A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

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Age: 26 Occupation: Private Equity

Monday, March 31, 2008

Hillary Says to Copy Japan?

Sometimes, I can't believe what I hear from our politicians. But then, I realize that our politicians know as much about economics as they do about, well, anything else except politics (no, they are not smarter than a 5th grader). So, in essence, they know what is spoon-fed to them by their overworked, underpaid and understaffed staff, which is often incomplete and sometimes dead wrong.

At first, I was delighted to hear 1990s Japan brought into the discussion. That is, until I heard Hillary say that we should be more like Japan. Then I was shocked. Yes! Bring on the agonizing, torturous 15-year funk that was Japan after 1990! What amount of self-loathing would actually lead someone to desire such an outcome? Is she going to try to legislate mandatory self-flagellation for 5 hours per day, and bi-weekly root canals with no anesthetic, as well? Sometimes, we just have to gape in awe at the folly of our fellow (wo)man.

Saying we should try to emulate Japan is no different, IMHO, than holding up the Pittsburgh Pirates as the blueprint for baseball success (I still love you, Buccos, but your 15-year funk puts you in the same category as Japan's economy as far as futility is concerned, though on a slightly different scale).

At least someone is paying attention.


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Hillary's Bad History
March 31, 2008; Page A18

No, not sniper fire in Bosnia. We're referring to Hillary Clinton's lament last week that the U.S. is flirting with a 1990s Japan-style deflation. Perhaps it's a good time to remind everyone what really happened in Japan, so Mrs. Clinton and the rest of Washington don't make the same mistakes.

"I don't think we can work our way out of the problems we're in in the broad-based economy with monetary policy alone," Mrs. Clinton said in the interview with Journal reporters. "I think the Japanese tried that and tried and tried that." She added Japan should have relied more on fiscal stimulus spending and aid to banks and homeowners, which is what she wants Washington to try now.

The Senator needs a refresher in Japanese economic history. Far from easing monetary policy, the Bank of Japan kept money too tight for too long in the early 1990s. Japan's stock market slide began in early 1990, but its central bank raised interest rates through most of that year and didn't cut them until July 1991. While the Bank of Japan eventually chased interest rates down to zero, it was always too late to break the deflationary spiral.

There's little sign the U.S. is facing a similar danger today, given that the Federal Reserve has been dropping rates quickly as the economy has slowed. If anything, the problem is the opposite, with the Fed risking future inflation by putting rates into negative real territory and devaluing the dollar. (See Ronald McKinnon nearby.)

Japan also made the mistake of refusing to make banks pay for the mistakes they made during their global lending spree in the late 1980s. As the world economy fell into recession in 1990, so did Japan. But rather than letting banks take their losses, the Liberal Democratic Party kept bailing them out. This merely delayed the day of reckoning, as insolvent banks were allowed to exist as "zombies," alive in name but unable to lend.

[Hillary's Bad History]1

The government also raised consumption taxes, burdening consumers at exactly the wrong time. Meanwhile, with encouragement from the Clinton Treasury, Tokyo launched a vast Keynesian spending program. Roads, bridges, trains -- you name it, Japan built it. The nearby chart shows the impact this spending had on overall Japanese government debt, which exploded over the decade. The nearly annual spending programs led to several false recoveries with growth blips, but they never changed incentives enough to revive domestic risk-taking.

Yet this is exactly the policy that Mrs. Clinton now wants the U.S. to emulate. Rather than let housing speculators and lenders take the hit for mispricing credit and allow the market to clear, she wants a 90-day freeze on foreclosures and a five-year freeze on mortgage resets. She also wants the feds to buy up mortgage-backed securities and guarantee troubled mortgages. Rather than let housing markets find a bottom where they can begin a recovery, she and her allies in both parties would prolong the agony. While some homeowners and banks would be saved from foreclosure or greater losses, the cost would be to lengthen the housing recession.

A better model is the one the late Al Casey put into practice during the savings and loan crisis in the early 1990s. As president of the Resolution Trust Corp., Mr. Casey sold almost $400 billion of bankrupt assets as rapidly as he could. Declaring that his purpose was to "put the RTC out of business," Mr. Casey let investors buy those assets even at "vulture" prices. The real estate market was able to find a bottom, and the recovery came so fast that Bill Clinton inherited an economy that grew by 3.3% in 1992.

The Beltway class also now wants to indulge in the same Keynesian "stimulus" that failed in Japan. Mrs. Clinton's "Rebuild America Plan" would invest $10 billion over 10 years in an "Emergency Repair Fund" -- a plan she claims would create 48,000 jobs for every billion dollars spent, or close to half a million jobs. She would build ports, railroads, airports, public transit, tunnels and roads. Senate Democrats are proposing more than $35 billion in new spending -- on top of their $168 billion in tax rebates. These may also lead to false recoveries, but they won't ignite a new round of risk-taking and investment.

Japan finally emerged from its funk earlier this decade after it realized its bank losses and caught the updraft from global monetary reflation. Still, its economic growth remains mediocre -- a level that wouldn't be tolerated in the U.S. and may not be enough even in Japan. Sluggish growth has already sunk one Prime Minister and could prove fatal to the current leader, Yasuo Fukuda, whose approval ratings are dropping fast.

The way to revive U.S. growth is by learning from Japan's mistakes, and doing the opposite. The U.S. needs monetary policy that maintains a stable price level, bank supervision that recognizes mortgage losses and lets markets clear, and marginal rate tax cuts that boost incentives to work and invest. In short, the American policies of the 1980s, not those of Japan's lost decade.

Friday, March 28, 2008

Waiting for that one, dumb home buyer

Tim Iacono, in his fantastic blog "The Mess that Greenspan Made," has some great points in his post below.

Waiting for that one, dumb home buyer

Amid the very low real estate sales volume in many parts of the country today, the prices of those few homes that are sold are now falling much faster than the asking prices of homes currently for sale.

That fact is clear to see in many neighborhoods as sellers sit and wait, either not knowing or not caring that they have little chance of getting anywhere close to what they're asking unless that one, dumb home buyer shows up who knows less about real estate market conditions than they do.

The New York Times had a story about this yesterday - what some call "riding the market down" - and they touched on a couple of the key issues:
In most other areas of the economy, this combination of plummeting sales and stable prices would not happen. When demand for airline tickets drops, the airlines cut their prices until they have sold their seats. When stocks become less appealing, share prices fall, sometimes sharply.

Just try to imagine stock prices staying roughly flat over a three-year period while sales volumes sank because investors considered the market overvalued. Bear Stearns is still worth $150 a share, and I’m not selling until someone pays me $150!

Real estate, though, is different. For both economic and psychological reasons, there is no asset more conducive to hopeful overvaluation.
That means real estate slumps tend to grind on for years, until sellers submit to reality and reduce their prices.
In many ways, it would be better if the housing correction would happen more swiftly and sharply. The pain might be worse, but it would be over quickly. We seem to understand this principle when we’re removing a bandage. Why, then, is it so much harder with housing?

Because houses are almost perfectly engineered to trick owners into overvaluing them.

For starters, people have an obvious emotional connection to their house. After you have raised a family or enjoyed long meals with friends there, you are naturally going to place a higher value on it than a dispassionate buyer would. It’s your home.
David Laibson, a leading behavioral economist, categorizes this sort of behavior under the heading of “the principle of the matter.” His point is that people often go to great lengths to avoid taking a loss — or simply having to acknowledge one. “Even a small loss evokes a sense of frustration,” said Mr. Laibson, a professor at Harvard. “There’s something magical about ‘at least breaking even.’ ”

Often, this hurts no one so much as it hurts the would-be sellers. They stay in homes where they no longer want to live, rather than accepting their loss and moving on. Or they move but endure the hassle of renting out their old home, waiting, usually in vain, for the mythical buyer who understands its charms. All the while, their money is tied up in the house, and inflation is eating away at its real value.
There are a bunch of houses in our neighborhood that have been on the market since 2006 and the asking price hasn't budged. In some cases the price has been lowered by a tiny amount - for example, from $595,000 to $589,000 - in what seems to be a mini-capitulation for the benefit of either themselves or their real estate agent.

They look ridiculously out of place now that bank foreclosures are coming onto the market priced hundreds of thousands of dollars lower.

Wednesday, March 19, 2008

Blecch! NAR's Yun Named Top 10 Forecaster by USA Today

Isn't he the guy who revised his forecast on a monthly basis because he was wrong?

There must only be 10 economic forecasters...

NAR Economist Among Top Forecasters

THE NATIONAL ASSOCIATION OF REALTORS'® Chief Economist Lawrence Yun has been named among the top 10 economic forecasters by USA Today. Yun is ranked fifth on the list and is responsible for NAR’s real estate statistics and economic forecasting. The annual list recognizes accuracy in forecasting.

“NAR is proud of USA Today’s recognition of Lawrence Yun and his economic forecast accuracy. He is a highly regarded economist, and the housing and real estate industry have come to rely heavily on his economic analyses,” says Dale Stinton, NAR executive vice president and chief executive officer. “This acknowledgement contributes greatly to NAR’s reputation as the leading innovator in housing-related research.”

Yun was named NAR’s chief economist and senior vice president of research in November 2007. He has been with the association since 2000, previously serving as vice president and senior economist. He pioneered the development of the Commercial Leading Index after helping develop the residential Pending Home Sales Index.

“I’m honored to be recognized among some of the best economists in the country,” says Yun. “The economy and housing industry are facing many challenging issues at this time, which makes this an interesting and stimulating position.”

USA Today enlisted the help of the Federal Reserve Bank of Atlanta to determine the most accurate forecasters among the economists surveyed in the newspaper’s quarterly survey on the U.S. economy.

The economists, whose identities were unknown to those gathering the data, received four scores — one for each quarterly survey — and were ranked on the average of those four scores. FRBA used statistical methods to assess the joint accuracy of the predictions rather than assessing the accuracy of each forecast variable separately, as is commonly done.

Before joining NAR, Yun worked as an economic consultant to the U.S. Department of Veterans Affairs and the U.S. Department of Education. As a research associate at the University of Maryland, Yun developed the graduate economics curriculum for and taught free-market economics in the former Soviet Union as that country transitioned from communism to a free-market system.

Yun received his Ph.D. in economics from the University of Maryland in 1995. He received a B.S. degree in mechanical engineering from Purdue University in 1987.

REALTOR® magazine online

Tuesday, March 4, 2008

Japan, Here We Come!!!

We are at a crisis point, indeed. However, lost in all of this hoopla is that this isn't a foreclosure crisis, but a housing affordability crisis. You need no proof aside from the fact that foreclosures began to spike in a time of extremely low unemployment and a generally strong economy. Prior, foreclosures have largely been a symptom of economic hardship, not the cause. Many cannot afford to handle a "market" housing payment even at today's somewhat reduced values. For those who can, paying off our housing debt continues to suck up valuable income that can be used to buy goods and services and stimulate the economy.

As I've said before, either incomes must rise dramatically (unlikely given the economic outlook) or housing prices must fall dramatically (10-15% with stable interest rates) before the system regains equilibrium. In this housing fiasco, where the order of magnitude stretches into the trillions, there is literally nothing we can (or should try to) do to stop this process from occurring.

Unfortunately, some of us, especially those desperate to hold onto political offices, feel like we should try. Some folks across the Pacific in Japan thought the same thing back in the 1990s. Let's see how that turned out...

Thanks to Charles Hugh Smith, from whom I borrowed the chart above.

From Wikipedia on the Japanese RE bubble:

The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low guarantee of being repaid. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many "zombie businesses".

The time after the bubble's collapse (崩壊 hōkai?), which occurred gradually rather than catastrophically, is known as the "lost decade" (失われた10年 ushinawareta jūnen?) in Japan. The Nikkei 225 stock index eventually bottomed out at 7603.76 in April 2003 before resuming an upward climb.

Instead of letting things get back to normal, where people had to be able to pay for stuff out of their incomes, Japan struggled mightily to prop up failing banks and dwindling asset prices. Despite Japan's sincerest efforts, this only served to prolong the agony and balloon the national debt, leading to Japan's "lost decade." Today, due to the bloated cost of government bailout programs during the last 15 years, 70% of Japan's tax revenues are dedicated to servicing debt, up from about 30% prior.

The lesson: We have to take our medicine one way or another, and quick and painful seems much better than prolonged and agonizing.

We haven't seem to have gotten the message. Just when I thought we couldn't get any denser, Ben Bernanke comes out of the woodwork and says that lenders should simply reduce the amount people owe on underwater loans. Am I missing something here? Gee, instead of keeping the loans the way they are and the lender collecting 3/4 of the money... why don't we all just "fuhgeddaboudit" and reduce the principal wholesale, so the lender loses the 1/4 he was going to already along with the 3/4 he would have collected anyway? Who needs all those hundreds of billions anyway? Brilliant (sarcasm).

That's even better than the "negative amortization certificate" idea where banks would buy underwater loans, reduce the principal owed and get a warrant for the reduction amount, which they could collect with interest when the house is eventually sold, provided it sells for enough to cover both the mortgage and the warrant. Hmmm, so why wouldn't I just sell my house to get rid of your warrant and buy a similar house? That way, I wouldn't have to pay anyone when I sell...

Ridiculous... I hope we all don't lose a decade because of this...

Bernanke Says Homeowners
Need More Help on Loans

March 4, 2008 4:35 p.m.

ORLANDO, Fla. -- More needs to be done to help troubled homeowners, including a broader effort to write down the principal of some problem loans, Federal Reserve Chairman Ben Bernanke said Tuesday.

[Ben Bernanke]

"In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure," Mr. Bernanke said in prepared remarks. (Read the full speech.)

Speaking at the Independent Community Bankers of America conference in Orlando, Fla., Mr. Bernanke said the current turmoil in the housing market "calls for a vigorous response."

"Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done," Mr. Bernanke said.

Though most loan modifications by lenders have focused on reducing the interest rate on a borrower's loan, Mr. Bernanke said a reduction in the principal might be more appropriate. Specifically, with many borrowers owing more on their home than the value of their mortgage, "a reduction in principal may increase the expected payoff by reducing the risk of default."

Mr. Bernanke also suggested a number of policy options that could help the current situation. Reforming the Federal Housing Administration, including giving the agency more latitude to set underwriting standards, could help reduce foreclosures.

Additionally, Fannie Mae and Freddie Mac could have a bigger role in dealing with the current problems if both companies raise more capital, Mr. Bernanke said.

"New capital raising by the GSEs, together with congressional action to strengthen the supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they securitize," Mr. Bernanke said.

Write to Michael R. Crittenden at michael.crittenden@dowjones.com