patrick.net

tatupu70 says

Both of your points are incorrect. The Federal Reserve most definitely does not set rate caps on savings accounts. The free market sets savings rates.

Of course it does, by setting overnight lending rate. If the TBTF bank can borrow at less than 0.25% for as much money as needed at the FED window, why would it pay any deposit much more than that rate.

And, second, we've been over illogical your bailout theory is. #1 not all banks got bailed out. #2 even the banks that got loans still lost huge sums of money

Of course not all banks get bailed out. Only the TBTF gets bailed out; that's the point in having a cartel. Also the TBTF field gets more and more concentrated under the Federal Reserve's 100 year history. I'm not sure what you are trying to say regarding the banks getting the loans still lost huge sums of money. Of course banks lose money when they bet wrong. Without the bailouts some of them would be out of business, and their counter party would also be out of the alleged winning. Artificial construct of lost money in some cases is the deliberate effort at getting taxpayer money. e.g. the AIG case, the real bailout beneficiary is not AIG but GS.

tatupu70 says

With each post, you seem to change your reasoning as to how low interest rates cause a bubble. You had it right earlier. It's an information and behavioral problem that is more likely correlated with low interest rates rather than caused by them. Low interest rates occur when there is lots of money around with nowhere to go--like now--and those times are ideal for bubble creation.

I didn't change my reasoning at all. The most important piece of mistaken information in bubble decision making is regarding the interest rate. The mistake maker assumes the FED would continue with the lower interest rate for even longer. When we are talking about Federal Reserve Notes as money, when there is lots of money around is not exactly a naturally occurring or random event, but a controlled event by the FED.

Reality says

Of course it does, by setting overnight lending rate. If the TBTF bank can
borrow at less than 0.25% for as much money as needed at the FED window, why
would it pay any deposit much more than that rate.

I will admit that I'm not an expert on how banks can manipulate the reserve requirements, but I find it hard to believe that they can overtly mock them by using the overnight lending window each night to meet the requirement.

Reality says

Of course not all banks get bailed out. Only the TBTF gets bailed out;

lol--it's impossible to know beforehand whether you are one of the TBTF banks. So you can't make decisions based on it. I'm sure Lehman thought they were TBTF.

Reality says

I'm not sure what you are trying to say regarding the banks getting the loans
still lost huge sums of money. Of course banks lose money when they bet wrong.

You're arguing moral hazard. I'm saying--how is it moral hazard when they lost huge?

Reality says

The mistake maker assumes the FED would continue with the lower interest rate
for even longer.

The bubble didn't burst because of higher interest rates. Even if rates continued low, housing went have tanked. It was lack of underwriting standards, and that was a time bomb no matter what the rates were.

Reality says

Not true. Pink slime can only go into ground products. It's not physically possible to mix that into a steak or even soup chunks. Costco never put pink slime in its ground beef, nor did Wholefoods, even before the Pink slime scandal broke out.

Uh, Ground Beef is ground, no? It sure looks like it went through the mill to me.

I'm damn sure that the low grade beef sold as "Grade A" in supermarkets is trash, simple test, cook two patties next to each other, one "Grade A Pink Slime" and the other Grass-Fed Beef, same fat content. I think you'll notice very obvious results. Cows are meant to eat leafy green plants, not just corn kernels.

Competition isn't necessarily done by Robert's Rules. Companies compete by any means necessary, including trying to regulate their competitors out of business or at least trying to regulate away their ability to communicate the quality of their product to the consumer.

The COOL law is a battle between importers who want to source the cheapest meat from Chernobyl and Mukden farms and slap a "Grade A" sticker on it, without telling the customer about it. While whiny US rancher-millionaires-on-subsidies want to peddle sickly monotonously-corn-fed cattle as "Grade A".

How come companies don't want to inform the consumer? Usually if it's a good thing, they like to brag. They don't want to tell the consumer because they know many people will not pick up ground beef labelled "Mix of healthy beef from delightful Northern China."

And regulation without enforcement is useless. How many people you know have been arrested for removing the mattress tag from their bed?

Just because crap got by regulators, doesn't mean we shouldn't have regulators.

That's like saying because the police don't make an arrest for every murder or robbery, we shouldn't bother with police at all.

Pink Slime still used in over-the-counter Walmart meat sales:
http://ayzha.wordpress.com/2012/06/02/walmartsams-club-continues-to-use-pink-slime-in-ground-beef/

Pink and White Slime is "Grade A" though!

And I imagine others are doing ditto.

Just to add, most companies only want consumers to know the good shit they want to tell them about their product, not the bad shit.

For example, meat glue or collagulant. Meatpackers and restauranteurs want this little tidbit hidden from the consumer, not disclosed except under the misleading name of "formed meat" which means nothing to the ordinary public. Allows them to charge a premium price for sub-par meat.
http://www.youtube.com/watch?feature=player_embedded&v=S6BAspR3LPo
http://www.dailymail.co.uk/news/article-2144981/How-chefs-use-meat-glue-pig-blood-stick-steaks-together.html#axzz2KJoWTxFb
http://abclocal.go.com/kgo/story?section=news/iteam&id=8888921

How to identify "Meat Glue":

They should be forced to call it what it is, "transgluminase". Not by an industry-approved bullshit term carefully tested in front of focus groups.

thunderlips11 says

Pink Slime still used in over-the-counter Walmart meat sales:

http://ayzha.wordpress.com/2012/06/02/walmartsams-club-continues-to-use-pink-slime-in-ground-beef/

Pink and White Slime is "Grade A" though!

And I imagine others are doing ditto.

Just to add, most companies only want consumers to know the good shit they want to tell them about their product, not the bad shit.

Yet Costco and Whole Foods never put any pink slime or white slime in any of ground meet products. That's the beauty of the Free Market, or more precisely Freedom of Choice! If you want better quality meat, you can go to Costco and Whole Foods, even local farms where you can buy warm meat within hours of slaughter! If you are going through a phase of life when low price is more important, Walmart is also available as a choice without requiring you to catch mice or squirrels just to put some meat on the dinner table.

In places where the government bureaucrats are in charge, the standard issue ground beef in the school lunch program and in the prison system all have pink slime! In fact, they apparently buy the least expensive ground beef most heavily loaded with pink slime! That's how the pink slime issue was discovered as the cooks thought the meat was contaminated with ammonia . . . when in fact that's fully compliant with government regulations!

In fact, if we get more regulations, it's far more likely to see the local farms banned from selling truly fresh meat, just like fresh milk is banned due to Big Milk corporations don't want more tasty and more nutritious competition to their pastuerized milk that can travel on national distribution networks.

tatupu70 says

I will admit that I'm not an expert on how banks can manipulate the reserve requirements, but I find it hard to believe that they can overtly mock them by using the overnight lending window each night to meet the requirement.

That's what "lender of last resort" means. The window is not open when not needed, but open every night when needed, just like the old joke about listening to the husband when the two agrees but listening to the wife when they don't agree. The "reserve requirement" is lowered to Zero on most bank deposits during crunch. Heck, they even forced FASB to suspend honest accounting rules.

tatupu70 says

lol--it's impossible to know beforehand whether you are one of the TBTF banks. So you can't make decisions based on it. I'm sure Lehman thought they were TBTF.

Only a small clique of oligopolies qualify as TBTF. If the opportunity arises for further consolidation within the group, they will, further tighten the grip by reducing competition even within that clique. That's how a cartel works. It's not a disarmament agreement or non-aggression agreement. It's a cartel for keeping others out.

tatupu70 says

You're arguing moral hazard. I'm saying--how is it moral hazard when they lost huge?

The actual decision makers do not lose huge. Angelo Mozillo took home hundreds of millions. Dick Fuld took home tens of millions over the bubble years. Most Lehman Brother executives found employment with the remaining more concentrated clique.

tatupu70 says

The bubble didn't burst because of higher interest rates. Even if rates continued low, housing went have tanked. It was lack of underwriting standards, and that was a time bomb no matter what the rates were.

The bubble was caused by unsustainably low interest rates. The inability by Speculative Borrowers and Ponzi Borrowers to roll over debt when the artificially low rate period was over led to the bubble burst. The underwriting standards issue is a big fig leaf: it's just another phrase for lending to the wrong people on wrong terms. The reality is that from a bubble to a bust someone making $100k a year building houses in a bubble can easily make $0 during the bust! Someone still making $100k a year may also opt to walk away from his home which has dropped from $500k to $200k! There is no bureaucratic lending standards that can guarantee ahead of time people not lose jobs or choose strategic default, unless we are talking about down payment requirement in the 50%+ range. The political class obviously wouldn't let happen, nor would the fiat banking industry bent on rent-seeking on the society via lending as much conjured up money as possible. Don't be naive. Most of what the mainstream media tells you is probably someone's "advertisement"/propaganda including the Money Czar Bernanke's own pronouncement about there being no housing bubble in 2007 and housing market wouldn't collapse in 2008.

Reality says

The underwriting standards issue is a big fig leaf: it's just another phrase for
lending to the wrong people on wrong terms

Of course. That's basically what underwriting standards mean. Reality says

The reality is that from a bubble to a bust no consistent underwriting standards
would work: someone making $100k a year building houses in a bubble can easily
make $0 during the bust! Someone still making $100k a year may also opt to walk
away from his home which has dropped from $500k to $200k!

You're missing the point. The bubble never gets blown up without the abandonment of underwriting standards. You're looking at the bust--you need to look at the why the bubble occurred in the first place. And it wasn't because of low interest rates. It was because of liar loans, neg. amortization loans, teaser loans, etc.. The abandonment of underwriting standards.

thunderlips11 says

Uh, Ground Beef is ground, no? It sure looks like it went through the mill to me.

Costco and Whole Foods grind their own ground beef from chunks. Whole Foods even pack their own sausage. They have been doing that for decades, in order to ensure quality.

thunderlips11 says

I think you'll notice very obvious results. Cows are meant to eat leafy green plants, not just corn kernels.

I can certainly tell the difference. However, there was also a time in my life when cheaper beef was more important. If every cow has to have two acres of grazing ground for 3-5 years instead of 1 acre of corn for 8-12 months, a lot of Americans would have to do without eating beef every day or even once a week. Morally, that decisions should be left to the
individuals consumers instead of some self-appointed know-it-all.

thunderlips11 says

Competition isn't necessarily done by Robert's Rules. Companies compete by any means necessary, including trying to regulate their competitors out of business or at least trying to regulate away their ability to communicate the quality of their product to the consumer.

And your love for regulation plays right into the hands of wannabe monopolists. Regulation creates a power center over-riding consumer choice, and that power center is ripe for capture by the monopolists.

thunderlips11 says

And regulation without enforcement is useless.

The cost of enforcement is yet another argument against regulation.

thunderlips11 says

Just because crap got by regulators, doesn't mean we shouldn't have regulators.

That's like saying because the police don't make an arrest for every murder or robbery, we shouldn't bother with police at all.

If you want to use that analogy, then the failure of most regulations is not failure to arrest criminals but the "police" commiting criminal behavior themselves or "police" being criminal gangs in cop uniforms. BTW, even the real police usually fail to live up to the for-children version description; in real life, most police departments in the world become hopelessly corrupt and need thorough "reform" every generation or two. Just look at the police shooting of innocent people without pretense of investigative work in LA this week. Power corrupts. Over time, even police become caring about nobody but only their own safety, and doing a piss poor job of it, like the broad pattern spray and pray shooting they did. That's why disarming a population and relegating protection responsibility to the police (or regulators) lead to much higher crime rate.

You have to take responsibility for yourself, simply because ultimately you are the one who cares the most about yourself and knows your own situation the best.

tatupu70 says

Of course. That's basically what underwriting standards mean.

So what underwriting standards would you propose that would ensure ahead of time that they will keep paying mortgage even after losing jobs? and won't walk away when their home price drops to $200k when the mortgage is $500k?
I can think one: requiring 50%+ down payment, but that's politically not feasible. Can you think of a specific set of writing standards that work? instead of abstract "higher underwriting standards" the requirement of which is only known after the defaults take place.

tatupu70 says

You're missing the point. The bubble never gets blown up without the abandonment of underwriting standards.

Not true. Low interest rate alone is quite sufficient to blow a bubble. The defaults turned out not limited to subprime, contrary to Bernanke's prediction in 2008.

You're looking at the bust--you need to look at the why the bubble occurred in the first place. And it wasn't because of low interest rates. It was because of liar loans, neg. amortization loans, teaser loans, etc.. The abandonment of underwriting standards.

Defaults were not limited to those. When those loans showed up, the housing market bubble was already well underway. In fact, out of all the metrics, the one best correlated to default rate is low down payment. Guess what's enabling low down payment, to this day? Political institutions like FHA, Fannie and Freddie. In fact, the default rate among loans initiated after the bubble already burst and sanctioned by FHA in the most recent years are running very high . . . because FHA programs are designed to enable extremely low down payment.

Reality says

I can think one: requiring 50%+ down payment, but that's politically not
feasible. Can you think of a specific set of writing standards that work?
instead of abstract "higher underwriting standards" the requirement of which is
only known after the defaults take place.

I think 20% traditional downpayment is sufficient. That represents multiple years of savings. People are unlikely to bail and walk away due to "price declines" with so much skin in the game. Requiring 50% down is rather harsh especially with rising home prices and rising rents. Rising rents present a direct impediment for being able to save for a higher downpayment.

Reality says

So what underwriting standards would you propose that would ensure ahead of time
that they will keep paying mortgage even after losing jobs? and won't walk away
when their home price drops to $200k when the mortgage is $500k?

Again--you're missing the point. The key is to keep the bubble from being inflated. That's what good underwriting standards do.

Reality says

Can you think of a specific set of writing standards that work?

Sure--how about the standards used from 1945 til 2000? Those seemed to work pretty well.

Reality says

Not true. Low interest rate alone is quite sufficient to blow a bubble. The
defaults turned out not limited to subprime, contrary to Bernanke's prediction
in 2008.

I disagree 100%. Low rates can cause an increase in prices, sure. But not a bubble. Only the abandonment of underwriting standards caused that.

Reality says

Defaults were not limited to those. When those loans showed up, the housing
market bubble was already well underway. In fact, out of all the metrics, the
one best correlated to default rate is low down payment.

Sure--down payment is one crucial aspect of underwriting! Allowing no down payment loans is by definition poor underwriting.

dublin hillz says

I think 20% traditional downpayment is sufficient. That represents multiple years of savings. People are unlikely to bail and walk away due to "price declines" with so much skin in the game. Requiring 50% down is rather harsh especially with rising home prices and rising rents. Rising rents present a direct impediment for being able to save for a higher downpayment.

20% down payment is sufficient before the bubble is underway. When the bubble gets so big like in some of the states in 2006-7 facing eminent 50% decline, a 20% down payment requirement was no longer sufficient. Yet, what did the government officials do? Instead of tightening lending standards, the government pressured Fannie and Freddie into buying sub-prime loans that they used to refused to securitize! all in the name of helping home buyers of course (when in reality is using those government sponsored agencies to take junk paper risk off the hands of the politicians' friends the loan originators). That's regulation in action for you.

Reality says

Yet, what did the government officials do? Instead of tightening lending
standards, the government pressured Fannie and Freddie into buying sub-prime
loans that they used to refused to securitize!

Come on. Now you're just posting BS. Next you'll be telling me about the CRA.

This was a private party that Freddie and Fannie joined very late.

tatupu70 says

Again--you're missing the point. The key is to keep the bubble from being inflated. That's what good underwriting standards do.

Artificially low interest alone is sufficient to blow a bubble even in the face of what normally would be considered good underwriting standards. For example, our friend Roberto is buying property with rental yield around 10%. It's workable in a 4% interest environment, but unworkable in an 8% interest environment.

tatupu70 says

Sure--how about the standards used from 1945 til 2000? Those seemed to work pretty well.

What would that be? There were many regional real estate bubble and busts in that half century. Mortage securitization and government encouragement of low down payment were put in place in the 1930's. In fact, Fannie was spun off from the federal government's own balance book to become a government sponsored "independent" company during LBJ administration precisely because its books was so full of trash back then that it was risking the federal government's credit worthiness. Sound familiar?

On top of that, near the peak of the bubble, the congress pressured Fannie and Freddie into buying sub-prime loans form the originators, providing the final leg of extension to the housing bubble "trend line."

tatupu70 says

I disagree 100%. Low rates can cause an increase in prices, sure. But not a bubble. Only the abandonment of underwriting standards caused that.

Do you realize the self-confliction in that? If you agree that low rates produces high prices, what do you think un-sustainably low rates that would have to be corrected upwards would do to price? Unsustainable high prices that would have to fall back . . . and what do we call that? Asset Price Bubble.

tatupu70 says

Sure--down payment is one crucial aspect of underwriting! Allowing no down payment loans is by definition poor underwriting.

Yet that's exactly what the government agencies have been doing . . . to this day! 1/3 of FHA securitized mortgages initiated in the last two years have less than 3% down payment! Many 0%, with builder or bank sponsored "non-profit" providing the 3% downpayment requirement being allowed.

That's once again, the allegedly benevolent Government-god in action for you.

tatupu70 says

Come on. Now you're just posting BS. Next you'll be telling me about the CRA.

This was a private party that Freddie and Fannie joined very late.

Due to exponential growth nature of those bubbles, the final leg of the bubble is the source of the most grief. That's precisely what government intervention does in the market place: encouraging stock ownership in 1998-99, encouraging housing price in 2005-06, pressuring Fannie and Freddie into buying sub-prime in 2006-7. How much did the stock market bubble go up in the final leg? The NASDAQ went up nearly 100% in 1999. How much did the housing market go up in the final leg? The Las Vegas, Phoenix and Miami markets once again went up nearly 100% in 2007.

It takes more and more suckers in a Ponzi Scheme. In order to retrieve the banksters' chestnuts from fire, the bubbles had to be massively inflated in the final leg to provide the cover to transfer the trash to the "muppets." The FED and other government regulators help the banksters accomplish this.

OK--let's take a step back here. There is a difference between a "boom" and a bubble. Prices may rise based on factors such as interest rates, real wage gains, tax reductions, etc., but that does NOT indicate a bubble.

If interest rates are low, affordability is higher, and prices will naturally rise (assuming income stays the same). It does NOT create a bubble. With good underwriting, people still buy only what they can afford. The vast majority of people buy fixed rate mortgages and if/when interest rates rise, affordability goes back down (assuming income is constant) and prices may fall. Prices rise and fall all the time (in real terms--inflation masks the fall many times)--this does not indicate a bubble.

OK--now to your points:

Reality says

Artificially low interest alone is sufficient to blow a bubble even in the
face of what normally would be considered good underwriting standards. For
example, our friend Roberto is buying property with rental yield around 10%.
It's workable in a 4% interest environment, but unworkable in an 8% interest
environment.

See above. When rates rise, Roberto will still be enjoying nice income from his property and will be under no pressure to sell. Rising interest rates mean almost nothing to him. There is absolutely no bubble aspect to Roberto's investments

Reality says

There were many regional real estate bubble and busts in that half century

I should have been a little more clear. Poor underwriting caused this bubble. It's not the only way to blow up a bubble. Let's look at each case individually and analyze why the bubble started. Please post your examples.

Reality says

Do you realize the self-confliction in that? If you agree that low rates
produces high prices, what do you think un-sustainably low rates that would have
to be corrected upwards would do to price? Unsustainable high prices that would
have to fall back . . . and what do we call that? Asset Price Bubble.

Completely incorrect. I said higher prices, not unsustainable high prices. Every time the price goes up does NOT mean a bubble has formed.

Reality says

to this day! 1/3 of FHA securitized mortgages initiated in the last two years
have less than 3% down payment! Many 0%, with builder or bank sponsored
"non-profit" providing the 3% downpayment requirement being allowed.

While I agree that a higher down payment is preferred, they are demanding a huge insurance on the monthly payment. Instead of getting all the money up front, they are getting extra each month to make up for it. It's actually a horrible deal for the buyer.

Reality says

It takes more and more suckers in a Ponzi Scheme. In order to retrieve the
banksters' chestnuts from fire, the bubbles had to be massively inflated in the
final leg to provide the cover to transfer the trash to the "muppets." The FED
and other government regulators help the banksters accomplish this.

See, this is what you always do. Most of what you say is correct, but then you feel the need to place the blame on the government or Federal Reserve for everything with no explanation for why. Wall St. and the TBTF banks did this on their own. No government assistance was needed...

Reality says

20% down payment is sufficient before the bubble is underway. When the bubble
gets so big like in some of the states in 2006-7 facing eminent 50% decline, a
20% down payment requirement was no longer sufficient.

ok, let me create a concrete example. Lets say a 2006 bubble price is $600,000. A buyer goes in with 20% down. Within a couple of years, the post bubble price is now $400,000 and a buyer is underwater. Do you really think such a person/family would ahem "strategically default" if this 120,000 represents several years of savings?

tatupu70 says

OK--let's take a step back here. There is a difference between a "boom" and a bubble. Prices may rise based on factors such as interest rates, real wage gains, tax reductions, etc., but that does NOT indicate a bubble.

The only difference between a boom and a bubble is whether it is sustainable. So what does that say about a "boom" that is solely caused by an artificially low interest rate that is not sustainable?

If interest rates are low, affordability is higher, and prices will naturally rise (assuming income stays the same). It does NOT create a bubble.

What happens when the artificially low interest rate has to give way to a more sustainable higher interest rate, all else being equal? the "boom" gain is fully given back, therefore proving the previous "boom" was really an interest-rate / money-supply induced bubble.

With good underwriting, people still buy only what they can afford.

The affordability formula is highly dependent on interest rate. What is "affordable" at 3% interest rate may well be "unaffordable" at 6% interest rate unless the price is reduced by 30% or more.

The vast majority of people buy fixed rate mortgages

That assumption is not correct in recent years. Even the previous FED chairman was encouraging the public to take on lower adjustable rates at congressional hearings. In any case, average Americans stay in one house for an average of 5-7 years in normal economic times. If they are upside down, they can not move, which means they can not follow job opportunities. Fixed rate mortgages have been non-assignable for the past couple decades

and if/when interest rates rise, affordability goes back down (assuming income is constant) and prices may fall.
Prices rise and fall all the time (in real terms--inflation masks the fall many times)--this does not indicate a bubble.

Not sure what you are trying to say, a price bubble is not a price bubble? An asset price bubble by definition means price rising quickly then fall back and giving back all the gains. Cutting mortgage interest rate from a historical average of 8-9% to 3-4% in recent years produces a huge asset price bubble just by itself.

tatupu70 says

See above. When rates rise, Roberto will still be enjoying nice income from his property and will be under no pressure to sell. Rising interest rates mean almost nothing to him. There is absolutely no bubble aspect to Roberto's investments

He wouldn't be in the market bidding at the price if the bank interest rate were 8%. What you are saying is about as silly as claiming that Apple price at $700 was not a bubble even if its price drop to $400 or even $200, just because it's still paying dividends.

tatupu70 says

I should have been a little more clear. Poor underwriting caused this bubble. It's not the only way to blow up a bubble. Let's look at each case individually and analyze why the bubble started. Please post your examples.

What example are you talking about? Even lower lending standards, in the early stages, is largely a result of investors chasing yield, eventually becoming government sponsored lower lending standards (or is that all along, as in the low downpayment requirement)

tatupu70 says

Completely incorrect. I said higher prices, not unsustainable high prices. Every time the price goes up does NOT mean a bubble has formed.

What do you think higher prices caused solely by artificially lower interest rate, when the interest goes back to sustainable higher levels? when nothing else has changed?

tatupu70 says

While I agree that a higher down payment is preferred, they are demanding a huge insurance on the monthly payment. Instead of getting all the money up front, they are getting extra each month to make up for it. It's actually a horrible deal for the buyer.

That fee only rose to the current high levels very recently, as default is going through the roof from underwriting done in the past few years with much much lower insurance fees. How's that for your Governemnt-gods trying their own hands at calculating loan risks? Do you think the same clowns would be able to do much better regarding "lending standards" during the bubble?

That's why lenders have to bear their own risks, instead of offloading risks to the taxpayers via government and useless regulations.

I don't care how much people put down as long as the banks have to disclose their loans so you can bank with prudent banks. And if they don't they go to jail. Also fractional lending AKA leverage needs to be abolished. One dollar lent needs to be backed by one dollar of collateral, period. Oh and fuck the criminal QE, the criminal bailouts and all its apologists. Abolish the Fed, put all the fraudsters in jail and let bankruptcy be your friend. Other than that, feel free to borrow as much as you can, it's you personal liberty as it is mine not to bail your sorrow ass out.

Reality says

The only difference between a boom and a bubble is whether it is sustainable.
So what does that say about a "boom" that is solely caused by an artificially
low interest rate that is not sustainable?

I disagree that that's the only difference. And I also disagree that interest rates are "artificially" low.

Reality says

What happens when the artificially low interest rate has to give way to a
more sustainable higher interest rate, all else being equal? the "boom" gain is
fully given back, therefore proving the previous "boom" was really an
interest-rate / money-supply induced bubble.

Again--not artificial. And not a bubble.

Reality says

Not sure what you are trying to say, a price bubble is not a price bubble?

I'm saying you need to rethink your definition of a bubble. A key point of a bubble is that prices diverge from intrinsic values. For houses, the best guide is equivilent rent. When rates are low, the intrinsic value of a house rises, so naturally the price rises as well. NOT a bubble. It's normal.

Reality says

What example are you talking about?

lol--the ones your referenced in your post. All the other bubbles that you say occurred over the last 50 years.

dublin hillz says

ok, let me create a concrete example. Lets say a 2006 bubble price is $600,000. A buyer goes in with 20% down. Within a couple of years, the post bubble price is now $400,000 and a buyer is underwater. Do you really think such a person/family would ahem "strategically default" if this 120,000 represents several years of savings?

What's the point such an artificial example? If the price drops to $300k, what do you think the default risk would be? It takes only a 5-10% default rate to put a typical mortgage portfolio under water.

The national median price peaked around $315k in 2007, and dropped to $155k before the recent rise. In many parts of the country, the drop was more than 50%

tatupu70 says

I'm saying you need to rethink your definition of a bubble. A key point of a
bubble is that prices diverge from intrinsic values. For houses, the best guide
is equivilent rent. When rates are low, the intrinsic value of a house rises, so
naturally the price rises as well. NOT a bubble. It's normal.

I agree - typically when price/annual rent ratio is over 20 it is a better deal to rent. When it's over 25 it's a sign of a bubble. During the peak, the ratios were pushing 30, now they are in the 15-20 range for the most part.

tatupu70 says

I disagree that that's the only difference.

So what's the difference between "boom" and "bubble" if it's not the post-peak give-back? Somehow you have your own definition for that too? Even the former Money-Czar Greenspan, the top bureaucrat for money, agreed in congressional hearing that the only way to tell a bubble for certain is in the aftermath, not apriori.

And I also disagree that interest rates are "artificially" low.

The governement subsidized mortgage rates are definitely artificially low, that's why the vast majority of mortgages have been government subsidized. The interest rates being paid on deposits are also artificially low; it's lower than even the BLS' grossly under-stated inflation rate. The interest rates on Treasury are also artificially low: the FED is indirectly buying 3/4 of recent Treasury 30yr issues, obviously by bidding at a higher price (i.e. lower rate) than the vast majority of market participants.

tatupu70 says

Again--not artificial. And not a bubble.

despite all evidences to the contrary, so you insist.

tatupu70 says

I'm saying you need to rethink your definition of a bubble. A key point of a bubble is that prices diverge from intrinsic values. For houses, the best guide is equivilent rent. When rates are low, the intrinsic value of a house rises, so naturally the price rises as well. NOT a bubble. It's normal.

With all due respect, there is no such thing as "intrinsic value," not even Gold. All economic value is ascribed subjective value. That breakthrough in economics took place in the late 19th century. The "equivalent rent" you are talking about is actually called: present discount value of future cash flow, or Present Value of discounted future cash flow. What does that "discount" refer to? Interest rate. In other words, the future net cash flow's Present Value is very highly dependent on interest. For the same net monthly income (after tax, insurance, repair reserve), a historically 8-9% interest rate discount would cut the Present Value in half compared to using the current 3-4% interest.

tatupu70 says

ol--the ones your referenced in your post. All the other bubbles that you say occurred over the last 50 years.

Did you forget the Savings&Loans crisis in the late 1980's caused by the regional housing bubble back then? Do you not know that Fannie nearly went bankrupt in the early 70's?

dublin hillz says

I agree - typically when price/annual rent ratio is over 20 it is a better deal to rent. When it's over 25 it's a sign of a bubble. During the peak, the ratios were pushing 30, now they are in the 15-20 range for the most part.

The historical average mortgage interest rate is 8-9%, or about a couple points above historical bank interest rate 6-7%. With property tax typically running 10-15% of rent, insurance 5% of rent, water and sewer 5% of rent (either town or reserve fund for septic and well), repair and renovation reserve 10% of rent (for roof, furnace etc.), the nominal rent yield needs to be 12-13% in order to be able to pay for the big ticket repairs and beat other forms of investment in the long run, with a net return of about 8% before income tax if exactly on that line. That's assuming 100% occupancy!

Personally I wouldn't touch any investment property with nominal rent yield much below 15% if not 20% . . . i.e. 6:1 or 5:1. The 15:1 "buy-to-let" phenomenon in recent years is utter nonsense due to the artificially low interest environment; may well end badly for the wannabe landlords when major things break, like a roof leak or a furnace break/replacement.

Reality says

There is no intrinsic value, except for people who are economically illiterate

I know what you are saying, but there is a rational value. Call it what you like. You know the point.

Reality says

Using that artificially low interest rate, they get an artificially high PV
(Present Value) for the future rent cash stream discounted forward.

It's not artificial at all. They get a 30 year fixed rate and that PV is correct. Reality says

individuals acting rationally on mistaken information is the cause of bubble.

It's not mistaken!!! The PV is what it is.
Reality says

More importantly, why did you praise "the lending standards of 1945-2000" as if
there were high standards throughout that time period?

Uh, because there were?

Reality says

Personally I wouldn't touch any investment property with rent yield much
below 15% if not 20% . . . i.e. 6:1 or 5:1. The 15:1 "buy-to-let" phenomenon in
recent years is utter nonsense due to the artificially low interest environment;
may well end badly for the wannabe landlords when major things break, like a
roof leak or a furnace break/replacement.

I was referring from the standpoint of a primary residence purchaser, not landlord. A potential purchaser should evaluate buy vs rent for comparable properties. Historically speaking, if the purchase price was 15 or less than what they would pay in annual rents based on that year's prices, it would be a much better deal to buy; 15-20 annual rents - would be competative between buying and renting, over 20 renting would be better usually and 25+ would indicate a bubble. For example if a luxury apartment is renting for $2500 a month, annual rent would be $30,000. From this perspective if the purchase price of a comparable condo is under $450,000 buying wins hands down and if purchase price is between $450,000-$600,000 buying has a good chance of being a successful decision as well. Now if purchase price is $750,000 or more it's a good barometer that a bubble is in the works.

tatupu70 says

I know what you are saying, but there is a rational value. Call it what you like. You know the point.

I know what are trying to say. That's the common mistake made by people who do not have a sharp economics background. The absence of any intrinsic value can be illustrated by this simple thought experiment: What if the town allows a development to take place next door with houses better than yours and charge less rent than yours and can accommodate as people as needed and still have vacancy? What would happen to your house' rent value or PV/"intrinsic value"? As you can see, there's nothing intrinsic about PV, or even rent.

tatupu70 says

It's not artificial at all. They get a 30 year fixed rate and that PV is correct.

That PV is only "correct" at the moment for the present interest rate and present rent. That's all it is, PV is calculated from cash flow and interest rate. As for 30yr fix rate mortgage, that would not help the family much at all because average Americans move every 4-7 years. 30yr mortgages are not assignable. When the interest rates go up, all else being equal, the family would have to sell at steep losses in order to move . . . or not able to move to new jobs at all if they can not come up with the cash difference to pay off the mortgage. In other words, they may well default when need to move out of town for a new job.

tatupu70 says

It's not mistaken!!! The PV is what it is.

Of course it's a mistake: mistake in guessing future interest rate and its impact on PV in the future. Would you deliberately pay up the high price of 2007 if you knew the price would be cut in half in the following 4 years?

There is nothing magical about PV; it's just a mathematical formula assuming unchanging interest rate and unchanging cash flow into the indefinite future. It certainly is not "intrinsic value" unless you think neither interest rate nor rent cash flow would ever change . . . which obviously would be mistaken assumptions.

tatupu70 says

More importantly, why did you praise "the lending standards of 1945-2000" as if

there were high standards throughout that time period?

Uh, because there were?

If you believe that, then why do you think the allegedly high lending standards led to the late 1980's S&L crisis and early 1970's near-bankruptcy of Fannie? That would entirely dash your thesis about low lending standards being the primary or even sole cause of bubble.

dublin hillz says

I was referring from the standpoint of a primary residence purchaser, not landlord. A potential purchaser should evaluate buy vs rent for comparable properties. Historically speaking, if the purchase price was 15 or less than what they would pay in annual rents based on that year's prices, it would be a much better deal to buy; 15-20 annual rents - would be competative between buying and renting, over 20 renting would be better usually and 25+ would indicate a bubble. For example if a luxury apartment is renting for $2500 a month, annual rent would be $30,000. From this perspective if the purchase price of a comparable condo is under $450,000 buying wins hands down and if purchase price is between $450,000-$600,000 buying has a good chance of being a successful decision as well. Now if purchase price is $750,000 or more it's a good barometer that a bubble is in the works.

See, tatupu70, what I said earlier about extended periods of artificially low interest rate cause very rational people to operate on mistaken information regarding long term interest pictures that they have no first-hand experience.

The younger generation is being / has been conditioned to "Asian-like" asset multiples (as in the far east, no Asian Americans) by the FED policy.

Dublin, while it is certainly a possibility that 30 years from now, the 450k condo may be worth 4.5 million largely due to inflation, it's very hard to justify even the 450k valuation in the absence of faith in future inflation. IMHO, of course. A $2500/mo condo may well have a $500/mo association fee . . . and that's assuming the neighbors keep paying their shares instead of defaulting. I have a hard time paying up $450k for any condo, unless it's in a world class metropolis like Manhatten, where there is no other housing option except condos and apartments. In most other places where single family houses exist, condo is a 5-digit proposition for generating $1000-1500/mo rent regardless how many molding strips the builder put in there. $100k can buy a lot of molding strips and radioactive granite counter tops.

Reality says

condo is a 5-digit proposition for generating $1000-1500/mo rent regardless how
many molding strips the builder put in there. $100k can buy a lot of molding
strips and radioactive granite counter tops

How do you then explain that it's basically impossible to find a decent 2 bedroom apartment in bay area for under $2,000 a month and most of them tend to be closer to $2500?

Reality says

That's the common mistake made by people who do not have a sharp economics background

Let's not go there. I'm fairly certain my economics background is superior to yours, but it doesn't matter--focus on the argument, not the background of the individual.

Reality says

What if the town allows a development to take place next door with houses better than yours and charge less rent than yours and can accommodate as people as needed and still have vacancy? What would happen to your house' rent value or PV/"intrinsic value"? As you can see, there's nothing intrinsic about PV, or even rent.

That thought experiment is ridiculous. I could make one up for anything showing that everything is in a bubble, by your argument. What if a meteroite of gold landed in Chicago tomorrow? What if Shell discovered an 100 billion barrel oil deposit in shallow ground tomorrow? You can't base investment decisions or values based on what if thought processes. You base them on your best knowledge today.

Reality says

That PV is only "correct" at the moment for the present interest rate and present rent

Of course--the future is unknown. You can base your PV models around likely future scenarios, however. There are nice calculators here and on NY times websites.

Reality says

When the interest rates go up, all else being equal, the family would have to sell at steep losses in order to move

Like I've said before, all else is never equal. To assume so if folly.

Reality says

Of course it's a mistake: mistake in guessing future interest rate and its impact on PV in the future. Would you deliberately pay up the high price of 2007 if you knew the price would be cut in half in the following 4 years?

You wouldn't. But, unless you have a time machine, you don't know that. Like I said, you estimate PV based on your best assumption of the future.

Reality says

See, tatupu70, what I said earlier about extended periods of artificially low interest rate cause very rational people to operate on mistaken information regarding long term interest pictures that they have no first-hand experience.

No I don't see at all. If anyone is operating under mistaken information it's yourself.

dublin hillz says

Reality says

condo is a 5-digit proposition for generating $1000-1500/mo rent regardless how

many molding strips the builder put in there. $100k can buy a lot of molding

strips and radioactive granite counter tops

How do you then explain that it's basically impossible to find a decent 2 bedroom apartment in bay area for under $2,000 a month and most of them tend to be closer to $2500?

I'm not living in the Bay Area. However, a cursory search on Craigslist seems to show a lot apartments with 2-3 bedroom in the sub-$2000 range. Including some in your area, presumably Dublin. Of course, I did hear that the Bay Area rent has gone up a lot in the past year or so due to money supply increase being funneled into tech companies in the area.

tatupu70 says

Let's not go there. I'm fairly certain my economics background is superior to yours, but it doesn't matter--focus on the argument, not the background of the individual.

My calling the "faith in intrinsic value" a common mistake was simply trying to exculpate my dear debate partner. If someone having a pedigreed economics education makes that mistake, it would be quite inexcusable.

tatupu70 says

That thought experiment is ridiculous. I could make one up for anything showing that everything is in a bubble, by your argument. What if a meteroite of gold landed in Chicago tomorrow? What if Shell discovered an 100 billion barrel oil deposit in shallow ground tomorrow?

Excellent thought experiment. That's exactly the thought experiment an economics professor would use to illustrate to his incredulous students that there is no intrinsic economic value to anything, but only ascribed value. That's precisely the point of my earlier proposed thought experiment too.

Neither thought experiments can prove either house or gold as bubble, but value being extrinsically ascribed. Price crash itself does not indicate bubble. Bubble means the run-up followed by crash giving back all the gains. Just to try as close to your thought experiment on gold, if the gold price runs up dramatically because there's worldwide gold miner strike, then the price crashes back after work resumption, the round trip would have been considered a bubble.

You can't base investment decisions or values based on what if thought processes. You base them on your best knowledge today.

The thought experiment was not brought up as a way of assessing risks in real estate investment, but as a way of showing that house value and rent value are not intrinsic to the house itself. Your gold thought experiment was excellent at showing the same point about gold's value not being intrinsic. While both scenarios have very small chances of happening, their probability-weighted influence on investing in house or gold should be very small indeed. The probability-weighted influence of adverse interest change however is not small, especially near the end of a long linear trend line. One can not invest according to present conditions alone or linearly extrapolate the most recent trend alone. . . that is if one is keen not losing his money.

tatupu70 says

Of course--the future is unknown. You can base your PV models around likely future scenarios, however. There are nice calculators here and on NY times websites.

Taking educated guesses about the future is at the core of investing. Nobody said it's easy.

tatupu70 says

You wouldn't. But, unless you have a time machine, you don't know that. Like I said, you estimate PV based on your best assumption of the future.

Current PV is based on current interest rate and current rent income. Guestimated future PV will have to be calculated based on guestimated future interest rate and future rent income. People do not buy houses exactly at the concurrent PV at that time, because people have different guestimates about the future PV (and front-run it). The different guestimates are what makes a real estate transaction possible; otherwise one wouldn't be selling to the another buying; in fact, the difference between the two parties have to be at least big enough to accommodate the Realtor's 6% the Attorney's $2-5k plus other overhead fees for the transaction. Some guestimate future more accurately than others. . . . just like buying/shorting stocks, bonds, or derivative contracts.

tatupu70 says

See, tatupu70, what I said earlier about extended periods of artificially low interest rate cause very rational people to operate on mistaken information regarding long term interest pictures that they have no first-hand experience.

No I don't see at all. If anyone is operating under mistaken information it's yourself.

The extended periods of low interest rate environment since about 1997 (shortly after Greenspan's "Irrational Exuberence" speech being attacked by many congressional members) has caused a young generation of Americans to assume interest rate will always be around 4-5% . . . hence treating 20:1 buy to yearly rent cost as the line of demarcation. That IMHO is dangerous, because the historical average interest rate is significantly higher than that, about double that.

Reality says

if the gold price runs up dramatically because there's worldwide gold miner strike, then the price crashes back after work resumption, the round trip would have been considered a bubble.

This is where we disagree. I wouldn't call that a bubble. If supply is very short, then price naturally rises. Bubbles require irrational behavior.

Reality says

Taking educated guesses about the future is at the core of investing. Nobody said it's easy.

Agreed. And those guesses are INCLUDED in the rent/buy ratios. And PV of the house. That's my point.

Reality says

Current PV is based on current interest rate and current rent income

See my last statement-current PV includes best guess about future rent rises and future home price movment. If one think interest rates will rise and income will not rise, than I would assume he/she would model home price falling in their PV calculation.

tatupu70 says

This is where we disagree. I wouldn't call that a bubble. If supply is very short, then price naturally rises. Bubbles require irrational behavior.

Bubble just means significant round trip price movement. Investor behavior would appear "irrational" in hind sight but not necessarily while the bubble is on-going. For example, a few decades from now, people looking back may well consider our current time period as a bubble in government . . . would you say everyone working for or work with government now as irrational? I wouldn't. They are just taking what they can based on information as known to them, just like the Union real wage bubble we had in the 50's thru 90's. Postulating fully half of market participants as "irrational" is not economics but rather troubling political rhetoric assuming that somehow people ought to be all-knowing.

tatupu70 says

Agreed. And those guesses are INCLUDED in the rent/buy ratios. And PV of the house. That's my point.

Rent/buy ratio is not a guesstimate about the future but a current number using most recent (backward looking) data . Market price of a house however involve buyer and seller guestimating future rent, future price and future interest rates. That's why Buyer and Seller disagree on these future values, therefore can have transaction. At least one of them will be proven wrong. It would be a mistake to label one or both of them as behaving irrationally.

tatupu70 says

See my last statement-current PV includes best guess about future rent rises and future home price movment. If one think interest rates will rise and income will not rise, than I would assume he/she would model home price falling in their PV calculation.

In most standard PV analysis, PV refers to a simple mathematical formula using current rent and current interest; i.e. in effect producing a "current PV" that assumes constant rent and constant interest rate into perpetuity. It's just the PV formula. That's why people who use PV formula alone to calculate how much a house is worth without realizing they are implicitly making the two assumption will most likely run into problems in a few years if the purchase takes place when the market is in an interest rate induced bubble . . . yet people often do make purchase decisions based on comparing rent payment to monthly mortgage payment alone, which has a similar effect as using current PV alone: i.e. assuming constant or favorably dropping interest rate in the future.

For example, some of the current young generation saying 20:1 as the decision line between rent vs. buy. People able to pop out that number at all are probably already among the more intelligent and financially literate among their generation. Yet that line implies 4-5% or lower interest rate into the perpetuity. I wouldn't call their line as irrational, just misinformed and misguided by the FED policies since 1997, IMHO.

Reality says

Rent/buy ratio is not a guesstimate about the future but a current number using most recent (backward looking) data

OK, bad terminology. I think you knew what I meant, but I'm refering specifically to rent/buy calculators. They include predictions of future prices, rents, inflation, etc.

Reality says

That's why Buyer and Seller disagree on these future values, therefore can have transaction. At least one of them will be proven wrong. It would be a mistake to label one or both of them as behaving irrationally.

Buying a house is not like buying a stock. You live in a house. It's a completely different transaction.

Reality says

At least one of them will be proven wrong. It would be a mistake to label one or both of them as behaving irrationally.

It is not true that one person in the transaction will be proven wrong. Like I said, housing is a unique asset. Of course you would only label one or both of them as behaving irrationally if their version of the future was irrational.

Reality says

In most standard PV analysis, PV refers to a simple mathematical formula using current rent and current interest; i.e. in effect producing a "current PV" that assumes constant rent and constant interest rate into perpetuity

You obviously haven't explored Patrick's site or the Internet. There are LOTS of rent/buy calculators out there. I don't think anyone assumes constant rent or constant interest rate. It's not how the formula works.

Now, it is a little more difficult if you want to assume one rate for the first 5 years, then a different one later, but I think I've seen calculators out there that do it.

Reality says

yet people often do make purchase decisions based on comparing rent payment to monthly mortgage payment alone, which has a similar effect as using current PV alone: i.e. assuming constant or favorably dropping interest rate in the future.

Wrong again. The assumption is that when interest rates rise, incomes will also be rising. Which has historically been the case. You are the one making an assumption that would be a historical outlier. Interest rates very rarely rise without inflation and wage inflation.

tatupu70 says

Buying a house is not like buying a stock. You live in a house. It's a completely different transaction.

How is buying a house different from buying a bond that makes coupon payment or buying a stock that pays dividends? as far as the financial/economic value is concerned. In fact, in investing, the terms are similar: rental yield (including owner-equivalent), (interest) yield, dividend yield.

tatupu70 says

You obviously haven't explored Patrick's site or the Internet. There are LOTS of rent/buy calculators out there. I don't think anyone assumes constant rent or constant interest rate. It's not how the formula works.

Now, it is a little more difficult if you want to assume one rate for the first 5 years, then a different one later, but I think I've seen calculators out there that do it.

PV is an established accounting term. The various caculators that you talk about may call themselves "home value estimator" etc. as they wish, but not a PV calculator.

tatupu70 says

Wrong again. The assumption is that when interest rates rise, incomes will also be rising. Which has historically been the case. You are the one making an assumption that would be a historical outlier. Interest rates very rarely rise without inflation and wage inflation.

You are just rephrasing the assumption that "you can always refinance when the fixed period ends and adjustments begin" How did that assumption work out for millions of people who bought 2005-2007 after the FED chairman himself encouraged people to take adjustable rate mortgages?

Your statement on the tight coupling between interest rate and income assumes perfect timing of FED interest rate policy and instantaneous market reaction. In real life, FED policy makers are far from perfect, and there is typically a 6-18 month delay in the real economy to FED policy. That's more than enough to put someone several months behind in mortgage payment. A 90day late has a statistically likelihood of more than 90% leading to foreclosure. It is in real life where people lose their homes. In your (or anyone else') ideal world, nobody default on loans or lose their homes.

When there's a low ratio between annual rents and purchase prices, something other than interest rates is likely to be at work. Namely, it reflects the fact that majority of the population is poor. So while those of us in Bay Area may think, "wow the purchase price is only 5 annual rents over there" to the people living the reality on the ground, that number is something that they cannot reach. Try saving enough money over there when you can barely pay for cost of living which includes shelter, food, etc. You often find this situation in many regions in latin america.

Bad Advice Cat says:

Reality says

Costco and Whole Foods grind their own ground beef from chunks. Whole Foods even pack their own sausage. They have been doing that for decades, in order to ensure quality.

Walmart uses Pink Slime; aka "Finely Textured Beef". They said they would offer alternatives, but did not take Pink Slime out of their main ground beef products.

Reality says

And your love for regulation plays right into the hands of wannabe monopolists. Regulation creates a power center over-riding consumer choice, and that power center is ripe for capture by the monopolists.

Vigilance and Education is the cost of Freedom and Democracy. It's true there is regulatory capture, but that has more to do with the false equivalence of money and speech. Anybody alive who can write or speak can speak, but not everybody has millions to spend on political donations, attack ads, think tanks, and underwriting scholars-for-dollars.

Reality says

Morally, that decisions should be left to the

individuals consumers instead of some self-appointed know-it-all.

Problem is economy of scale. If corn-fed beef is a bit cheaper, competition will make it become the standard (esp if in real wages, purchasing power is flat or declining over the years), making grass fed beef even more expensive than when it was the standard.

The battle meatpackers have waged against country-of-origin labeling and even extra-FDA voluntary branding is anti-consumer choice, by keeping them deliberately ignorant.

I'm all for transparency over regulation whenever possible, but often profit-making institutions don't want an informed public and band together to keep the public ignorant.

Reality says

That's why disarming a population and relegating protection responsibility to the police (or regulators) lead to much higher crime rate

Not so:

New data presented at the conference by a Dutch scholar, Pieter Spierenburg, showed that the homicide rate in Amsterdam, for example, dropped from 47 per 100,000 people in the mid-15th century to 1 to 1.5 per 100,000 in the early 19th century.

Professor Stone has estimated that the homicide rate in medieval England was on average 10 times that of 20th century England. A study of the university town of Oxford in the 1340's showed an extraordinarily high annual rate of about 110 per 100,000 people. Studies of London in the first half of the 14th century determined a homicide rate of 36 to 52 per 100,000 people per year.

By contrast, the 1993 homicide rate in New York City was 25.9 per 100,000. The 1992 national homicide rate for the United States was 9.3 per 100,000.

http://www.nytimes.com/1994/10/23/us/historical-study-of-homicide-and-cities-surprises-the-experts.html

Some cops suck. Most are okay. Some are great. Like any human endeavor. Compared to the alternative, private justice, as much as it pains me to say as somebody with an anarchist bent, suck balls compared to the modern system of law enforcement.

Private Justice, as practiced by the Vikings for example, was more about showing up to the moot or thing with as many armed supporters as possible, than any kind of justice.