy, and commodity prices. Each of these has played a role in boosting demand for housing or holding back supply. This has affected both market activity and prices in recent years. Understanding these trends is important to any analysis.

Demographics -- Roughly 80% of all people between the ages of 50 and 64 own their own homes, versus 70.6% of people aged 35-49, and 69% of all Americans. The number of people in the U.S. aged 50-64 jumped from 35.3 million (13.3% of the population) in 1996 to 49.4 million (17.2% of population) in 2005. No wonder housing is strong. As the population ages, homeownership rates rise -- it's as simple as that.

In addition, the baby boomer bulge is creating a great deal of churning in the housing market. Empty-nesters are selling the home they raised their family in and moving to less time-consuming digs like condos, or buying a second home. In many areas, older housing stock is bought only to be torn down and replaced.

Taxes -- Prior to 1997, homeowners 55 years of age or older were allowed a once-in-a-lifetime, tax-free gain of up to $125,000 upon selling a home. But taxes could be avoided by rolling any capital gain from a home sale into a new house. The result was a massive increase in pent-up home equity.

This equity was released in 1997, when President Clinton signed tax legislation that allowed couples to sell a home they had lived in for at least two years and take up to $500,000 in gains tax free. Given the deductibility of mortgage interest, housing is probably the least-taxed investment available to U.S. citizens. Tax something less and more of it is created.

Wealth -- Just as the post-WWII economic boom led to two-car families, the wealth-creating boom of the 1980s and '90s is spawning new homeowners and many two-home families. All that pent-up housing wealth created by baby boomers over the past 30 years had to go somewhere.

While many believe that irresponsible borrowing is creating a bubble in housing, this is not necessarily true. At the end of 2004, U.S. households owned $17.2 trillion in housing assets, an increase of 18.1% (or $2.6 trillion) from the third quarter of 2003. Over the same five quarters, mortgage debt (including home equity lines) rose $1.1 trillion to $7.5 trillion. The result: a $1.5 trillion increase in net housing equity over the past 15 months.

Interest Rates and Fed Policy -- After realizing that it had tightened excessively in 1999 and 2000, creating deflationary pressures, the Fed cut the federal-funds rate 11 times in 2001, eventually pushing it to a 45-year low of 1%. Using the Consumer Price Index (CPI), the real federal-funds rate has been below zero for more than two years -- the most accommodative monetary policy since the mid-'70s.

Because productivity in home building has not increased as rapidly as in other industries, and regulation and land restrictions have reduced available supply in some areas, an outward shift in the demand curve due to easy money and demographics has lifted housing prices more than overall consumer prices. The average price per square foot of a new home jumped 43.5% between 1992 and 2003. The CPI, excluding housing costs, increased 27.2% during the same years. Housing prices have increased roughly 1.5% faster than overall consumer prices -- a sign of strong demand and rising commodity prices, but hardly a bubble.

The Fed has also helped lift housing activity by working hard to hold down long-term interest rates. When he was a Fed governor, Ben Bernanke urged the Fed to use its public communications to help manage the bond market. He argued that if the Fed could lower the markets' expectations of the future path of short-term interest rates, this would pull the entire yield curve lower. This thinking was the birthplace of the term "measured." By telegraphing slow and steady rate hikes, the Fed has engineered low long-term rates. Artificially low long-term interest rates have helped fuel strength in housing.

We suspect that Chairman Greenspan has been surprised by the bond markets' response to his use of the word "froth." Many believe that the Fed waited too long to hike rates in response to "irrational exuberance" in the equity market, so by raising the possibility of "local bubbles" in housing it would seem rational for the market to expect the Fed to address this issue more quickly.

But the market reacted in the opposite direction. Following his "froth" speech, long-term bond yields fell sharply as if the market expects the Fed to slow its rate hikes. This, however, would be a mistake. The stock market exuberance of the late '90s occurred during a period of falling gold prices and disinflation or deflation. Recent robust housing markets have occurred during a time of rising gold prices and growing rates of inflation. The Fed is creating an environment where bubbles can exist today; this was not true in the late '90s.

The good news is that demographic, tax and economic factors explain most, if not all, of the greater-than-expected activity in housing. Moreover, the age groups with the largest propensity to own homes will continue to make up a greater share of the population for the next 10 to 20 years. Adjusting for demographics, it is virtually impossible to believe a nationwide housing bubble exists. Nonetheless, if the Fed does stop hiking rates at current levels, a bubble could easily form. The best course of action for the Fed is to ignore the housing market altogether. History has shown that the Fed makes its worst mistakes when it takes its eye off inflation. Every significant decline in housing has occurred during a recession and the worst slumps in housing happened in the stop-and-go, stagflationary era of the '70s and early '80s.

To avoid repeating those days again, the Fed must boost rates enough to head off any further upswing in inflation. Doing so may remove the monetary stimulus to housing, but what appears clear is that it won't change the very positive trends already in place.

Mr. Wesbury is Chief Investment Strategist with Claymore Advisors, Inc.

http://online.wsj.com/article/SB111749811222546623.html

That was written over 2 years ago. The bubble started to burst I think sometime in 2007. He wasn’t wrong in May 2005 IMHO.

Nice find. Credibility shot. Nobody knows for sure if we are in the beginning of a recession or if we will avoid one, but certainly and for sure, his credibility is nil. Again, nice find and thanks for posting.

Housing bubble burst in 2007? Not even close. The housing bubble was decidedly burst by Winter 2005.

Article in “The Nation,” called “Pop Goes the Real Estate Bubble” from October 2005...

http://www.thenation.com/doc/20051024/real_estate_bubble

Here is an article from the Seattle Post-Intelligencer from November 2005 talking about the housing bubble bursting...

http://seattlepi.nwsource.com/business/248140_boomsover12.html

MSN article from April 2006, “The Housing Bubble has Popped”...

http://moneycentral.msn.com/content/P149596.asp

Even a brief GOOGLE search and 5 minutes time will show that the bubble was bursting by Winter 2005, and not 6-months earlier this doofus was talking about the infallibility of the US real estate market.

Credibility, Kaput!

What A Credit Crunch Looks Like http://commonsenseforecaster.blogspot.com/2008/02/what-credit-crunch-looks-like-when-fed.html

When the Fed decreases interest rates to increase loan demand, but the banks make it tougher to borrow because of deteriorating loan conditions, we have a credit crunch. The real problem is that the Fed will continue to decrease rates, but it will not achieve the desired effect. The Fed is running out of ammunition. The banks still have a ways to go in terms of deteriorating loan conditions. No one is sure how bad the economy in the US will get in 2008 and 2009, which will exacerbate both interest rates and loan opportunities. Ever wonder what a slippery slope looks like? Now you know. Text in bold is my emphasis. From Bloomberg:

The Federal Reserve said it became tougher for U.S. companies and consumers to get loans in the past three months, particularly to buy real estate.

Most lenders anticipate more delinquencies and losses this year, assuming ``economic activity progresses in line with consensus forecasts,'' according to the central bank's quarterly survey of senior loan officers released today in Washington.

The survey, conducted last month through Jan. 17, was available to Fed policy makers last week and may help explain the central bank's fastest easing of monetary policy since 1990. Chairman Ben S. Bernanke and his colleagues lowered their benchmark rate by 1.25 percentage points last month, aiming to revive lending and spending, averting a recession.

``It's definitely a broader-based tightening than we've seen before,'' said Edward McKelvey, senior U.S. economist at Goldman Sachs Group Inc. in New York. ``The economy is weakening and weakening in a pretty substantial way.''

About 80 percent of banks raised standards on commercial- property loans, a record, while a majority tightened terms on prime home mortgages.

Bernanke warned in a Jan. 10 speech that there was ``considerable evidence that banks have become more restrictive in their lending to firms and households.''

``Financial markets remain under considerable stress, and credit has tightened further for some businesses and households,'' the Federal Open Market Committee said in its Jan. 30 statement.

The survey covered 56 domestic banks and 23 foreign institutions. The 56 banks together have $5.95 trillion in assets, representing about 54 percent of the country's $11.1 trillion total for all domestically chartered, federally insured commercial banks.

About one-third of U.S. banks said they increased their standards on commercial and industrial loans, while two-fifths said they widened spreads of interest rates over their cost of funds. Both responses represented an increase from the October.

In commercial real estate, the proportion of banks tightening terms was the highest since the Fed began seeking information on the subject in 1990. About 45 percent, on net, of both U.S. and foreign institutions said demand for such loans weakened in the past three months.

Many banks became stricter because of a ``less favorable economic outlook,'' and a ``large fraction'' of U.S. banks reported a ``reduced tolerance for risk,'' the Fed said. Examples of credit standards in commercial real estate include the maximum loan size and maturity and loan-to-value ratios, the Fed said.

For home loans, about 55 percent of U.S. banks toughened terms for prime mortgages, up from 40 percent in October, while 85 percent of respondents made it tougher to get nontraditional loans, up from 60 percent, the survey said. A majority of U.S. respondents said demand worsened for prime, nontraditional and subprime mortgages. (Remember my comments about how the demand for housing was being choked off?)

The Fed also asked banks about their outlook for delinquencies and charge-offs in 2008. For seven of eight questions, no banks expected loan quality to improve for business and consumer loans; most expected the quality to worsen.

Banks are making it tougher to get financing after $146 billion in asset writedowns and credit losses since the beginning of 2007 damaged their balance sheets.

Surging defaults on subprime mortgages caused losses to ripple through the finance industry, and banks and securities firms are now searching for as much as $84 billion of capital to shore up their finances.

Fed Governor Randall Kroszner today urged lenders to ``quickly'' enact modifications of home loans at risk of default, before 2 million mortgages reset higher over the next two years.

The Treasury last year brought mortgage lenders together through an alliance called Hope Now to fast-track loan modifications and keep Americans in their homes.

Today's Fed survey showed that 35 percent of respondents expected ``streamlined loan modifications of the sort proposed by the Hope Now alliance to be at least a somewhat significant loss- mitigating strategy for banks.''

Some 85 percent of banks said loan-by-loan modifications based on individual circumstances would be ``significant'' in their approach to stemming losses.

``As rates reset, it is important that we take steps to protect homeowners, communities, the mortgage market, and the economy from the adverse consequences of unnecessary defaults and foreclosures,'' Kroszner said in a speech at a conference in Las Vegas today.

Housing figures have yet to signal a recovery. A report last week showed that purchases of new homes in the U.S. unexpectedly fell to a 12-year low in December, capping the worst sales year since records began in 1963. The median price dropped 10 percent from December 2006, the most in 37 years, the Commerce Department said.

The tougher standards may have yet to spread to smaller companies. William Dunkelberg, chief economist at the National Federation of Independent Business, which conducts its own survey of members, said he hasn't seen ``any difference in credit availability for small businesses'' since mid-2007.

Credit-card lenders have tightened loan standards for consumers in California, Florida and other states most affected by the housing slump. Citigroup Inc., the third-largest lender to Visa Inc. and MasterCard Inc. cardholders in the U.S., reduced lines of credit for borrowers it considers more likely to default and had to double fourth-quarter reserves for card losses.

Sorry...

Link for above should be:

http://commonsenseforecaster.blogspot.com/2008/02/what-credit-crunch-looks-like-when-fed.html

It is worth repeating the thesis of the above article.

"The real problem is that the Fed will continue to decrease rates, but it will not achieve the desired effect."

Below excerpts from this source:

http://prudentbear.com/index.php/MidWeekAnalysisHome

We have said that the slowdown in consumer spending would happen once lenders quit lending. It has become very apparent that the credit environment has turned and has shut out the consumer. The most recent Federal Reserve survey of senior bank-loan officers found that over half the banks tightened lending standards for consumer loans. The survey found that banks have tightened lending standard for commercial loans as well. One-third of the banks surveyed tightened credit for commercial and industrial loans as well. Commercial real estate loans were tightened at 80% of the banks. Additionally, about half said they have widened their spread over their cost of funding.

While the Fed has lowered interest rates and will most likely continue to lower rates, banks are less willing to lend and are increasing the spread for loans. This will obviously curtail the impact of the rate cuts. If lending standards continue to tighten, the impact of the Fed cuts might be negligible. Unfortunately, with losses piling up on banks balance sheets along with leveraged loans from the M&A boom, this will be the most likely outcome.

Once again, from above, repeated for emphasis:

This will obviously curtail the impact of the rate cuts. If lending standards continue to tighten, the impact of the Fed cuts might be negligible.

I no longer like to think about it. It seems to be very bad indeed and in several months it’ll move from abstract to very, very real.

BULLISH!

Come on, Bennie! Slash that FED rate to 1%!

I’m scared too. The arrow is in flight and there isn’t any way to call it back. I just don’t expect TEOTWAWKI. I feel like the American economy is just too resilient for a total meltdown, collapse, depression or Weimar.

I have no clue what to expect from here on out. We’ll just do our best I guess. Time to keep my nose clean and just prepare to weather the storm. I mean, how bad can it be?

You know what that will mean. I can’t bring myself to type the words but it involves a Wicked Witch in the White House. If people think the economy is heading south now, wait until Hitlery begins shredding it. Hitlery and her minions just COULD be the nail in the coffin of the US economy.

I mean, how bad can it be?

It can be very bad. Every single Wall Street guy I meet lately just seems twitchy as hell. Not that they have “secret information,” they just seem to feel it in the air.

Great post. He’s a typical permabull “expert,” a real “go to guy.” Two years ago, touts like him were selling the line that Real Estate was rock solid.

As their positions are overrun by reality, they ignore their past failed prognostications, and fall back to the next line of trenches.

In 2005 he was making PREDICTIONS, that turned out to be totally 100% wrong.

Many of us here were saying so at the time.

Now we should listen to this Mr. Magoo?

Don’t worry, President Hillary Obama will save us with a New New Deal.

Best.

Article.

Ever.