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References for
"Why Home Prices Are Going
through the Roof "
San
Francisco: see Rebecca Solnit, "Hollow City," Utne Reader
(click on hyperlink at the bottom of the left-hand column of this web
page).
Asset
inflation: generally refers to a strong rise in asset prices (here we are
referring to the stock market and the real estate market) with an increase in
the ratio of the asset price to (some measure of ) the current fundamental
value. "For example, the ratio of property prices to rents tends to
increase when property prices are strong. Similarly, when equity [stock] prices
are strong, price-earnings ratios tend to be high" (Bank of International
Settlements, Contact Group on Asset Prices, "Turbulence in Asset
Markets," September 2002, p. 11). The price-rent ratio is the real estate
equivalent, in other words, of the price-earnings ratio. Based on a few
multifamilies (January 2003), I get a price-rent ratio of at least 1.4 in
Northampton. In other words, these houses are priced 40 percent over the
value justified by the income stream of these rentals. Northampton and
Amherst are at the extreme high end, but, with the exception of Turners
Falls (and outlying areas like Orange and Holyoke), there is no place in
the Pioneer Valley where real estate is a "good investment."
Single-family homes are similarly overvalued, and land even more so.
Brazil and other Third
World countries: see James K. Galbraith, "The Brazilian Swindle and the
Larger International Monetary Problem," originally published in February
2002 by the Levy Economics Institute, now available in the first issue (January
2003) of the Post-Neoliberal Review.
"Fannie
and Freddie Were Lenders": Title from a paper by Richard Freeman,
"Fannie and Freddie Were Lenders: U.S. Real Estate Bubble Nears Its
End," which appeared in the June 21, 2002 issue of Executive
Intelligence Review. Fannie Mae = Federal National Mortgage
Association; Freddie Mac = Federal Home Loan Mortgage Corporation. Both
are publicly traded private corporations and are therefore under pressure to make a profit for their
shareholders.
Mortgage-backed
securities (MBSs) are
financial instruments that are increasingly used to securitize debt, that is, to offload it
from your own balance sheets, bundle it up with similar debts (e.g., bundles of
car loans, of mortgages, of credit card debt), and sell this new interest-bearing security to
investors. These "asset-based securities" enable companies to
"socialize" risk, that is, to spread it through the entire financial
system (especially to workers' pension funds, insurance companies, and mutual funds).
Derivatives are
financial instruments that "derive" their value from an underlying
fundamental, such as a variable interest rate or currency exchange rate. They
are used to hedge risk (so the term "hedge" funds), as when a US
company is doing a lot of business in Japan and wants to protect its profits
against a sudden change in the yen-US$ exchange rate. But derivatives are
increasingly used for speculation. They tend to be highly leveraged and the
unregulated over-the-counter derivatives market dwarfs all the activity in
currency markets and financial markets throughout the world. Long Term Capital
Management was a large (at the time) hedge fund whose collapse in 1998 created
an international financial crisis until they were bailed out by the US
government (by US taxpayers ultimately). So they privatize the speculative
profits they make, and when they suffer devastating losses, it creates such
systemic risks that they are able to "socialize" their losses.
International investors love entering into derivative contracts with Fannie and
Freddie because they are certain that the US government will bail them out if
things spin out of control. Socializing risk, but privatizing profit: this is
the modus operandi of the "new economy."
Wall Street
Journal: See editorial of March 19, 2002, "Fannie Mae
Enron?" See also BusinessWeek Online, September 2, 2002,
"Everybody Out of the Risk Pool?"; The Economist, July
19, 2002, "Big Scary Monsters: Mortgage-Lending Agencies in
America"; Washingtonian, August 2002, Ross Guberman,
"Balancing Act: Fannie Mae Projects a Happy Image, But as Its Debt
Grows Bigger and Bigger and Its Executives Get Richer, Should Taxpayers
Start to Worry?"; the website FannieMaeWatch.org; Robert Blumen,
"Fannie Mae Distorts Markets," July 1, 2002, on the website
Mises.org; and Flow of Funds: Review and Analysis (a publication of
the Financial Markets Center), 3rd quarter 2002, "The Overheated
Mortgage Machine."
For a clear and comprehensive
treatment of this, see the 118-page February 2003 report of the Office of
Federal Housing Enterprise Oversight (OFHEO, an agency responsible for
overseeing Fannie and Freddie), "Systemic Risk: Fannie Mae, Freddie Mac and
the Role of the OFHEO." Shortly before this was released in early February,
President Bush asked for the resignation of the OFHEO director, Armando Falcon,
whom he felt was spreading discouraging news about the economy. He appointed in
his place an anti-regulation hedge fund executive, who doubtless can be trusted
not to make waves.
Has helped to
drive prices up: for the clear link between credit expansion and asset
bubbles, see Bank of International Settlements, Contact Group on Asset
Prices, "Turbulence in Asset Markets," September 2002. Available
online at BIS.org.
One often-trotted-out explanation for high
real estate prices--the short supply of houses and the demand for houses in
certain towns--is certainly a factor. But it is a different supply-and-demand
dynamic that raises values to a price level that is beyond the aspirations of
most prospective homebuyers in a town like Boston. That dynamic is the
exponential growth of the money supply, especially since 1995. An oversupply of
money and credit, not productivity or profits or supply and demand, created the
boom of the late 1990s in equity markets and real estate.
In past
inflationary environments, wages and consumer prices would have risen in tandem
with home values. We would not see the divergence we see today between income
and house prices. But in today's economy, our export of industry to low-wage
countries and our import of inexpensive goods from these same countries, have
depressed wages in the United States and restrained inflation of consumer goods.
So the Fed, unmindful of the dangerous inflation in our asset markets (real
estate and financial markets), looking only at our low wages and low
consumer-goods prices, has pumped massive amounts of money into the economy.
This is the source of the asset inflation in equity markets and in real
estate since the early 1980s. Fannie and Freddie have added to the problem by
opening our mortgage market to global capital inflows, which have flooded the
mortgage market with easy credit and enabled workers with low purchasing power
to take on a mortgage that he or she will work their whole lives to pay off. (Thanks, Fannie, for being in the American Dream business!)
It is absurd to suppose that an 18th-century
economic model (supply-and-demand for widgets) can explain the volatile inflation of real
estate markets in our global economy. We need more interactive, nonlinear models
(such as those being developed by Steve Keen of Western Sydney University in
Australia) to explain the turbulence in today's asset markets.
Additional note: Robert Shiller, a Yale
economist and author of Irrational Exuberance (the term by the way was
borrowed by Alan Greenspan from Shiller, and the book predicted the bursting of
the stock market bubble), spoke recently (January 17, 2003) at a Los Angeles
conference on "The Housing Bubble: Fact or
Fiction?" and he described the housing bubble as a Ponzi phenomenon
similar to the tulip mania in 17th-century Holland or the recent NASDAQ bubble
(where the astonishing profits of early investors creates an excitement that
brings in new buyers and drives up prices). This psychological dimension is an
important feature of bubbles, but the fundamentals driving the original
inflation are, I think, even more important to address.
Daily
Telegraph: Sunday Telegraph, January 12, 2003, Money section.
The US real estate
market: our central bankers do not seem to be taking asset inflation
seriously enough (see Michael D. Bordo and Olivier Jeanne, "Monetary Policy
and Asset Prices: Does 'Benign Neglect' Make Sense?" IMF Working Paper
2002/225, December 2002). Central bankers
and economists in Europe and Australia, or at least a few of them, seem to be
more concerned with asset inflation and its destructive effects on the economy.
Alan Greenspan and the Federal Reserve apparently don't want to take away the
punchbowl, however. They have continued to pump money into the economy, with the
clear aim of sustaining asset markets and preventing deflation of these markets.
Other clear indications of their reflation policy are in the speeches made by
Greenspan on December 19, 2002, and Bernanke on November 21, 2002, and in the
white paper done by the staff economists at the Fed in June 2002,
"Preventing Deflation: Lessons from Japan's Experience in the 1990s."
The message is: Reflate at all costs. This very policy will tend to dilute the
value of the dollar and make dollar assets less attractive to foreign investors.
Mortgage
slaves: Mortgages were, in the 1920s,
only 5 or 7 years long. You paid off the house and then owned it outright and
could save and enjoy the fruits of your labor. Later the amortization period
extended to 15 years, and then to 30 years. Now in the UK there is talk of 50
year mortgages because home prices are so high that people cannot afford the
monthly payments with their income. In Japan there are already 100-year,
intergenerational mortgages. (Most of this distortion, by the way, has taken
place since the early 1980s.) Such long mortgages come perilously close to
indentured labor, mortgaging your work life and that of your children to the
bank or to foreign investors. As Michael Hudson
has noted, it is more reminiscent of preindustrial, feudal economies than
of modern democracies.
The commonweal
of the American people: I'll pursue this last thought in a piece on
"Property and Social Wealth."
Acknowledgements: A keen
interest in the causes of the rampant inflation in property values
in the Valley led me inevitably into the highways and byways of global
finance. I formulated
these ideas with the help of papers written by Michael Hudson, author of Superimperialism
(papers available on the "Gang of 8" discussion group on
Creditary Economics at Yahoo.com); articles by Henry C.K. Liu published in
Asia Times; a paper by Gary A. Dymski, "Asset Bubbles and
Minsky Crises in East Asia," published by the Levy Economics Institute of Bard
College, April 1999; and commentaries of Doug Noland in his Credit
Bubble Bulletin on the Prudent Bear Funds website. Thanks too to
Winton Pitcoff for his helpful suggestions.
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