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Saturday, October 6, 2012

Transcript: 522 Housing and the Macro Game

Part Three of the Housing presentation from here at Demand Side.

Part One was a digression on how the housing problem is really the investment problem. You were convinced that we are overbuilt in housing. We are overbuilt in consumer goods production. And what we need is big investment in public goods, specifically education, health care, transportation and energy infrastructure.

Part Two A relayed the simplistic housing market theory. Housing is recovering by the numbers. Stable prices. Higher home sales. Not much higher. You wouldn't be able to detect the uptick in a twenty-year chart. But in a five-year chart, sure. The housing bottom is in. We heard it from Calculated Risk, Bill McBride.
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Part Two B was the bifurcated market theory. On both the demand side and the supply side, there are two classes. Buyers are now split between traditional homeowners and vulture funds and others moving in because there's no money elsewhere, and besides capital is cheap. Lever up, boys.

Sellers are split between traditional sellers and distressed sales. Even the traditional sellers are taking a bath on what they thought their home was worth. Other homes are coming out of one or another phase of foreclosure. There are cross-currents between the two parties on the two sides.

Now is part three. The macro game. Here we see the Fed and the Treasury have positioned themselves as heroes defending the bridge. They have leveled their guns in defense of ... the banks. By which we mean the private holders of the bad debt. The treasury has abandoned the homeowner and the legitimate write-down of the debt in favor of mark-to-whatever. The Fed, largely led by Bernanke, has determined that mortgage backed securities, if bought, will be the key. Private buyers of these securities are in the market only because the Fed is there, keeping up the price.

First let's dispense with the notion that this is about jobs. First the happy talk from Ellen Zentner of Nomura Securities.


Here is a riposte from Robert Eisenbeis, formerly of the Atlanta Fed, now of Cumberland Advisors.


Now, of course, $980,000 is not the net cost per job. Since the securities on the Fed's balance sheet have some resale value, the real cost is the difference between the purchase price and the sale price. If you believe the Fed will ever sell these.

This is keeping the prices of these down and forcing money into the economy. The Fed is buying with dollars it is inventing. Those dollars are going to float the financial markets. They are not going to buy food. It is not the excess cash to rich people that is driving up the demand for food and gasoline and so on that is creating the consumer price inflation, such as it is. It is the excess cash that is going to rich people that is driving up the prices of these as they speculate in those markets, the risk markets. It is a commodities bubble driven by speculation. It is a stock bubble driven by search for yield. You actually hear this more and more among the professional analysts.

This is monetary policy. It is not working. It will not work. It cannot work. The most it can do is keep the financial markets floating. The inflation hawks are right at the Fed and elsewhere. The inflation is not locked in some time capsule, pressurized time capsule, ready to be released on the world at some unknown future date. The inflation is bubbling up the commodity markets, the stock markets, the bond markets, the securities markets. This is the intent of Fed policy and it is working.

The transmission of that into a job is not working, whether it is the intention of the Fed or not.

Unfortunately, it is not the real economy. If one-tenth the capital used in this effort to save the banks were used to actually hire people to do things that need to be done, yes, you would see some inflation, but you would also see a recovery in the real economy. If the credit expansion that is the source of automobile sales and student debt were in the public sector creating jobs doing things that need to be done, the real economy would take off.

But the real economy is captive to the financial economy. The jailers are the Fed and Treasury and Wall Street's control of the political process. All are active in the futile attempt to avoid an inevitable and ongoing deflation of asset prices. Deflation? Yes, deflation. We have made the point that there are two types of inflation/deflation, in consumer prices and in investment goods. When there is no investment, there is a natural tendency for the economy to stagnate. But how do we know investment goods are deflating? One, prices are going down. We saw a collapse in the primary category of investment over the 2000's – housing. Two, we see people prefer cash to investing. There is a lot of talk about uncertainty, but the uncertainty is not government regulation. The uncertainty is demand, and more than that, whether there is a need for more investment to meet an upturn in demand. Housing is overbuilt, and industrial capacity is overbuilt, both as a result of decades of public subsidy mostly through the tax rules.

Demand Side begins with the premise that the economy is constrained or is driven, depending on your verb, by the demand side. We don't create employment by favoring business and banks, we create employment by creating employment, and that favors businesses and banks. Where you see income growth or credit growth now, associated with the real economy, you see growth growth. Where you see the Fed buying massive amounts of securities. you get nothing, or at best a slowing of deflation. Effective demand is composed of the change in debt and income. The change in debt is largely to the downside in the private sector as households delever, that is household austerity. Businesses lead in the austerity race. States and municipalities are driven to austerity by balanced budget frameworks. Now the federal government is in a posturing war that may force it to austerity. Do we expect a different outcome for ourselves than Greece? Probably not. That's why we call it the fiscal cliff in the U.S. instead of austerity.

Deleveraging should be done by writing down debt. Debt that did not produce the revenue to service it should be written down.

It is a strange and bizarre world we live in where half a decade of evidence is ignored in favor of the paradigm that created a crisis.

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