by Calculated Risk on 2/21/2006 03:06:00 PM

From PIMCO: Chris Dialynas Discusses Causes and Implications of Low Interest Rates and the Yield Curve Conundrum

Here are his views on housing:

Q: If the global economy is awash in liquidity, wouldn’t that normally lead to inflation?

Dialynas: The inflation has occurred. The inflation is in the housing market. The inverse of the current account deficit has been debt creation, and debt has accumulated in the consumer side and federal component of the economy. So the inflation that we have realized in the U.S., the U.K., Australia and other current-account deficit countries, but also in some surplus countries like China with low-priced labor and undervalued exchange rates, has been huge price inflation in the real estate markets. Housing price inflation is, in essence, the externality of this global liquidity and fixed exchange rate regimes.

Housing price inflation has some very important longer-term implications. A housing bubble leads to more investment in housing, which contributes to current GDP growth. However, if that investment were in plant and equipment of equal magnitude then we would have a productive resource with which production could be utilized to repay the current account deficit. In the case of a housing bubble and construction boom, no such product is available. The economic prospects for the national economy will rise and fall with the housing market. A pop in the housing bubble may invoke a ruinous downward multiplier reduction in the U.S. economy while the debts remain. Ultimately, the houses themselves may need to be liquidated to settle debts with foreigners.

Ouch.

by Calculated Risk on 2/20/2006 06:52:00 PM

Forbes reports: Trichet says market expectations for ECB rate hike are 'reasonable'

European Central Bank president Jean-Claude Trichet reiterated that market expectations for an ECB interest rate hike are 'reasonable'.

The ECB is widely expected to raise its main refinancing rate to 2.50 pct from 2.25 pct at its next meeting on March 2.
...
He also said that house price rises in some euro zone countries are 'not normal'.
...
In its February monthly bulletin, the European Central Bank said it sees tentative signs that the euro zone housing market is becoming overvalued following recent sharp price rises in some countries.

Some recent house price rises in some euro zone regions may be unsustainable, it said.

Trichet told the committee that the real estate sector is important for the ECB and one of the parameters that it considers when taking interest rate decisions.

And he said it is important to 'avoid further inflation of the bubble' in some euro zone housing markets.

Its interesting that Trichet commented on real estate being important with regards to interest rate decisions. I'm not sure if he is talking about targeting asset prices, or just that the real estate sector is an important part of the economy.

by Calculated Risk on 2/17/2006 08:59:00 PM

The Financial Times' Jim Pickard has lunch with Dr. Robert Shiller: The man and the bubble. A few excerpts:

What I really want to know, not least as a homeowner, is when and how the property market will crash. So I ask him.

For a man whose written predictions seem so definite - and dire - he appears loath to be nailed as an inveterate doomster. "I really don’t know what prices will do," he says hesitantly, playing with his cutlery.

But hasn’t he predicted a huge drop in US house prices? Only in some specific cities and states, he clarifies.

The professor is no doubt aware that the history of economic forecasting is littered with the names of those who made the right forecasts at the wrong time.

And more:

What, exactly, can Ben Bernanke, Greenspan’s successor, do to rescue the US economy if the property market crashes? Has the Fed already used up its one silver bullet - that of interest rate cuts?

"Bernanke thinks there is no housing bubble," says Shiller. "According to the White House website, he said recently that the fundamentals explained house price movements except in some speculative markets." The new chairman of the Fed is a "brilliant man", Shiller continues, but he has not shown any interest in behavioural economics.

And this is where he has underestimated the danger posed by real estate speculation. "He is not attuned to one of the great innovations of our time, that is, bringing psychology back into economics."

Here we come to the crux of Shiller’s theories about asset bubbles, whether tulips, shares or property: people get excited as they see the price of an asset rising, so they buy more, which pushes the prices up further until they are unsustainable. "The bubble is made by a ‘story’, by excitement and glamour," he says. And then, once a market loses that momentum, it will experience negative feedback, where people rush to sell before things worsen further.

I'm disappointed that Shiller didn't offer a suggestion as to what Bernanke could do.

Last year I provided some supply-demand diagrams to model the market dynamics of speculation that might be of interest to some readers: Speculation is the Key

by Calculated Risk on 2/16/2006 08:58:00 PM

From Barron's Online: Is It Crunch Time for Housing? (hat tip: Gary Evans for the link)

Bear markets, be they in stocks, housing or commodities, go through certain identifiable phases, like Elizabeth Kubler-Ross's famed five stages of dealing with dying -- denial, anger, bargaining, depression and finally acceptance.

"It's a three- to five-year cycle on the downside," says Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at UC Berkeley.

Rosen calls himself a real-estate bear who endorses the doom-and-gloom scenario of Yale University professor Robert Shiller (see Barron's, "The Bubble's New Home," June 20, 2005)."

We've already passed stage one, characterized by "a falloff in new sales and orders," says Rosen, and are just entering stage two, in which unsold inventories build up.

That may be where the crunch begins.

Prospective sellers, of course, can just take their homes off the market and live in them until they think they can get a better price.

But speculators don't have that luxury: At some point they can no longer carry a money-losing investment, so they may throw in the towel and unload their once-promising albatross.

That's stage three, says Rosen, and it usually finishes about three years from the beginning of the downturn.

The final phase is when we see massive defaults or delinquencies on mortgage loans. That's several years away, he says, and this time the damage could be worse because of the large number of exotic loans giddy lenders extended to desperate home buyers (see Barron's, "Coming Home to Roost," Feb. 13)."

There is more in the article. I think the sequence is more like:

1) A surge in inventories as sellers try to get out at today's high prices.

2) followed by a drop in orders as buyers become leery of buying at the top. Historically house prices tend to be sticky as sellers want prices close to those of recent sales in their neighborhood. And buyers want a discount from recent sales. The result is a drop in orders.

3) Then prices start falling as some sellers (speculators and homeowners in distress) need to get out.

There are other economic impacts:

1) as prices stagnate or fall, homeowners will withdraw less equity from their homes and that will impact retail sales.

2) as transactions decline, housing related employment will fall.

3) and finally, as mentioned in Barron's, there will be defaults or delinquencies on mortgage loans.

Already inventories are rising rapidly. And I believe sales are just starting to decline. The next few months will be interesting.

by Calculated Risk on 2/16/2006 07:26:00 PM

Click on image for full cartoon.

David Horsey is a cartoonist for the Seattle Post-Intelligencer.

And for more on the National Debt, please see pgl's post on Snow's actions today: Snow Withholds Checks to the Retirement Accounts of Federal Workers

As of February 15, 2006, the National Debt is $8.238 Trillion.