A speech on housing by the Fed’s William Poole made the rounds this week. I thought I’d link to it because it clearly illustrates a point that I think is crucial to always keep in mind: that the folks at the Federal Reserve are politicians first and economists second.
Let’s jump right in with this line from his speech:
In practice, there is no perfect definition of a price bubble; so, identifying a bubble in real-time is inherently a judgmental exercise. Indeed, given that bubbles always burst—if there is no burst, then there was no bubble—clear advance evidence of a bubble can never exist. If the evidence were clear, then everyone would know about the bubble and forthcoming burst, but then the buying that created the bubble would not occur in the first place.
This is a ridiculous argument, because everything in economics is a "judgmental exercise." We need go no further than the last paragraph of his speech for an example:
My hunch, though, is that housing activity will stabilize and remain at a high level this year. I base this forecast on the belief that the FOMC will keep underlying inflation low and stable, and that the growth of real household income will recover nicely due to the waning influence of last year’s spike in energy prices. Continued healthy job growth will also help keep housing conditions at a high level.
Let me see if I have this. Poole has no problem telling us—based on a "hunch," apparently—what will happen in the next year for housing activity, inflation, energy prices, incomes, and jobs. So predicting post-bubble home price correction is an "inherently judgemental exercise," but predicting housing activity is not (as long as the prediction is positive, anyway). It’s also not a judgmental exercise to predict interest rates, energy prices, or job and income growth–despite the fact that these topics are all hotly debated in the financial press.
This is a complete contradiction, and it’s nonsense. The fact is that speculative bubbles absolutely can be identified as they are occurring. And the Fed knows it. They knew about the tech stock bubble, as Fed meeting notes have now shown, and they know that there are (at least) regionalized housing bubbles right now. Poole again:
The conventional view, which I subscribe to, is that a housing price bubble does not exist on a national average basis, but there may be pockets of the country where prices have risen beyond levels that can be justified by economic fundamentals.
Wait a minute—I thought you couldn’t tell if something was a bubble in real time? So how is he so convinced that there is not a national housing bubble right now? Per the claim above (which I disagree with, obviously) that a bubble turns out to have been a bubble only if it bursts after the fact, he shouldn’t be able to make that claim.
He then goes on to say that there "may be pockets of the country where prices have risen beyond levels that can be justified by economic fundamentals." Wait a minute; that kind of sounds like a bubble. So now he’s saying that he is able to identify bubbles, but only regionally? Oh, wait… there "may" be regional bubbles. Maybe he should look into that.
So in conclusion, you can’t tell if a bubble is taking place until after the fact, but you can tell when a big bubble isn’t taking place, and when little bubbles may be taking place. Thanks for clearing that up, Bill.
The whole speech is an exercise in double talk and double standards. It’s clearly intended to soothe housing bubble fears and to talk up the economy while throwing in vague references that there "may" be regional bubble for CYA purposes. I think the speech entirely without merit, except to prove the point I made above: Federal Reserve members are economists by training, but they are politicians by trade. Their economic commentary should be regarded accordingly.
March 11, 2006 @ 10:44 PM
I get so annoyed w/ mindless
I get so annoyed w/ mindless chatter from economists who probably are briliant, but can’t talk about the truth for fear of getting reprimanded. I just wrote an editorial to the Union-Tribune, and among others, criticized Alan Gin for his mindless rosy reports.
Getting back to Poole…he’s basically stuck with saying this stuff. He’s a marketing manager/salesman for the economy. He’s not there to tell us the truth. That would destroy the dollar, and cause a run and a panic. It would cause economic collapse, wouldn’t it?
Can you imagine what would happen to the economy if he said (and I’m exaggerating a bit), “We are just dropping off the cliff of the largest housing bubble in our country’s history. There is a high risk of bank default, pension fund collapse, and about 25% of homeowners will face foreclosure. We’ll see massive layoffs in construction, real estate, retail, and the restaurant industry. Sell your stocks in these industries, look for another job if you must, leave the country…Your best bet is to sell your house while you still can get enough to meet your mortgage obligation. If you file bankruptcy, any unpaid mortgage balance is treated by the IRS as income, and taxed accordingly. We’re sorry this is happening, but as you know, we don’t regulate the financial markets, and they are the ones who lent you the money to buy your houses and spend your equity. Brace yourselves for a recession. Although the next few years will be rough, we will emerge stronger. Oh, and if you’re worried about a banking collapse, just buy gold. We’ll be cranking up the printing presses and your dollars will be devalued. Now folks, how do you like the new Open fed market committee, where we are Open with you on everything?”
He can’t say anything remotely similar to this.
Most Americans aren’t even going to read this anyway, since they’re too busy watching reality TV shows. Those that do, should know by now that state-funded economists are politicians first, as you said.
I hope large investors pay attention to hints in the Fed’s speeches, so they know they must reduce their risk in buying these speculative financial products. If the Fed can at least give some hints, and MBS products are priced for higher risk, lending standards would tighten up. That will be a beginning to slowing this all down, and ensuring the safety of the financial markets. I’m just worried about who will wind up with the losses when millions of homeowners are in foreclosure.
March 13, 2006 @ 11:23 AM
Jeremy Grantham, founder of
Jeremy Grantham, founder of Grantham Mayo Van Oterloo (which manages about $80 billion in assets), noted in a recent research piece (in so many words), “Unlike the Federal Reserve, I have no problem whatsoever identifying a bubble: a bubble occurs whenever an asset group’s prices move more than two standard deviations from that asset’s long-term mean trend line. By that measure, we have had 29 asset bubbles globally since World War II. 27 of the 29 ultimately reverted to below-trend prices. The two that didn’t are the U.S. stock market bubble and the global property bubble which we are currently witnessing. History suggests they will… eventually.”
I would agree completely with Grantham’s definition of a bubble. What prohibits the Fed from using such simple, powerful logic? The applause meter, that’s what. The Fed no longer targets inflation or the economy when setting interest rate policies; it targets whatever policy generates the most applause from Wall Street. The last Fed chairman with any true integrity was Paul Volcker… I weep for the future.
March 13, 2006 @ 5:53 PM
rich, at the lowest points
rich, at the lowest points of your graph, what is the approximate multiple of median home price vs. median household income? thanks.
March 13, 2006 @ 6:13 PM
I had been thinking that we
I had been thinking that we would hit that same low point again with the next bottom, i.e. 7.5x per capita income, but what happens if the low point is hit during a recession, and the foreclosure rate during those years is double that of previous low points due to exotic financing? What would be a reasonable low point based on the higher risks this bubble took on?