Lets set aside the critical question of whether a perpetually appreciating housing market should be a goal of economic policy, and assume that home price appreciation is a necessary (but not sufficient) condition for the U.S. economy to improve.
But there is a direct and self-evidently obvious way of reducing housing inventory, increasing business competitiveness and jump-starting the U.S. consumer base - much more immigration.
The Obama administration needs to look seriously at a completely fresh approach to immigration. To make any new immigration policy both fair and popular, any increases in immigration has to have the following elements:
Incentives for financially sound immigrants to move and invest in the U.S. - it is not unthinkable to impose a requirement that immigration seekers within the new system must own a minimum of (say) $250,000 US based property within a year of being granted US residency.
Strong disincentives for welfare-seeking immigrants - the last thing the economy needs now is an increase in the number of economically unproductive people.
Safeguards to ensure that the system does not evolve into the Dubai model - which places foreigners (and even their Dubai-born children) into a permanently lower class with no hope of citizenship.
The Obama administration should not be afraid of short-sighted union objections to increasing immigration - if it is serious in ending this economic depression, there should be no sacred cows.
The treasury bubble might be finally bursting - the 10-year yield has shot up by nearly 30% in the last few weeks (remember that Treasury yields move inversely with the price).
A bursting of the Treasury bubble would be bad news for two very important constituents. Firstly, large treasury bond holders (like China) would suffer capital losses on their investments. Secondly, an increase in long-term lending rates is bad news for businesses and homeowners who want to borrow long-term.
And so in this monetary policy chess-game, there are rumors that Bernanke is now considering buying long-term treasuries. There is a strong possibility that this is just jawboning. Bernanke is trying to get Treasury prices up (and yields down) simply by threatening to buy Treasuries.
If the market calls this bluff and still refuses to bid up longer-term treasuries, it could force Bernanke’s hand - either he risks losing credibility, or he unleashes yet another round of massive market distortions.
Like all bubbles the real estate bubble had a kernel of truth - real estate is a tangible asset that you could touch and potentially live in.
Those of us who feared that real estate was a bubble talked about the price-to-rent ratio, which allows us to value real estate in terms of the actual rental income it would bring.
It is possible to value college degrees with similar tools. The value of a degree is the net increase in lifetime income it brings. Every student who decides to spend her parents money (or his own future income) is making a bet that she will profit from this investment.
From John Robb comes this startling fact - the cost of a degree today is approximately equal to the increase in lifetime income - if true, a college degree provides no additional economic benefit after you factor in the cost of acquiring it.
As real estate shows, it is possible to overpay for anything - the tangibility of the asset does not prevent a mania from occurring.
So are we in an education bubble ? The graph certainly looks bubbly.
The real estate market is so awful that buyers are now scooping up homes for as little as $1,000.
There are 18 listings in Flint, Mich., for under $3,000, according to Realtor.com. There are 22 in Indianapolis, 46 in Cleveland and a whopping 709 in Detroit. All of these communities have been hit hard by foreclosures, and most of these homes are being sold by the lenders that repossessed them.
……
These houses are almost always small fixer-uppers. Wiring, plumbing and heating systems have to be replaced, walls and ceilings sheet-rocked, plumbing and light fixtures installed and new kitchen cabinets and counters put in. Few come with working appliances.
Often buyers are legally required to rehab these homes to bring them up to code. In Detroit, buyers are required to sign Affidavits of Compliance Responsibility, which obligates them to make repairs outlined in an inspection report. Only after that can a certificate of occupancy will be issued, which makes the house legal to live in.
But even factoring in these costs, they’re still bargains.
So whats the catch ? Here’s my prediction - many or most of these homes are in neighborhoods that will never recover. These bargain-hunters will be stuck forever paying for repair work and fending off drug addicts from these properties. The chances of getting renters or buyers for these properties are essentially zero - thats what the $1000 home sellers know that the “bargain hunters” dont.
Predictions are probably the best Rorschach tests for bloggers and investors. Everyone is in the prediction business, because every act of investment (including sitting on cash in the sidelines) is an implicit prediction about the future.
Writing down my predictions for the year has proven itself to be a great tool for me to become explicitly aware of my cognitive biases. Because if there’s one thing I’ve learnt in investing, its this - It’s not what you don’t know that kills you, but instead its what you know that’s wrong. (Can’t seem to find the original source for this quote).
So here’s the top 10 predictions on my mind as of today:
Stock market - The Obamarama stock market rally will be mostly over by Obama’s first quarter as President. By late 2009, it will be obvious that all of the government bailout and spending efforts are like holding an umbrella in a hurricane. The nation will finally resign to the reality of a longer term depression. This realization alongwith a few shocking municipal bankruptcies will cause the stock market to finally bottom in early 2010.
Bond bubble - The treasury bond bubble will continue to inflate, pushing yields to even lower levels than today. Bond bears will get clobbered in 2009 by being too early and too aggressive. The only thing that can burst the treasury bond bubble is a “growth scare”, which will not occur until 2010.
Obama - Barack Obama will not have the courage to give the economy the bitter pill it needs to quickly get rid of the mal-investments and excessive leverage that led to the current crisis. Nor will Obama have the courage to suggest that the government needs to be a referee in the market, rather than the dominant player it has become thanks to Paulson and Bernanke. The high of “Yes we can” will slowly morph into a hangover of “Yes we could have.”
Suburbia - 2008 will be seen in 2009 to have been the last year of the techno-triumphalist era. By the end of 2009, it will be apparent that technology (software, finance, green technology) alone cannot indefinitely sustain the now defunct credit-driven consumerist suburban SUV lifestyle. Austerity will be the new black.
Real estate - Real estate will overcorrect on the way down, and “fortress areas” like Cupertino in the Bay Area will also experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it harder for workers to relocate to where the jobs are.
Alternative energy - Alternative energy and OPEC countries will ironically find themselves on the same side, hoping for higher oil prices so that their respective industries and economies become viable. Oil prices will continue to disappoint them by being stagnant, and this will be a silver lining for the middle-class consumers.
Pakistan - The world will again be fashionably outraged for a few days in the Fall of 2009, when it becomes clear that new attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
Microsoft - Microsoft will realize (if it has not already) that there is no point going after has-been giants like Yahoo, and will instead (correctly) acquire Facebook and/or Twitter at bargain prices. For the first time in its history Google misses out on the obvious due to the “not built here” syndrome.
Google - Google revenue will surprise to the upside, but it will be at the cost of cutting down on other expenses, including payroll/bonuses, bandwidth bills for Youtube and possibly even Gmail and other Google apps.
Never intended as investment advice. Read my disclaimer.
Today we face the ironic situation of the US government abandoning free market principles to save the free market.
Whether or not the Government will succeed remains to be seen. But in the mean time, there are some fascinating unintended consequences going on (fascinating in a morbid sort of way).
It seems like every generation learns the hard way that central planning does not work, and indeed often worsens the situation that it claims to cure.
So here are just a few examples of how the current US government actions often worsen the situation that they are trying to solve:
1. Lowering interest rates reduces credit to companies
People who invest their money in CDs and money markets are (sometimes unknowingly) lending this money to companies who need the money and are willing to pay interest for short-term loans.
By driving interest rates so low, the Federal Reserve risks a perverse side effect - many money markets will have an expense ratio that’s higher than their interest rate! This means that many money market investors will have a negative return on investment. If this causes investors to withdraw from the money market (and invest into, say treasuries), it lessens the amount of money available for companies to borrow. This is already happening, as evidenced by the huge demand for treasuries (even at near-zero interest rates).
If the government wants more money to be available for lending to companies, it needs to increase interest that people earn on savings. This will provide incentives for people to save, which causes more money to flow into money markets and CDs, and hence increases the pool of money to be lent to companies! Right now the very opposite is happening.
2. Lower interest rates reduces lending to individual borrowers
If you are a bank, here is an easy way for you to get almost free money with virtually no risk:
Borrow nearly unlimited amounts of short-term money from the Fed (at the 0.5% “discount rate”)
Buy longer term treasuries with this money (earn >2%)
Hold to maturity if necessary
Repeat
Note that the above does not include having to lend to flaky retail borrowers! So this rate cut actually has an unintended consequence of making retail borrowers even less attractive to banks!
3. Helping defaulting homeowners encourages more to default
If the government provides relief to homeowners who are behind on their payments, it creates incentives for even more homeowners to fall behind, so that they too can get lower interest rates and hopefully even principal reductions!
Surely not what is intended.
4. Guaranteeing deposits causes money to leave good banks
By providing strong guarantees to money deposited in unhealthy banks, it creates an incentive for people to withdraw their funds from otherwise healthy (but not government-backed) institutions into bad banks that are guaranteed by the government!
5. Lesson learned by bankers - take even bigger risks next time
This is probably the worst of the unintended consequences. An entire generation (and probably more) of bankers and traders have now learned - that if you take risks, make sure you take huge ones. So that if you fail, you are more likely to be bailed out in the long run. The moral hazard being created by this bailout is just staggering.
The financial, mortgage, insurance and auto bailouts almost guarantee that the next bubble will be even bigger and even more disastrous when it bursts.
This is good news for those of us who are brave (or foolish) enough to be starting a business now:
U.S. entrepreneurial activity fell from 12.4 percent of the total workforce in 2005 to 9.6 percent in 2007, according to a joint study by Babson and Baruch Colleges.
Lawrence Summers, Obama’s soon-to-be top economic advisor, strikes a pragmatic tone on the crisis. Rather than toe the party line on greed and corruption in Wall Street, he points out that financial crises are not new and are actually rooted in human nature rather than on financial innovation.
He seems to be quite candid in this interview - but it remains to be seen what happens after he enters the Washington jungle.
(Originally written for VentureWoods - India’s leading venture capital and startup blog)
The following paragraph jumped out from something I wrote in 2005.
U.S. real-estate slowdown will have global consequences: Interest rates, U.S. bond prices, U.S. consumer confidence, dollar exchange rates (and hence the offshoring business), combined with the huge (and increasing) U.S. trade deficit are all pieces of a fragile domino game. This game could easily turn ugly if the U.S. real estate market accelerates its slowdown, or even worse, turns out to be a bubble. Bad news in the U.S. housing market could trigger a global recession.
This seems all remarkably prescient and oracle-y now, and I almost made a suitably massive upgrade to my ego. But like recent Sensex rallies my ego quickly came crashing down when I read some of my other predictions - e.g. Yahoo will start catching up with Google (Hope is eternal, and I might yet come back to gloat).
But lets get back to more important things:
There seems to be a tendency amongst many to regard a recession as a finite event, associated with a numerical reduction in GDP or stock market values. Business writers seem to compare a recession with a winter, where you hunker down (”cash is king”) and hibernate on minimal life support - after all, spring is just around the corner.
That might be a useful survival strategy, but it misses the bigger point - recessions (and especially this one) are discontinuities with totally unpredictable consequences (gosh I sound like a Nassim Taleb fanboy). To continue my useful but terribly flawed nature analogy, recessions are not like winters, but more like the Ice age that made the dinosaurs extinct. Like the Ice Age, this recession has already essentially destroyed the US Investment Bank business model.
What other changes will this Ice Age bring? I see a few possibilities:
1. Currency changes - The hegemony of the US financial industry (and the financial industry in general) is over. As I write this, the G-20 is meeting to discuss what could very well be the birth of Bretton-Woods II. A covert agreement to safely achieve a massive devaluation of the US Dollar is not out of the question (what will the Rupee do ?). Nor is it impossible to envision the emergence of an alternate reserve currency (or more likely a basket).
2. Consumer changes - We have lived, learned and grown up in a world where the world (now mostly China) manufactures and the US consumes. That world has changed. The US consumer is now on life support. She might live for a long while more, but that vitality and voracious appetite is unlikely to return. For the sake of my mental well-being I prefer to not imagine the consequences of this to the Chinese economy.
3. Fiscal policy changes - The ghost of Keynes is stirring - World governments will unleash the mother of all fiscal (deficit) spending rather than allow deflation to take hold. This sort of worldwide government stimulus is unprecedented, and its implications (or even its effectiveness) are unknown at this point. Will all the stimulus go into productive areas of the economy or will it be gambled away ?
4. Political landscape changes - The current bonhomie between nations and “global co-operation to solve the crisis” is very fragile and based on mutual fear. The Doha talks fiasco shows that developing nations are no pushovers now. There is a real chance that this “united in fear” sentiment could morph into a very ugly blame game. The parallels of the current situation to the Nixon Shock (when the French demanded gold from the US in return for dollars) are eerie and very scary.
So my question to the readership of this blog is this - does anyone see these changes too ? And more importantly, what other seismic shifts do you see occurring in our economic and business landscape ?
(Originally written for VentureWoods - India’s leading venture capital and startup blog)
Here are 5 questions about the US economy that I would love for the new administration to answer directly:
1. Do you agree that for a large number of people, walking away from their home and being foreclosed upon is to their financial advantage ?
(In many cases they will be able to rent an equivalent or better home at a far lower price than even the most generously re-negotiated mortgage!)
2. Do you support the idea that an average, middle-income American family should be able to afford the average home in their neighborhood ?
(If so, you should be cheering on house price declines, not trying to prevent them.)
3. Do you feel that America needs to save more and consume less ?
(If yes, why not increase interest rates to reward savers and punish debtors ?)
4. What specific steps will you take to curb the immense moral hazards created by the indiscriminate bailing out of financial and auto companies ?
(Or will future MBA students be taught to “go all in”, since the government will always backstop them if they get large enough ?)
5. You promised to not raise taxes for most of us. Isn’t deficit spending and the resulting inflation simply another way of taxation ?
(Is it not better to get Paul Volcker in as the new Treasury Secretary with the simple mandate - design a set of incentives that will reward the sorts of behavior we would like to see in the future, and punish the ones that we dont ?)
Laid-Off Foreigners Flee as Dubai Spirals Down - NYTimes.com No one knows how bad things have become, though it is clear that tens of thousands have left, real estate prices have crashed and scores of Dubai’s major construction projects have been suspended or canceled. But with the government unwilling to provide data, rumors are bound to flourish, damaging confidence and further undermining the economy.
Soros: "Bad Bank" for Troubled Assets Is Bad Idea "That (the "bad bank" proposal) will help relieve the situation, but it will not be sufficient to turn it around," Soros said during a live interview at the Davos economic conference in Switzerland. Instead, Soros said he would create a "good bank" and re-capitalize the good assets.
He admitted his alternative plan is not likely to get support because it too closely approaches nationalization. "The political will to do that is not there," he said.
China’s Economy Faces 2009 ‘Hard Landing,’ China faces an economic “hard landing” and the risk of social unrest with growth slowing to 6 percent or less this year, the weakest pace since 1990, Fitch Ratings said.
The Start-Ups We Don’t Need — The American, A Magazine of Ideas It also takes a lot of entrepreneurs to create lasting jobs. To get one business employing at least one person ten years from now, we need 43 entrepreneurs to begin the process of starting a company. And how many jobs will that startup have, on average, ten years after it was founded? The answer is nine. In short, 43 people have to try to start companies so that we can have nine jobs a decade from now. That’s not the spectacular yield that you might expect if you read the press reports about the job creation of start-ups.
Econbrowser: Federal Reserve balance sheet The bottom line is that Bernanke has made a gamble with something approaching 2 trillion. If the gamble wins, taxpayers owe nothing. If the gamble loses, taxpayers are committed to borrow a sum equal to any losses and start making interest payments on it.
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experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it ![202px-Hubbert_world_2004[1]](http://mungee.org/wp-content/uploads/2008/12/202px-hubbert-world-20041.png)
attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
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