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The Fed’s Housing Bubble Laughter

On January 22, 2012, in Housing, WTF?, by Tim

The Federal Reserve transcripts from 2006 released ten days ago continue to reverberate around the internet as the central bank has become a laughing stock for being so unaware of the U.S. housing bubble that was inflating to dangerous levels throughout the year.

Dean Baker’s Alan Greenspan’s ship of fools from last week is well worth reading if for no other reason than to learn what former Fed governor Frederic Mishkin was thinking late that year and I recently came across this item at The Daily Staghunt blog that charted how much laughter appeared in the transcripts over the years.

While Fed economists are purportedly a funny lot, it does look pretty bad to see increasing joviality at a time when they could have been doing something about the housing bubble.

The FOMC (Federal Open Market Committee) meets this week and they are expected to announce of a new communication initiative with two key features – expanded interest-rate projections and an explanation of their objectives for inflation and employment. Fed Chairman Ben Bernanke will surely discuss these in detail in the press conference after the meeting and, though normally keen on audience engagement, he’ll probably be hoping that he’s not asked about the 2006 transcripts.

If we’re really lucky, someone will ask him about this chart.

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On that Premature Tightening in 1937

On December 30, 2011, in Economy, by Tim

I’ve never really gotten that argument about how the Federal Reserve and U.S. government tightened too soon in the late-1930s and, as a result, induced another recession. In his column today, Paul Krugman notes:

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Yet, anyone able to look at the data back in 1937 would hardly see the U.S. economy as “depressed”, not after three straight years of real GDP growth averaging 11 percent. While perhaps not a “boom”, a “strong recovery” was certainly underway by then.

To be sure, the 1930-1933 downturn was severe, but, according to the data from the BEA above, the U.S. economy had returned to its 1929 bubble output by 1937 when all the policy mistakes were supposedly made.

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Models Behaving Badly

On December 14, 2011, in Economy, by Tim

Now, this looks like a good stocking stuffer – a book about the failure of economic models written by a physicist who used to work at Goldman Sachs. In Models Behaving Badly, as reviewed in this item at the Wall Street Journal, we learn all kinds of neat things about how the dismal set has become increasingly detached from the real world.

Trained as a physicist, Emanuel Derman once served as the head of quantitative analysis at Goldman Sachs and is now a professor of industrial engineering and operations research at Columbia University. With “Models Behaving Badly” he offers a readable, eloquent combination of personal history, philosophical musing and honest confession about the dangers of relying on numerical models not only on Wall Street but also in life.

Mr. Derman’s particular thesis can be stated simply: Although financial models employ the mathematics and style of physics, they are fundamentally different from the models that science produces. Physical models can provide an accurate description of reality. Financial models, despite their mathematical sophistication, can at best provide a vast oversimplification of reality. In the universe of finance, the behavior of individuals determines value—and, as he says, “people change their minds.”

In short, beware of physics envy. When we make models involving human beings, Mr. Derman notes, “we are trying to force the ugly stepsister’s foot into Cinderella’s pretty glass slipper. It doesn’t fit without cutting off some of the essential parts.” As the collapse of the subprime collateralized debt market in 2008 made clear, it is a terrible mistake to put too much faith in models purporting to value financial instruments.

This was just added to my Amazon.com wishlist and, hopefully, Santa will take notice.

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Bernanke Has “Delayed the Inevitable Future”

On December 13, 2011, in Economy, by Tim

Since we’ll be out when the Federal Open Market Committee meeting adjourns in an hour or so, offering up yet another policy statement for an increasingly fragile global economy, this story at The Onion seemed worth sharing between now and the time that we return.

To no one’s surprise, Fed Chief Ben Bernanke came in #1 in the short list of most influential economists and, sadly, the satire website’s characterization of what he’s accomplished probably isn’t too far off the mark.

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Economists and the Housing Bubble

On December 13, 2011, in Housing, by Tim

More evidence that economists in general and dismal scientists at the Federal Reserve in particular are hopelessly and dangerously detached from reality (i.e., guided by the mistaken belief that, if something doesn’t exist in their models, neither does it exist in the real world) comes via this Associated Press story about a new study by the central bank detailing how wild speculation drove the late, great U.S. housing bubble.

A new federal report shows that speculative real estate investors played a larger role than originally thought in driving the housing bubble that led to record foreclosures and sent economies plummeting in Nevada, California, Arizona, Florida and other states.

Researchers with the Federal Reserve Bank of New York found that investors who used low-down-payment, subprime credit to purchase multiple residential properties helped inflate home prices and are largely to blame for the recession. The researchers said their findings focused on an “undocumented” dimension of the housing market crisis that had been previously overlooked as officials focused on how to contain the financial crisis, not what caused it.

More than a third of all U.S. home mortgages granted in 2006 went to people who already owned at least one house, according to the report. In Arizona, California, Florida and Nevada, where average home prices more than doubled, investors made up nearly half of all mortgage-backed purchases during the housing bubble. Buyers owning three or more properties represented the fastest-growing segment of homeowners during that time.

“This may have allowed the bubble to inflate further, which caused millions of owner-occupants to pay more if they wanted to buy a home for their family,” the researchers noted.

I saw this last week when it was originally published and should have mentioned it at the time (the report from the New York Fed can be found here), but, now that it’s getting lots of attention in the mainstream media it’s a case of better late than never.

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Achuthan Unbowed

On December 12, 2011, in Economy, by Tim

Apparently ECRI’s Lakshman Achuthan was on Bloomberg late last week to talk about his U.S. recession call from last month and,  in his weekly commentary today, John Hussman brings us the sad news that the recession hasn’t been canceled – it’s just been delayed.

As noted last week, we continue to estimate a very high probability of oncoming recession.
…
That view is clearly shared by the Economic Cycle Research Institute, where Lakshman Achuthan noted on Bloomberg last week that “forward looking data since two months ago has remained weak, it’s getting weaker, it’s not turning up. So, to my fellow forecasters out there, I’d say they’re roughly in two camps. There are those who say that the economy is firming and will continue to firm into next year. We reject that. There’s nothing there that suggests that at all. I think there’s a larger camp that says we’re going to muddle through; we’re going to get this kind of slow growth, ‘I’m not terribly optimistic, but we’re going to muddle through.’ I would point out that that’s never happened. We never muddle through. A market economy does not want to have a static state. It either accelerates or it decelerates, and these forward looking indicators say decelerate.”

Achuthan also noted that “the other half of the GDP report,” gross domestic income or GDI (which tends to be the more accurate measure of GDP) was up just 0.3% in the most recent quarter. The Federal Reserve has observed that when GDP and GDI differ, the GDP figure tends to be revised toward GDI, not the other way around. Achuthan warned that the GDI figures are “a big red recession signal.” In response to the question “You had a recession call, what happened?,” Achuthan simply answered “It’s happening.”

Those preferring the “glass half full” version might want to have a look at this Bloomberg article today U.S. Economic Data Surprising Forecasters, where, right off the bat you learn that “U.S. economic data are outperforming expectations by the most in nine months” and, later on, a plethora of other economic indicators are at their highest levels in nearly a year.

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