21 April 2013

Shilling For Shiller, Part The Second

Here's the link for Shiller's second column on the housing problem.

I find, on the whole, the column both irrelevant and wrong headed. Irrelevant to explaining the motivation for the Great Recession, which was the flood of The Giant Pool of Money to "risk free" returns into "nearly risk free" housing in the wake of Greenspan crashing Treasuries. While the history comports to what I understand it to be, it offers no further insight into the 2000's conflagration.
Fundamental factors like inflation and construction costs affect home prices, of course. But the radical shifts in housing prices in recent years were caused mainly by investor-induced speculation.

Here is where Shiller starts to go off the rails. Land speculation, as described in the column, has nothing in common with the run up to The Great Recession. The exotic and toxic mortgages, created for the explicit motivation to create more high quality and high value instruments that were "nearly risk free", weren't being scarfed up by Uncle Bill's House Builders, but by segments of The Giant Pool of Money. Not individuals, but corporations, were being scammed. Individuals were the pawns in the scam: "yeah, you're only a hamburger flipper, with fries, at Mickey D's, but you can sell it off in a few years and may be actually make a few bucks".
Interest rates have been declining for decades now. Clearly, that cannot continue on the same track for another 10 years, because rates would have to turn negative.

Well, not negative, but it doesn't follow that interest rates must necessarily rise in some future time. There's no theory that demands that interest rate level be cyclical. In the olde days, one could take a course in Business Cycles (and even an easy one for undergrads and a math-y one for grad students). So long as, 1) there remains a Giant Pool of Money seeking returns, and 2) real returns to physical investment continue to fall then we can expect weak interest rates to continue. In economics, there are a few base principles which not even the math-y types can ignore or deny. One of these is opportunity cost, in essence, how I spend my money involves weighing the various ways to use it. For investment decisions, this boils down to finding the best return. While the banksters consider their fiduciary fiddling to be worthy of interest, it doesn't result from real economic progress. For that, one can only turn to real investment. As The Great Recession demonstrated, only if mortgage holders earn more from their employment can they pay more vig. When household earnings stagnate, so must the prices of everything. And everything includes housing.

When real returns to physical investment decline, for whatever reason, the opportunity cost to investors declines in sync. The "risk free" rate of return will "always" be lower than risky investments, but the difference can only compress so much, if at all. It has been found that capital returns are falling, and so long as that continues, the "risk free" rate will stay about where it is.

But, of course, inflation can rise -- and it's easy to imagine that both it and interest rates will rise substantially, creating a bonanza for home buyers who have already locked in low rates.
What bonanza? Rising rates drive down the price of bonds and house prices or any instrument inverse to rates. House prices will stabilize at a real value commensurate with the interest rate, so if you buy now, you're guaranteed to see little to no capital gain when you go to sell. Those that made out like bandits, from a capital gain point of view, were those that bought when interest rates spiked in the late 1970s. Only if one believes the Bond Vigilantes are right, and I stand with Krugman on that, will there be an interest rate spike any time soon. The middle class remains emaciated, all that QE money remains locked up by banksters and corporations, so there's no money falling out of the sky to drive inflation. To the extent that we see inflation, ceteris paribus, it will be driven by supply shortages, notably in resources. Commodities, however, in a story below the fold of Shiller's piece in my dead trees version, documents that such isn't happening.

In the end, I don't see what land bubbles have much to teach us about The Great Recession, or the near term future, amusing as the history might be.

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