The preposterous credit world view presented in Ben Bernanke’s lecture series at George Washington University
Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)
"This isn’t right. This isn’t even wrong"
-Wolfgang Pauli, Cambridge University physicist, attempting to read a colleague’s paper.
60 MINUTES: "Can you act quickly enough to prevent inflation from getting out of control?"
BERNANKE: "We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now."
60 MINUTES: "You have what degree of confidence in your ability to control this?"
BERNANKE: "One hundred percent."
"60 Minutes," December 5, 2010
Federal Reserve Chairman Ben Bernanke’s lecture series at George Washington University is most unfortunate. Whether he believes what he is saying or not, he is a punch bowl of contaminated mead.
The first instinct, at least here, is to let it pass. Wolfgang Pauli’s exasperation came to mind when reading capsules of the Fed chairman’s lectures. Where to start? Where to end? To what purpose?
The last, first. The purpose here is to throw light on a mind so inadequately prepared, yet 100% sure, of extracting the world from an unprecedented gamble. The gamble is Bernanke’s dry run of his professorial emissions. The professor’s chalkboard smog is the basis for his current policy. Real interest rates are below zero and the central bank is creating immeasurable quantities of dollar bills that Bernanke is sure will right the U.S. economy while not sacrificing his wandering price stability.
"Immeasurable," since Bernanke and other members of the FOMC do not know when they will stop. Listen to their contradictory speeches. We are not witnessing the introduction of an economic theory. We are chips in a poker championship.
Rather than address my stated purpose by rehabilitating either Bernanke’s disfigured explanation of the 1930s or how the gold standard functioned – the disentanglements alone would require pages – we will look at one of his simpler claims. Following is an effort in pointillism.
Two of the man’s characteristics will be addressed in what follows. First, his inability to anticipate. Second, his limited understanding of the past, which is a cause of his inability to anticipate.
On March 22, 2012, the Fed chairman told students at George Washington University: "The decline in house prices by itself was not obviously a major threat." To clarify this statement, Bernanke was responding to a question about the housing bubble. He was addressing the aftermath, when prices fell. He concluded that falling house prices, by themselves, were not obviously a major threat to the economy, and, presumably to the financial system that serves to finance that economy.
Wolfgang Pauli would probably agree that Bernanke’s attempt at clarification is neither right nor wrong. It is meaningless. As a general statement, rising house prices do not constitute a bubble. Nor, are falling house prices synonymous with a crash. The most important distinction is the degree of borrowing that contributed to the upswing. Of the recent housing enthusiasm, Panderer to Power made this clear. During the Greenspan-Bernanke chairmanship, the U.S. did not experience a housing crash, it suffered a mortgage collapse.
Bernanke claims the "decline in house prices by itself was not obviously a major threat [before it crashed in 2007 – FJS]." The man was either unaware of how housing finance was conducted in the U.S. during bubble years or considered it irrelevant.
As a Federal Reserve Board member (from 2002 to the present day, with a short sabbatical as economic adviser to President Bush) Bernanke completely missed the coming mortgage collapse. He admits that. He also claims nobody else saw it coming. The Federal Reserve chairman, like all cloistered academic economists, would never condescend to read a newspaper, so would not see what the average bartender knew. Anyone reading the following knew that houses were the new momentum trade that replaced the dot.comfandango:
August 8, 2001, Wall Street Journal, Headline: "’Subprime’ Could Be Bad News for Banks: Riskier Loans, Now Prevalent in Industry, Show Problems" We read: "American Express so far this year has taken more than $1 billion in junk-bond-related write-downs."
August 31, 2001, Wall Street Journal, Headline: "Is Appraisal Process Skewing Home Values?" We read: "Appraisers are frequently encouraged to fudge the numbers." From Mark Vitner, an economist at First Union Corp., the "upward spiral of prices becomes self-reinforcing." The Wall Street Journal reporter concluded: "Some believe home prices are beginning to act like technology stocks. Mr. Vitner says they’re moving up so fast that any value seems reasonable."
September 3, 2001, Forbes magazine, Cover: "WHAT IF HOME PRICES CRASH?" Picture on the cover of a young couple: "Their house lost $1 million in value. It could happen to you. It could happen to a lot of people and wreck the economy." We learn that their house – in Palo Alto, California, fell in value from $2 million to $1million over 7 months.
March 28, 2002, Economist, cover story: "The houses that saved the world" We read: "…homes have kept the world economy aloft."
April 18, 2002, Wall Street Journal,Headline: "Reverse-Mortgage Rules May be Loosened" We read: "Congress is looking to loosen the rules on reverse mortgages. The move could allow millions of seniors to extract far more money from their homes than is possible – though to some critics that isn’t necessarily a good thing."
July 22, 2002, Business Wire, Reporting on recent testimony of Federal Reserve Chairman Alan Greenspan: "We’ve looked at the bubble question and we’ve concluded that it is most unlikely."
July 22, 2002, Business Wire, Same article, quoting National Association of Home Builders Chief Economist David Seiders: "The time has come to put this issue to rest. The nation’s home builders have said it, the Realtors(R) have said it, and now Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble."
The web of interests was obvious by 2002. Princeton professor Ben S. Bernanke joined the Federal Reserve Board on August 5, 2002.
At that point, the question that occupied the alert observer was how long the web could keep spinning. When Ben Bernanke joined the Federal Reserve Board in 2002, he dragged his "zero-bound" twaddle to FOMC meetings, and soon enough the Fed was launching helicopters, suffering conundrums, and holding real rates below zero.
And now, on March 23, 2012, the man running the Federal Reserve, who not only could not see the housing bubble but can not rotate his mind to believe anyone else did, is "100% sure" he will extract the world from a money-printing escapade that has increased central bank balance sheets from about $4 trillion in 2008 to about $13 trillion in 2013 (these numbers are from memory), and not destabilize the world price structure.
The second characteristic of the Bernanke mind to be addressed is his historical illiteracy. Given the quoted statement made to George Washington University students, he does not know how financing contributed to previous housing booms and busts. We will look at one state, where, it is 100% clear that fly-by-night finance was the leading cause of post-binge trauma.
The population of Los Angeles rose from 10,000 in 1880 to 50,000 in 1890. Yet, a severe real estate bust wiped out most of the wealth in 1887 and 1888. David Starr Jordan described the boom and bust in California and the Californians: "[A]lmost every bluff along the coast, from Los Angeles to San Diego and beyond was staked out in town lots." He continued: "Every resident bought lots, all the lots he could hold. The tourist took his hand in speculation.[My italics – FJS] Corner lots in San Diego, Del Mar, Azusa, Redlands, Riverside, Pasadena, anywhere brought fabulous prices. A village was laid out in the uninhabited bed of a mountain torrent, and men stood in the streets in Los Angeles… all night long, to wait their turn in buying lots. Land, worthless and inaccessible, barren cliffs’ river-wash, sand hills, cactus deserts’ sinks of alkali, everything met with ready sale. The belief that Southern California would be one great city was universal. [The far-sighted investor was correct, but lost his shirt in 1888. – FJS] The desire to buy became a mania. ‘Millionaires of a day,’ even the shrewdest lost their heads, and the boom ended, as such booms always end in utter collapse."
"Tourists" includes speculators from the east, north, and south, drawn to the latest California gold rush. It was not only Los Angeles. Kansas City crested in 1888, Chicago in 1890, and the country as a whole in 1888-1889. When everyone from Alan Greenspan to Standard & Poor’s swatted down bubble concerns ("real estate slumps are local affairs"), the nation’s participation in regional manias was not considered. Other significant features of L.A. in the 1880s were a price collapse when the population rose 500%, and, no central bank existed to prod the insolvency.
Los Angeles boomed in the 1920s as did its real estate. The sun, movies and discovery of oil in Los Angeles County encouraged wagon trains from the East. Across the country, speculators were drawn to real estate between 1920 and 1925.
In Ten Years on Wall Street, Barnie Winkelman set the stage: "The shortage of offices, apartment houses, and dwellings which had resulted from the protracted holiday from construction during the World War, had brought on a wave of building. In its wake came the flotation of real-estate bonds running into hundreds of millions, financing practices which embodied the worst practices of Wall Street bond flotation, and saddled millions of school teachers, physicians, widows, the aged and infirm, who had forsworn stocks on the Exchange and railroad and industrial bonds, with realty obligations infinitely less substantial. On back of these over-appraised real estate liens were second mortgage loans held by individuals and building and loan associations. The collapse of many building and loan associations in 1925 marked the gradual recession in real estate prices….."
That’s enough. Upon reading "financing practices which embodied the worst practices of Wall Street," you knew how this would turn out. The Florida land boom and bust (1926) is synonymous with the decade. Today, the degree of national participation is not so celebrated. Nor, that the residential real estate building boom across the country generally peaked at the same time. Real spending on new, private, non-farm housing fell 89% from its peak in 1926 to its trough in 1933.
A chart of Los Angeles County residential real estate activity points nearly straight up between 1920 and 1925. (Lewis A. Maverick, "Cycles in Real Estate Activity: Los Angeles County") Chicago also achieved its personal best in 1925, though New York was just warming up, particularly in the commercial area, rising until 1930. (The average price of office-building bonds fell from $1,000 upon issue to $187 in 1932.) Even with the booming Southern California economy, the graph of L.A. County real estate activity falls from 1926 through 1930, and presumably beyond.
The 1970s was a boom time for houses, but much of those gains were lost to inflation. House prices rose 8.0% a year during the decade, while the consumer price index rose at a 7.4% rate. (Nationally, house prices rose 17.7% in the first nine months of 1979; the CPI passed 16% that year.)
California was a star performer where house prices rose 20% in 1974, 17% in 1975, and 28% in 1976. (The standard belief that lower interest rates will solve house troubles is taken for granted. The prime rate rose from 9.50% in early 1974 to 15.50% in late 1979.) William Greider wrote in Secrets of the Temple: "People were not buying houses to live in or even as long-term investments. They were buying homes in order to sell them."A builder in Contra Costa County (California) found that 60% of his sales were to speculators. In San Diego alone the number of realtors doubled between 1975 and 1979. A condominium bought in Irvine Ranch (California) for $87,000 was sold for $117,000 – two weeks before the mortgage closing was completed. We need not tarry here; this is so old that it’s new.
The 1970s boom was followed by a bust, but not of today’s dimensions. One reason being that mortgage lending did not rocket off its moorings, either in terms offered or in the variety of lenders. In the early 1980s, homeowners’ average equity (nationally) equaled 70% of house market values.
The 1980s savings-and-loan catastrophe left the Southern California mortgage market in a miserable state. The S&L boom was the product of relaxed regulations, funny finance, and dreadful accounting – all of which should have been evident to Ben S. Bernanke in 2002. According to the San Diego Union Tribune: "When the bubble burst in 1989, some home prices fell 10 to 20 percent, while the price of raw land dropped even more. End result: As real estate analysts see it, local developers, builders, bankers, planners and home buyers all made a fatal assumption three years ago. [They splurged near the peak. – FJS] …. [I]n 1987, 1988 and 1989 prices soar[ed], doubling from $89,000 to $198,000. The average price now stands at $95,000 per acre and [a market analyst] doesn’t think it will recover even half its former, inflated value any time soon."
The market analyst may have been correct if not for L. William Seidman. He headed the Resolution Trust Corporation (RTC), which closed the bad banks and disposed of the busted real estate at fire sale prices. We should have followed the same blueprint today, but have done exactly the opposite. Thus, instead of clearing the market, we have millions of houses floating in limbo.
Upon completion of his assignment, Seidman shut down this federal agency. He was very critical of Bernanke’s (and Paulson’s) TARP (Troubled Asset Relief Program). Comparing TARP to the RTC: "What we did, we took over the bank, nationalized it, fired the management, took out the bad assets and put a good bank back in the system." Comparing Seidman’s purging of bad banks to Bernanke’s handling of the Too-Big-to-Fail Banks (which hold much larger quantities of assets today than in 2008), is, again, cause to believe Bernanke has no idea what he is doing.
Like Sisyphus, California real estate prices pushed and pushed harder up the hill from 1995 to 2005. This is too well known to recall here. Some reminders: The median price for an existing, single-family house in California rose from $237,060 in 2000 to $542,720 in 2005. That this was a mortgage bubble par excellence, and not so much a housing bubble, can be seen in the evolution of financing: Mortgages written in California responded to Bernanke’s "zero-bound policy" in spectacular form. Only 2% of home mortgages were of the non-principal paying "interest-only" version in 2002. This rose to 47% in early 2004 and to 67% by late 2004. In February 2012, the median price for an existing, single-family house in California was $266,600, and falling at a 7% annual rate.
Doug Noland, author of the Prudent Bear’s Credit Bubble Bulletin, wrote untiringly during the boom years of the "moneyness of credit." (He still writes every week and is still well worth reading.) Noland wrote that the Fed and Wall Street refused to understand the explosion of credit and credit derivatives were behaving like money and inflating house prices. This should have been understood. It was the ability to buy (sort of) a house without showing up with one penny at the closing that gave Sisyphus his third and fourth wind.
Bernanke has shown no understanding of either the quantity or the quality of credit. Yet, he is 100% sure of his infallibility.
Frederick Sheehan writes a blog at www.aucontrarian.com