Mar072013

Never forget the bulls and bubble deniers were completely and totally wrong

Now that prices are going up again, the bulls are regaining some of their previous smugness, and some are trying to revise history about how wrong they were over the last six years. Today I want to take a look back at the insanity of the housing bubble and remind everyone that when they hear the kool aid intoxicated bellow their bullish arguments and sentiments, many of the bulls pontificating today were completely and totally wrong for the last six years — and I don’t mean just a little wrong — most of the bulls were wrong about everything. They were wrong about the sustainable rate of price increase. They were wrong about the direction of future prices. They were wrong about the success of affordability loan programs. They were wrong about the availability of future credit. They were wrong about loan delinquencies and foreclosures. They were just wrong, wrong, wrong.

Politicians and central bankers completely missed the housing bubble and its impact on the larger economy. I’ve often wondered if any of them feel any guilt about the losses absorbed by investors and homebuyers who believed their false assurances. I rather doubt it.

The Housing Bubble and the Limits of Human Knowledge

By Alex J. Pollock Friday, March 1, 2013

How much can you trust the word of government officials? How much about the financial future can central bankers or anybody know? Consider the lessons of these 10 quotations.

Fannie Mae and Freddie Mac lost an aggregate $246 billion during the shriveling of the great American housing bubble. They lost all the profits they had made since 1971 plus another $140 billion — quite a performance.

The government rushed in to rescue Fannie and Freddie’s creditors with $187 billion of taxpayers’ money, to bring their capital up to zero: this means that ordinary Americans are being taxed so that foreign and domestic bondholders get back every penny they lent Fannie and Freddie.

Most people don’t realize that one of the main reasons the too-big-too-fail institutions weren’t allowed to go under is because there were no established protocols for winding down large multinational banks. If many of those institutions would have gone under, the bondholders would have been wiped out, and that would have started a domino effect wiping out banks all over the globe. It would have sparked years of international lawsuits with uncertain results. So in the end, we are all paying for a bailout to prevent foreign bondholders from losing any money.

The reality of the government guaranty of the debt of these “government-sponsored enterprises” (GSE) has thereby been unambiguously demonstrated. Senior government officials previously denied that the government was on the hook for Fannie and Freddie (presumably thinking that their denial would never be tested by events — a bad theory).

What financial shape were Fannie and Freddie in as the crisis proceeded? How bad would the effects of the shriveling bubble be? How much can you trust the word of government officials? How much about the financial future can central bankers or anybody know?

Politicians and central bankers are clueless and inept liars. If you don’t believe that, please read on.

Consider the lessons of the following 10 quotations:

1. About whether Fannie and Freddie’s debt was backed by the government: “There is no guarantee. There’s no explicit guarantee. There’s no implicit guarantee. There’s no wink-and-nod guarantee. Invest and you’re on your own.” — Barney Frank, senior Democratic congressman, notable Fannie supporter, later chairman of the House Financial Services Committee

It would be difficult to imagine a statement more wrong.

2. “We do not believe there is any government guarantee, and we go out of our way to say there is not a government guarantee.” — John Snow, Republican and secretary of the Treasury

Saying it did not make it so, unfortunately.

3. “The facts are that Fannie and Freddie are in sound situations.” — Christopher Dodd, senior Democratic senator, prominent Fannie supporter, chairman of the Senate Banking Committee

Pronounced two months before Fannie and Freddie collapsed.

4. “We have no plans to insert money into either of those two institutions [Fannie and Freddie].” — Henry Paulson, Republican and secretary of the Treasury

Stated one month before the Treasury started inserting money into Fannie and Freddie.

5. “Home prices could recede. A sharp decline, the consequences of a bursting bubble, however, seems most unlikely.” — Alan Greenspan, chairman of the Federal Reserve Board

The common wisdom of the bubble years. At the time of this statement in 2003, the Fed was in the process of dramatically reducing short-term interest rates and stimulating house-price increases.

6. “Global economic risks [have] declined.” — International Monetary Fund

Observed four months before the international financial panic started in August 2007.

7. “More than 99 percent of all insured institutions met or exceeded the requirements of the highest regulatory capital standards.” — Federal Deposit Insurance Corporation

This statement was made in the second quarter of 2006, at the peak of the housing bubble. More than 400 such institutions later failed and others were bailed out in the ensuing bust. The FDIC failed its own required capital ratio, reporting negative net worth.

8. “The risk to the government from a potential default on GSE [Fannie and Freddie] debt is effectively zero.” — Joseph Stiglitz, Nobel Prize–winning economist, Peter Orszag, a future White House budget director, and Jonathan Orszag

Conclusion after considering “millions of potential future scenarios” — but obviously not the scenario which then actually happened.

9. “‘Not only didn’t we see it coming,’ but once the crisis started, central bankers ‘had trouble’ understanding what was happening.” — Remarks by Donald Kohn, vice chairman of the Federal Reserve Board

A candid statement of the truth.

10. Finally: “Libenter homines id quod volunt credunt.” That is: “People easily believe that which they want to believe.” — Julius Caesar

Nothing has changed in this respect since Caesar’s day, and his dictum applies to government officials, central bankers, economists, and experts — just as it does to you and me.

One facet of every financial mania is that people want to believe the impossible is possible, what’s too-good-to-be-true is actually true. Everyone who participated in the housing bubble wanted to believe the rapid rise in prices was sustainable and not going to reverse. The housing bubble made a lot of people rich, it gave a lot of people free spending money, and the late buyers didn’t want to believe they were going to lose a fortune. No matter how many people want to believe in something, that doesn’t make it so, and reality can overcome even the strongest denial.

More for the bull and bubble denier hall of shame.

Let’s not forget the statements from the National Association of realtors:

Have you ever checked out the Amazon.com comments on David Lereah’s book?

From April 2005: For me, this was more comic relief than any scholarly analysis. The author has a vested interest in the bubble not bursting, and he’s selling his soul with this book to prove it.

He spins webs of demographics and interest rates, but he never ever addresses the core issues that determine housing values. What is lost here is that housing in itself creates no value, its value is completely predicated upon peoples ability to pay for it. Ergo, housing prices for the last 100 years have tracked income remarkably closely, that is, except for the last five years. Historically, the ratio of housing price to annual income has been 2.1, with very little variation. In many parts of the country, this ratio is now approaching 10.5! Can you say “major correction?” Further, the amount of leverage used to buy homes during this boom has been increased to absolutely unprecedented levels. Even during the last boom of the late 80s/early 90s, the standard was still 30 yr fixed and 20% down. Not anymore. Last year, less than 15% of borrowers put down 20% or more! Further, the 30 yr fixed has been replaced by the IO, or interest only loan. See now, we have the same borrower capable of bidding 30-40% more for a property without any better credit or ability to repay. Neat trick, but sadly, Lereah at no point addresses any of these fundamentals.

That commenter was an ordinary guy with extraordinary insight.

Your Yugo Will Run Forever and How to Set the Land-Speed Record With It.

I found the pages much softer than Charmin, though not as soft as Quilted Northern.

Awesome Book! I totally agree with other posters on the historical significance. It has the same weight and dark humor aspects as Ernon’s “Code of Ethics” Employee Handbook from 2000. Aside from the hilarious writing, the best part has to be the great cover illustration of the floating house… It’s just out of reach…but maybe with an 80/20 Stated Income I/O loan package we can make it happen! Hooray!

LOL!

Irvine Renter’s track record

Some people weren’t totally wrong, and despite the ridicule from those that were wrong, some people stood up and called bullshit on the housing bubble. Back in March of 2007, six years ago this month, I predicted the demise of the housing market.

At the time I made these bold predictions, very few believed the housing market was going to crash. Homeowners were calling people like me “bitter renters” because those few of us that chose not to participate missed out on the free money, and it was assumed we were bitter and jealous of their superior judgement and good fortune. I still get filled with schadenfreude when I think about the insults that were hurled at me during the early days.

The chart below compares what I predicted with what the bulls believed back in 2007. Things didn’t get as bad as I predicted mostly due to market manipulation starting in 2009. If not for the suspension of mark-to-market accounting, deferred foreclosures through loan modification, and interest rates declining from 6.5% to 3.5%, based on the declines in 2007 and 2008, the crash would have been much worse than I originally predicted.

Because prices have risen so fast over the last year, some people are saying we’re in another housing bubble. While we are clearly reflating the old bubble, this time we are doing it with stable loan terms and affordable payments. While we might see a decline in prices again in the future when interest rates go up, we are not in a new bubble — at least not yet.

There are troubling signs: Buyers camp out for Bolsa Chica homes. However, as Jon Lanzner rather dismissively points out, New housing bubble? Hardly!

The OC Register published an article on how to spot a housing bubble. The advice is good but a bit sketchy. If there is another housing bubble, the overvaluation will show up in my monthly reports, and markets will drop from their current high ratings to very low ones. If you’re really concerned about a housing bubble subscribe to our monthly reports and keep reading this blog. If my analysis techniques prove better than the bubble deniers, and I believe they will, I will let you know when prices get out of bounds.