patrick.net

ChrisLA says

Jobs won’t come back.

Of course they will come back. Not every one, but unemployment will drop this year, and next year. Here's an article from today's news:

http://finance.yahoo.com/news/Poll-Hiring-plans-top-layoffs-apf-2575460790.html?x=0

just for the "jobs aren't coming back" crowd.
here's a primer on how the business cycle works

http://www.thebluecollarinvestor.com/blog/recession-a-normal-part-of-the-business-cycle/

If this is the case, and I can afford to buy a home within my means in the bay area, at a price where my mortgage is almost what I could rent the house for, isn’t it a good idea regardless just to protect my dollars?

I say yes. Unless your income uncertain.

I'm kind of baffled by your "if inflation continues" statement. Inflation is at 50 year lows.

seaside says

There’s nothing wrong about buying a home, when you can afford it w/in your means, you’re financially stable, and you will live there for long time, as you said. Those are right reason’s to buy a home for home buyers. If you’re one of those investors or speculators, this hedge thingy or protecting money thingy gets in there. So, what’s your main reason to buy a home? Home or hedging?

+1. good advice.

gameisrigged got it. Consider all other economic factors and take a educated guess, if you buy a 500K house now what will be its value 5 years from now? If you think it is going to go down then hold your $ and buy 5 years from now. If you think it is going to go up then buy it now(or you'll never be able to own). :)

here’s a primer on how the business cycle works

http://research.stlouisfed.org/fred2/series/CMDEBT

See that downleg at the end? Where is that in your theory?

Or how about $4T of added debt since the start of the recession?

http://research.stlouisfed.org/fred2/series/FYGFDPUN

These two items are related -- we abused our personal credit cards to get out of the tech recession and now we're abusing our government credit card to forestall the crash that should have hit in 2009.

Shows we need double the recovery we've had so far to just get back to the average postwar recession levels.

But note that previous recessions were caused and ended by Fed interest rate policy -- tightening money to slow the economy down and then loosening credit to get everybody rolling again.

Something similar happened in 2006 -- the Fed raised interest rates a bit and then everybody started to GTFO the housing sector -- but we were so, so overleveraged on housing -- we had borrowed $4T or so more than we could repay -- that a massive crash-boom-bang was inevitable.

This is not your father's recession.

Of course there's going to be inflation. As Petter Schiff explains in today's Yahoo Finance video, inflation will be the way that the U.S. pays for all the government bailouts and stimulus spending of the past 3 years: http://yhoo.it/fQCRsI .

Borrow $100k today and pay back $50k in real, inflation-adjusted, dollars over the span of your fixed-rate mortgage. Let the bank assume inflation risk by being dumb enough to hand out fixed rate 30 year loans at 5% interest. You profit from their bad business sense.

Mark_LA says

Borrow $100k today and pay back $50k in real, inflation-adjusted, dollars over the span of your fixed-rate mortgage. Let the bank assume inflation risk by being dumb enough to hand out fixed rate 30 year loans at 5% interest. You profit from their bad business sense.

I could make more money shorting bank stocks making these loans then right?

Mark_LA says

Of course there’s going to be inflation. As Petter Schiff explains in today’s Yahoo Finance video, inflation will be the way that the U.S. pays for all the government bailouts and stimulus spending of the past 3 years: http://yhoo.it/fQCRsI .
Borrow $100k today and pay back $50k in real, inflation-adjusted, dollars over the span of your fixed-rate mortgage. Let the bank assume inflation risk by being dumb enough to hand out fixed rate 30 year loans at 5% interest. You profit from their bad business sense.

Worked for Ronald Reagan!

Los Angeles Renter says

I could make more money shorting bank stocks making these loans then right?

You'd have to short the U.S. Government who buys/guarantees these dogs from the banks via the now government-controlled and owned Freddie Mac and Fannie Mae. But you can't because the U.S. owns the Fed's printing press, which they can run full steam as long as they need in order to have you ultimately pay for it all, without most people even realizing it.

Don't go against the grain...just profit from the knowledge. Borrow/leverage as much as you can and buy investment properties in places like Vegas where it's a lot more expensive to rent than to buy. You can buy a Condo that rents for $600/month for $40k there, as an example.

SF ace says

In simple terms, I borrow $10 @ 1% and lend it out at 5% for 30 years.

Yes, this model only works when banks can borrow at 1% from the government. The government doesn't assume any inflation risk, because they in fact are the ones who create the inflation through the Fed's printing presses (or quantitative easing as Tiny Tim Geithner and Uncle Ben Bernanke like to call it).

If banks were forced to lend out their own money (deposits), only adjustable rate loans would be available, where the borrower would assume the inflation risk.

Ace--

Any loan the bank makes at 5% is a loser if rates go to 10%. Whether or not they can roll it over is irrelevant. That money is not being as productive as it could be. It's only earning 5% when it could be earning 10% today.

Think of it this way. Banks that are "smart" and don't make 30 yr. loans at 5% today but invest that money elsewhere will be able to loan it all out later at 10%, thereby earning much more. And potentially driving the banks that are stuck with lots of 5% loans out of business.

Troy says

here’s a primer on how the business cycle works
http://research.stlouisfed.org/fred2/series/CMDEBT
See that downleg at the end? Where is that in your theory?

For one it's not MY theory. I didn't realize there was any debate over whether there is a business cycle. I mean this is pretty common sense stuff.

I dont see any of the charts you posted disproving it either.

toothfairy says

I didn’t realize there was any debate over whether there is a business cycle

http://en.wikipedia.org/wiki/Business_cycle#Explaining

eg:

"One alternative theory is that the primary cause of economic cycles is due to the credit cycle: the net expansion of credit (increase in private credit, equivalently debt, as a percentage of GDP) yields economic expansions, while the net contraction causes recessions, and if it persists, depressions. In particular, the bursting of speculative bubbles is seen as the proximate cause of depressions, and this theory places finance and banks at the center of the business cycle."

and

"Economists of the heterodox Austrian school argue that business cycles are primarily caused by excessive creation of bank credit - or fiduciary media - which is encouraged by central banks when they set interest rates too low, especially when combined with the practice of fractional reserve banking. The expansion of the money supply causes a "boom" in which resources are misallocated due to falsified interest rate signals, which then leads to the "bust" as the market self-corrects, the malinvestments are liquidated, and the money supply contracts."

~~

The way I see it, in 2000-2001 the US was heading into a cyclical downturn after the heady run-up of the 90s, much like the recessionary times of the 1990-1991 period. We can agree to call this "the business cycle" for the most part, since the Fed felt in control and did in fact tap the brakes, both in 1989 and in 2000:

http://research.stlouisfed.org/fred2/series/FEDFUNDS

However, AFAICT, due to exogenous political considerations -- not wanting GWB booted out of office like his dad -- the Fed over-stimulated the credit cycle in late 2003, eg. cutting the cost of Fed money in half, from 2% to 1%.

Coupled with this were the 2001-2003 tax cuts and the new lending paradigm of not caring if people could pay back the money they were borrowing.

This resulted in an immense asset bubble in real estate, since real estate was the one "capital good" being offered at such favorable credit terms -- to anyone who could fog a mirror.

That lending bubble gave us the Bush Boom, such as it was, from 2003-2006.

TENS of billions of dollars a month was being injected into the general economy via the housing bubble, both from economic activity of the REIC -- agents, loan processors, construction labor, etc etc -- and people liberating their equity via HELOCs and cash-out re-fis.

Fifty billion dollars a month doesn't sound like much, but that is SIX MILLION $100,000/yr jobs, and around TWENTY million jobs in total once all the secondary wealth effects are fully factored (ie velocity of money effects).

During the peak of the credit cycle 2005-1H07, over $100B/month was flowing into the economy via household debt extension. Stupendous!

1998-2000: +~$500B
2001: +$610B
2002: +$800B
2003: +$900B
2004: +$1.1T
2005: +$1.2T
2006: +$1.2T
2007: +$900B
2008: +$36B
2009: -$240B
1H10: -$140B

The economy lost this stealth stimulus when the bubble burst in 2008. We've been replacing it with over $3T of deficit spending over the past two years, but it is unclear how long this form of fiscal policy can go on.

The electorate gave the control of the nation's fisc to the Republicans, and their position is we need to cut government spending.

If they walk their talk there is going to be an immense crash coming, since so much of the private economy is being supported with this gummint intervention.

The Republicans want to cut a modest $100B/yr. That's around three million jobs lost in the scheme of things -- 2% of the workforce.

No biggie, the business cycle is turning and the private sector is coming back!

Pull the other one.

SF ace says

In simple terms, I borrow $10 @ 1% and lend it out at 5% for 30 years. Ten years later. (inflation) caused the borrowing cost to increase to 5% but that same inflation increase my lending rate to 10%. All that money I received from my first customer at 5% is now rolled over into new customers at 10%. I only lose if I can’t roll over the money.

But if inflation goes up to $5%, and you've got $1B in mortgages, and $1B in deposits, your getting 5% on your mortgages and having also to pay out 5% to depositors. Subtract operating costs and you're operating at a loss from your existing book, and it may be quite a while before new loans can close that gap.

Inflation is a HUGE risk for banks making long term loans. That's why we had GSEs.

toothfairy says

Troy says

here’s a primer on how the business cycle works

http://research.stlouisfed.org/fred2/series/CMDEBT

See that downleg at the end? Where is that in your theory?

For one it’s not MY theory. I didn’t realize there was any debate over whether there is a business cycle. I mean this is pretty common sense stuff.
I dont see any of the charts you posted disproving it either.

I agree with Troy. The credit aspect of the "business cycle" is very overlooked. Huge overhangs of private debt frequently lead to protracted slumps. Just look at Japan, or USA in the 30s.

Mark_LA says

Yes, this model only works when banks can borrow at 1% from the government.

Hmm? Banks lend to the government (they hold treasuries), they don't borrow from it. (Well, there was TARP, but that's pretty much over, and it was a lot more than 1%). Discount window loans from the Fed are small, and besides, the discount rate (and the other similar programs) is a higher interest rate than banks can borrow from each other - or from you and I for that matter.

Banks don't borrow from the government? Har, har. Stop it, you're killing me.

Troy we'll just have to agree to disagree. There's no way I'm getting caught up in theoretical causes of the business cycle. My only point is that it does exist and right now we are in the bottom end of a cyclical trend.
At some point both jobs and inflation will come back.

Probably sooner than later due to the massive amounts of stimulus response and padding of banks balance sheets. The money has to go somewhere.

toothfairy says

The money has to go somewhere.

Ah, that is the $64T question, isn't it?

The Republicans are saying no more stimulus, we need tax cuts instead.

Capacity utilization has recovered somewhat:

http://research.stlouisfed.org/fred2/series/TCU

but it's only back to the bottoms seen during past recessions!

I agree if J6P starts seeing some of this extra money coming his way then we'll get jobs & inflation again.

But more jobs and more wage income are tightly bound -- you can't have one without the other since it takes a tight labor market to put an upward trend on wages.

However, FEWER jobs and LESS income is the normal state of affairs, given the wage differential between the US and the rest of the world.

Part of the reason all recent "business cycles" have had increasingly jobless recoveries is due to globalization of the work force, we didn't have a $30B/mo trade flow with China in the 1970s.

Durable goods employment is back down to the Truman era:

http://research.stlouisfed.org/fred2/series/DMANEMP

Retail's lost about 2M jobs:

http://research.stlouisfed.org/fred2/series/USTRADE

If the Republicans allow Obama to triple the national debt like St Reagan did, then yeah, we should be OK this decade. Just more can-kicking I guess. I half expect this to happen.

But things can certainly go to Hooverville if all the small-government talk starts getting walked.

toothfairy says

There’s no way I’m getting caught up in theoretical causes of the business cycle. My only point is that it does exist and right now we are in the bottom end of a cyclical trend.

If you don't get the causes of a cycle right, you're not likely to predict it's future with any certainty. The article you posted didn't even mention the word "credit" or "debt" once. Irregardless of your opinion on the affect of debt levels on the business cycle, it pretty hard to argue that we are anywhere near the "bottom" of the debt cycle. Private sector debt levels are still at extremely high levels historically, after rising for two decades.

A couple points are important to me.

1. Business cycles do exist

2. Companies shed jobs bracing for a recession possibly depression

3. Recession officially ended in June 2009

In conjunction with the article I posted
it's enough evidence to tell me that jobs WILL be coming back. Maybe not to levels seen at the peak of the credit bubble (there I said credit)

private sector debt may be historically high level but it was like that during boom and bust so what am I missing?

toothfairy says

In conjunction with the article I posted

The one dated November 23rd, 2008?

The national debt ("Debt Held By The Public") on that day was $6,393,775,797,295.81.

Six months later it was $6,999,376,165,569.64 -- a deficit spending run rate of $100B/month.

Two years later the national debt was $9,205,377,401,824.96, a rise of $2.8T, a run rate of $116B/month.

Talking about "recessions ending" and "business cycles" strikes me as odd when such an immense external intervention occurred and is continuing.

private sector debt may be historically high level but it was like that during boom and bust so what am I missing?

You're missing the run-up of household debt that was allowed to occur (if not encouraged) 2002-2007.

So it was not really "like that during the boom". The run-up in debt -- from $9T in 1Q03 to $13.9T in 1Q08 WAS CREATING THE BOOM.

That was a shower of ONE TRILLION DOLLARS A YEAR entering the economy.

And as for the bust . . .

All we've done since the bubble crash of late 2008 is swap-in government deficit spending -- $120B per month -- for that lost credit stimulus.

We're running in a policy channel first carved out by Japan, 1990-now. Their debt-to-GDP is #2 to Zimbabwe. We'll be right up there if we continue this rate of debt expansion.

At least Japan's national debt is internal, so it's just an accounting artifact. I'm not entirely sure what's going to happen with our national debt -- if the Austerians take over policy we're going to be f---ed one way, and if they don't we're going to be f---ed another.

>> The one dated November 23rd, 2008?

yeah actually I could probably pull up an identical one from 1978. The ideas are nothing new and no it's not different this time.

>> Talking about “recessions ending” and “business cycles” strikes me as odd when such an immense external intervention occurred and is continuing.

again it's not me talking about it.
http://www.nber.org/cycles/cyclesmain.html

are you denying that the recession is over. NBER wrong? lying?

gameisrigged says

“If this is the case, and I can afford to buy a home within my means in the bay area, at a price where my mortgage is almost what I could rent the house for, isn’t it a good idea regardless just to protect my dollars?”
That’s a lot of “ifs”.
As far as I’m concerned, the only question you should be asking is, “Will house prices go up or down?” Let’s say you’re right, and buying a house is a hedge against inflation - If you can get the same house for less money in 6 months or a year, then it’s an EVEN BETTER hedge against inflation. So the hedge against inflation part of the argument isn’t relevant. The only way it would be relevant is if you’re deciding whether or not to buy a house AT ALL, and it would seem you’ve already made up your mind. The only question is when.

I disagree that the only thing you should ask “Will house prices go up or down?”. Might as well play the over/under in vegas. I also disagree that an inflation hedge is the only reason to buy a house. Inflation directly caused maintenance costs to go up. In my opinion if you are ever interested in buying a house the better question is "what kind of house can I get for what I can afford ?" If you are planning on living there and dont need financial trickery to make a purchase, then the price going up and down means little.

toothfairy says

are you denying that the recession is over. NBER wrong? lying?

NBER BCDC is just 9 academic economists doing what they are paid to do. They had more relevance back in the 1920s, back when government spending was not the dominant element it is today.

Calling the recession "over" when we are still well the fuck down from the 2003-2006 period of employment or output is sometihing of a deception, yes.

Things may have stopped getting worse -- perhaps temporarily -- but we are still in recession.

marko says

I disagree that the only thing you should ask “Will house prices go up or down?”. Might as well play the over/under in vegas. I also disagree that an inflation hedge is the only reason to buy a house. Inflation directly caused maintenance costs to go up. In my opinion if you are ever interested in buying a house the better question is “what kind of house can I get for what I can afford ?” If you are planning on living there and dont need financial trickery to make a purchase, then the price going up and down means little.

I think you missed the point and read my post way too literally. I didn't mean "will prices go up or down" is literally the only question you should ask. It goes without saying that you should be able to afford the house you're buying; I certainly wasn't implying anything to the contrary. If you had taken the full context of my post rather than zeroing in on one sentence to the exclusion of all others, it's obvious I was saying that affordability is more important than the concept of a house being a hedge against inflation. Finding a good deal is superior to overpaying for the first thing that comes along just to "get in", and is a wholly separate issue from whether it's a hedge against inflation.

I disagree that "the price going up and down means little". If you buy a house today that costs $500,000, but you could buy an equivalent house in 6 months that costs $400,000, the fact that prices went down would mean a great deal. It would save you $100,000. Just because you "plan on staying there" doesn't mean you should overpay. Money is money.

Whether housing is a hedge against inflation depends largely on how the property is acquired.

If a buyer pays cash then the price is locked in. (There is an opportunity cost with cash in the sense of not being able to get interest and other benefits.)

If the buyer pays with a fixed rate loan then the monthly cost is locked in.

If the buyer financing with an ARM then all bets are off, the risk of inflation has been moved in large part to the borrower from the lender. This is why ARMs are easier to get.

OurBroker says

Whether housing is a hedge against inflation depends largely on how the property is acquired.
If a buyer pays cash then the price is locked in. (There is an opportunity cost with cash in the sense of not being able to get interest and other benefits.)
If the buyer pays with a fixed rate loan then the monthly cost is locked in.
If the buyer financing with an ARM then all bets are off, the risk of inflation has been moved in large part to the borrower from the lender. This is why ARMs are easier to get.
Peter at OurBroker.com

Untrue. The inflation expectation is priced into the fixed rate products...that is, this is why a 30 year fixed rate is 2.5 points higher than a true ARM...and a 10/1 ARM has a higher initial rate than a 5/1, and 5/1 higher than 1/1, etc.

A fixed rate mortgage only wins if inflation outpaces expectations. Based upon the yield curve, which is relatively steep, there is an expectation of inflation and increasing interest rates. How inflation occurs vs. this expectation will determine whether or not an ARM or fixed rate product is superior.

Dave --

We disagree. While ARMs have been a good deal for a number of years because we have not seen rates at 7 percent, 8 percent and above, there's no certainty that such rates will not return. The idea that lenders can predict the future is obviously questionable -- just look at the smart folks who gave us option ARMs, the S&L crisiis, etc.

The European Central Bank has just raised its rates and its hard to believe that inflation will not catch up with us.

"As of January, the average interest rate paid on relatively safe vehicles such as short-term savings accounts, time deposits and money-market funds stood at only 0.24%. That's one-tenth the level of late 2007 and the lowest on records dating back to 1959. Such depressed rates don't come close to compensating for inflation, which was running at an annualized rate of 5.6% in the three months ended February." (See: The Wall Street Journal, Fed's Low Interest Rates Crack Retirees' Nest Eggs, April 4, 2011)

http://online.wsj.com/article/SB10001424052748703410604576216830941163492.html

I've been told that best inflation investment is into companies that can raise prices during inflation. Buying consumer goods themselves isn't going to net a profit necessarily, it's usually a money losing operation since under capitalism overproduction exists.

Everything I hear about Bay Area sounds like a bubble to me, so I'd advise against it. And if you really expect hyperinflation (very unlikely as people don't have the paychecks to back it) than you can invest into foreign currencies which are not pegged to the dollar.

I really though, do not see inflation. In our area too many are underemployed or unemployed.

Imagine that ARM interest rates rise to 7 percent from, say, 5 percent. That's not high by the standards of the past five decades, but monthly payments for a $100,000 ARM would go from $536.82 for principal and interest to $665.30. That may not seem like a big deal, except when you think about the unemployed and the underemployed. It's a bigger burden on top of other burdens.

If someone has a fixed-rate loan and not an ARM it's not an issue.

OurBroker says

The European Central Bank has just raised its rates and its hard to believe that inflation will not catch up with us.

All of the inflation experienced by the US and EU is due to commodity price surges. However Germany (er... I mean the EU, but really Germany calls the shots) has a different situation than the US:

1) The EU has a highly unionized workforce that can demand higher wages for the same productivity - setting off inflation. The United states does not.

2) In the US, really the only workers that have that kind of bargaining power are public unions, but states and municipalities are facing very serious debt problems so significant wage increases are unlikely for a years. Germany does not have that problem.

The EU has a much greater chance of inflation than the US from rising commodity prices. Already they're above 2% for their overall measure, while we are more like 1%, and they are less of a commodity dependent economy than we are.

Mark --

Agreed. The problem with commodity prices is that folks outside the US like the way we live and so there is increasing competition for oil, food, etc., and thus pressure to increase prices worldwide.

As well, if the Treasury cannot fund the debt at today's rates that will substantially increase government costs and be a huge problem.

Hi --

Also, a lot of US ARMs are based on the LIBOR.

It looks like China is a net buyer again as they pitched in for $700billion more of US debt last year. In the words of Joe Six Pack: "How much a month"? (I know, it should really be this chart, but the other one really drives home the point). So far, it looks like everyone is doing their part to help us out. It's going to get ugly if (when?) we are cut off...

toothfairy says

what makes anyone think jobs will come back? Look at any historical chart of unemployment.

But thos historical charts don't take into account that job can be outsourced today.

Fixed mortgage payment is a hedge insofar as you know what your payment will be for as long as you want to keep that mortgage. You don't know what rent will be. You also don't know what HOA fees will be if buying in a complex. If you never borrow additional principal, and are someday able to refinance to a lower rate, your payment can go down. Property tax will go up. Insurance will go up.

The amount I set aside each month for tax & insurance is $210/month higher today than when I bought my home 20+ years ago. Due to refinances at favorable interest rates, the principal & interest payment is $240/month lower than my earliest mortgage on this property. Because of extra principal payments, I will be paying off in 21 years instead of 30.

However, mortgage payment is not comparable to rent payment. I don't know about condos, but houses eat money! Be prepared for the home improvement store to suck money from your wallet every time you drive past it.

"Buying a house to protect against inflation, what am I missing"

Was true back in the 1970s when inflation impacted or was caused by increasing prices and wages. But that is no longer true, wages do not increase with price inflation.

In some industries you have deflation.. prices of goods sold have declining over the years which result into cutting into compensation.