In a recent report Tobias Levkovich says the importance of U.S. housing is exaggerated:
“The relative importance of housing to the consumer has been highly exaggerated….While the housing market’s ascent initially drove feelings of wealth during the mid-2000s, that relationship basically has broken down.”
House prices certainly didn’t matter to CitiGroup earlier in the decade when they were loading up on MBS by the truck load. You would think that some people haven’t lived through the recent crisis. There is a reason why housing is (over) 42% of the CPI – because it is by far the most significant input in consumer costs. The average American spends the majority of their non-discretionary income on rent and/or mortgage. In the case of the housing bubble millions of American’s were (and still are) paying several mortgages. This line of thinking, that asset values don’t matter, attempts to downplay the extreme financialization of our economy over the last 25 years.
This strikes me as particularly frustrating to read due to a conversation I was having over the weekend. I was corresponding with a somewhat well known (monetarist) economist and he was telling me why QE is going to work. He said:
“Cullen, if we can create a wealth effect then we’ll be able to get all that cash to work in the economy. Companies will stop hoarding and start spending and investing. Households will start borrowing and spending.”
“You’re making a critical error in your thinking though. The system is overly indebted. You can’t look at the cash on corporate balance sheets and at the household level without also looking at the debt levels. Debt is at record levels on the corporate side and near record levels at the household level. This is going in one of two directions. Either we reinflate the bubble and play it out all over or we suffer a workout period where debts get paid down, the economy is weak, asset prices normalize and the fundamentals come back in-line with reality. A third scenario (which is unlikely due to government intervention) is if asset values decline (specifically housing) significantly and debts are once again thrown into a disequilibrium with their original costs.”
“But for every creditor there is a debtor so that’s not a worry. The two offset.”
“You’re missing the whole point of what we’ve just been through. When the debtors can’t service their debts you have a recipe for a financial crisis. When asset prices decline versus the value of the original debt load the effects of ponzi finance have a real impact on consumer spending. When that asset happens to be the largest chunk of the monthly paycheck it leaves a particularly nasty mark. QE is classic Greenspan economics – trying to keep asset prices “higher than they otherwise would be” by constantly bailing everyone out and ensuring that no one ever takes a loss. It’s a classic case of financialization at its worst.”
The point is, real asset values matter. Assets that can be highly levered matter even more. It is the defaulting of such assets that is so crippling in this environment. Mr. Bernanke has rehashed the old Greenspan playbook and his sidekick Brian Sack is implementing the strategy.
There has been this incredible financialization of our economy over the last 25 years (thank you neo-liberals and bank lobbyists!) and we’ve become convinced that Americans can build real wealth by owning financial products – paper wealth based on ponzi finance. The worst part of all this is that it has become pervasive across our economy. In fact, most of the people running our government believe in this line of thinking. If we can just sustain higher asset prices we’ll all be rich. So what do we do? We implement home buyers tax credits. We incentivise consumers to take on more debt. We try to keep asset prices “higher than they otherwise would be”. Unfortunately, when you buy an asset on margin with nothing down you haven’t transferred a pile of cash into that asset. Its value is only some perceived value that is dependent on future market conditions. And if those future market conditions are not in-line with the underlying cash flows and fundamentals then you’ve gotten yourself in one heck of a mess.
This is frustrating to live through because we’ve just experienced this incredible economic downturn and here we are two years out and it seems as though no one has learned their lesson. The prudent are punished, the imprudent are rescued, asset prices are permanently altered via government intervention and the game goes on. The psychological impact is unquantifiable and I fear it is highly destructive. After all, what incentive is there to be prudent in this economy? Why should anyone save money? What incentive is there to NOT take extraordinary risks? We have attempted to remove natural selection from the capitalist system. And that is why our capitalist system is broken.
And for the last two years the same neo-liberals who got us into this mess are the same ones trying to get us out! Anyone who thinks we won’t have another financial crisis of some sort in the next decade is out of their mind. This psychology of capitalism without losers must be broken. Otherwise, the system will remain broken and ripe for another boom/bust cycle.
Real asset values matter and propping up prices only prolongs the market’s discovery process. But don’t tell that to Brian Sack and the boys at the Fed – they’re too concerned with keeping asset price “higher than they otherwise would be”.