Good Evening: After the bottom seemed to fall out on Friday, the major U.S. stock market averages soared today, recouping a large portion of those hefty losses. The news flow that set the backdrop for today’s gains was not universally supportive, but it was certainly construed as such. China (higher bank reserve requirements) and Australia (a huge tax on miners of natural resources) both introduced measures that aren’t exactly pro-growth, while the EU stitched together a rescue package for Greece to help prevent another banking panic. The economic news in the U.S. was more positive, which, along with some M&A news in the airline industry, helped set the tone for today’s rally. Though it would be foolish to compare what’s happening today to the housing bubble year of 2004, Friday’s release of the FOMC minutes from that year sparked some interesting memories for me. The Greenspan Fed claimed to be confused about rising home prices back then, but Bill Fleckenstein most certainly was not. As we will see, Bill’s warnings stood in stark contrast to the Maestro’s bewilderment.
When an EU-IMF rescue package of nearly $150 billion for Greece came together over the weekend, many were hoping its arrival would stanch the bleeding equities suffered on Friday (see below). The keepers of monetary policy in Beijing, however, stifled the celebration when they yet again hoisted reserve requirements for their banks. Copper and the other base metals were already retreating on this news when Australia introduced one of the dumbest tax schemes in recent memory (see below). I will have more to say in a future commentary about why it is not a great idea to raise revenue by driving a costly stake through the heart of a nation’s most thriving business, but it appears that even the fine people of Australia share the global affliction of politicians with alarmingly low economic IQs.
Stocks in both Asia and Europe were under pressure overnight, but U.S. names enjoyed a minor bid. United’s proposed merger with Continental undoubtedly helped, as did Monday’s early economic releases. Consumer spending rose 0.6%, though I don’t see how it’s good news that Americans are once again spending more than they make (personal income was up only 0.3%). The ISM survey was strong, though not quite up to the high expectations set for it. Stocks were already high and rising when the weaker data points (construction spending and auto sales) were released later in the trading session. Lost in the shuffle, they didn’t seem to matter.
After rising 0.5% at the open, the indexes chopped around a bit during the opening hour of trading. Once the buyers overcame their anxieties about problems overseas, though, share prices here took flight and never looked back. By day’s end, the 1.3% gains for the Dow and S&P actually lagged the other averages, while the Russell 2000 (+2.25%) and Dow Transports (+2.9%) were Monday’s leaders. Treasurys were soft, and yields rose between 1 and 4 basis points. The dollar benefited from another swoon by the euro (the deal for Greece still needs final approval by EU member governments and the Greek populace — good luck!), while commodities were mixed. The Aussie mining tax may have hurt the mining companies, but, aside from copper, the products themselves hardly budged. The CRB index fell all of 0.1% today.
As soon as I saw the article you see above, it brought with it a rush of frustrating memories from the housing bubble era. These commentaries were but a paragraph long back in 2004, but even back then it was pretty clear the Fed was fostering speculation in the housing market to help the economy recover from the equity bubble that popped in 2000. What I wrote in those days is locked away in a UBS database somewhere, but clear thinkers like Jim Grant and Bill Fleckenstein wrote about the housing bubble until their fingers cramped over their keyboards. Bill was outraged at the Greenspan Fed’s supposed inability to spot (let alone act to pre-empt) the craziness, and he has kindly allowed me to reprint the following excerpts from the 2004 editions of his always excellent “Daily Rap”. Please note that the datelines of these missives are just days prior to the June 30, 2004 FOMC meeting cited in the Bloomberg article above:
Daily Rap, 6/23/04 — “No Housing Bubble, No Stock Bubble, No Inflation, and No One Home at the Fed”
Fed Issues a Housing’s-Bubble-Free Decree
“As if to provide comic relief to my recent rants about the lunacy in the housing market, the New York Fed has weighed in on the housing bubble, and — surprise, surprise — surmised that there can’t be one. To quote the conclusion of NY Fed economist Jonathan McCarthy and NY Fed Vice-President Richard Peach:
“Our analysis of the U.S. housing market in recent years finds little evidence to support the existence of a national home price bubble. Rather, it appears that home prices have risen in line with increases in personal income and declines in nominal interest rates. Moreover, expectations of rapid price appreciation do not appear to be a major factor behind the strong housing market. . . . ”
“The most widely cited evidence of a bubble is not persuasive because it fails to account for developments in the housing market over the past decade.” I suppose these “developments” mean that houses are now better, so they have not really gone up in price, from a hedonic point of view — ergo, we can’t have a bubble. . . . ” (Obviously, I am being sarcastic.)
“Our observations also suggest that home prices are not likely to plunge in response to deteriorating fundamentals to the extent envisioned by some analysts. Real home prices have been less volatile than other asset prices, such as equity prices. Several reasons have been cited for the lower volatility, including the cost to speculate in the housing market.
“However, there have been examples of extreme home price volatility where it presumably has been costly to speculate, such as in Japan in the late 1980s and the 1990s. Therefore, we prefer instead to emphasize that the lower volatility of national home prices likely stems from the disjointed nature of the U.S. housing market.
“Furthermore, our state-level analysis of home prices finds that while prices have risen much faster recently for some states than for the nation, the supply of housing in those states appears to be inelastic, making prices there more volatile. We therefore conclude that much of the volatility at the state level is the result of changing fundamentals, rather than regional bubbles. Nevertheless, weaker fundamentals have caused home price declines in those areas with inelastic supply. If the past is any guide, however, that phenomenon is unlikely to plunge the U.S. economy into a recession.”
It Walks & Talks Like . . . But Fed Squawks: No Bubble
“I particularly liked the line: ‘Moreover, expectations of rapid price appreciation do not appear to be a major factor behind the strong housing market.’ I don’t know how completely and totally clueless you have to be to come to that conclusion. Rapid price appreciation is the primary driver behind what’s going on in the housing market, just like it was in the stock mania.
“It’s one of the key characteristics of a bubble, where the anticipation of price action causes buyers to get in, and then the price action changes itself, totally distorts the market, and it feeds back on itself in a “positive manner” until the whole thing exhausts itself, before collapsing. That’s what’s going on in housing. The Fed has been uniquely adept at blowing bubbles, and even more adept at rationalizing what’s patently obvious to anyone with an IQ of room temperature.”
Daily Rap, 6/24/04 — Houses: Heads We Win; Tails, No One Loses
NY Fed: Pick Up a Copy of the NY Times
“Lastly, there was a terrific article about real-estate speculation in today’sNew York Times, titled “The Ever More Graspable, and Risky, American Dream.” I just loved the following quote from one homebuyer named Ray Daneshi, because it completely and totally refuted the NY Fed’s view (which I discussed yesterday) that buyers are not driven by the expectation of price increases: ‘We will not be going to any movies or eating out at restaurants. . . . But in two years, the house will be worth a lot more, and we will have something to show for it.’
“Radically higher price expectations are precisely why folks are speculating in housing. As the article makes clear, they now believe that getting a 100% mortgage is their God-given right. Do they really thinkhousing is truly a one-way street? Why would any sane lenders be willing to take all the downside for none of the upside, and get a whopping 3.5% in return? I’m not sure where all this bad paper is hiding, but at some point it’s going to be tested, and then the availability of credit to the housing market will be $0.0.” (source for all quotes: www.fleckensteincapital.com)
I love that last line, since it proved to be more prescient than anyone at the time could imagine. Bill was not alone in spying the central problem — overly low interest rates and absurdly easy mortgage finance terms — but his views were clearly and distinctly different from the “puzzlement” reigning in the halls of the Eccles building at the time. I would also like to emphasize that this divergence took place a full 3 years before housing, mortgage finance, the markets, and the economy blew up in June of 2007.
Jim Cramer is often credited with being ahead of the curve with his August 3, 2007 rant, but actually he missed what was going on until it was too late to prevent untold damage. Bill saw it, warned everyone, and he did it in real time — when action could still have prevented the ensuing mess. Obviously, higher interest rates than the 1.00% fed funds rate that prevailed until the June 2004 meeting would have helped cool things down, but the Fed was “worried” about the impact of higher rates on the general economy. Let’s be gracious and grant the Maestro his concern, but there were many other tools he could have used to prevent the worst abuses of the last mortgage credit cycle.
First, the Fed had a bully pulpit with which to jawbone lenders into tougher standards than simply having a pulse and a pen with which to obtain an oversized home loan. If lenders were too weak (or too bonus-driven) to pay attention, the Fed had the legal power to enforce higher underwriting standards among its member banks (a power Bernanke actually invoked in late ’06/early ’07). Mr. Greenspan also failed to notice that Fannie Mae and Freddie Mac were taking on enough mortgage risk all by themselves that were enough to blow up the financial system. Worst of all, Mr. Greenspan actually encouraged folks to avail themselves of Adjustable Rate Mortgages and other “affordability products” that were becoming popular in 2004. The unchecked growth of the subprime and Alt-A segments of the mortgage industry weren’t a problem for Mr. Greenspan, nor were “low doc” or “no doc” (i.e. liars’) loans. He instead hailed them as “important innovations”. The last thing “Neg Am Option ARMs” needed was the most powerful central banker in the world shedding his suit for a cheerleader’s uniform. .
The mess Bill Fleckenstein so clearly foresaw and just as clearly warned everyone about finally came to pass in 2007/2008. He was so angry about the damage being unleashed at the time — and the Maestro’s central role in it — that he wrote a wonderful book on the subject, “Greenspan’s Bubbles: The Age of Ignorance at the Fed”. All I can say is that I hope that more people scrutinize the historical minutes of the FOMC. Once they do, “Easy Al” will be truly debunked, once and for all. We should also offer up a “well done” to Bill Fleckenstein. When it comes to foresight, his is 20/20.
— Jack McHugh