TCS Daily

Housing Market Blues

By Desmond Lachman - March 23, 2007 12:00 AM

As in a Greek tragedy, the present unraveling of the US housing market is being accompanied by all too predictable choruses. At periodic intervals, the Wall Street economist chorus assures us that the worst of the housing downturn is over and that the spillover affects to the rest of the economy will be minimal. For its part, the policymaker chorus intermittently spouts forth soothing words to calm nervous markets at this time of heightened investor uncertainty. And these choruses get rudely interrupted every now and again by ever worsening data coming out of the housing market only to start the cycle of reassuring choruses anew.

While the inclination of policymakers to act as cheerleaders is perfectly understandable, one can only hope that they do not allow their positive spin to blind themselves to the likely need for early monetary policy easing. For an aggressive easing in interest rates will soon be needed to limit the economic fallout from the housing bust that now appears to be in full swing.

In the debate as to where the housing market might be headed, all too much attention has centered on the grave troubles now surfacing in the sub-prime mortgage market rather than on the gross excesses that characterize the overall US housing market. In particular, scant attention is being paid to the fact that housing prices in constant dollar terms surged by a staggering 70 percent between 2000 and 2006, or by an amount that has no precedent over the past 100 years. Nor is much attention being focused on the fact that the remarkable relaxation of mortgage lending standards over the past six years has raised the percentage of US households owning homes from a fairly stable historical average of 64 percent to almost 70 percent by 2006.

Among the factors underlying these housing market excesses was the extraordinary easing in monetary policy following the bursting of the bubble in early 2001. Already by 2003, the Federal Reserve had reduced interest rates to as low as 1 percent and the Fed was very slow in restoring interest rates to more normal levels over the next three years. Equally important in explaining the housing market boom was an unprecedented easing in mortgage-lending standards and the introduction of exotic lending instruments like Adjustable Rate Mortgages or negative amortizing loans. As a result of these innovations, by 2006 as much as 20 percent of overall mortgage lending was in the form of sub-prime lending to borrowers with poor credit histories, who previously would not have remotely qualified for housing loans.

Like all good things, the housing market party, too, appears to have come to an end. As housing has become ever-less affordable, housing prices, which were increasing at an annual rate of 15 percent as late as mid-2006, have now flattened out or started to decline. At the same time, vacancy rates have surged to record levels, while the stock of unsold homes has risen to over 7 months' supply thereby adding to the downward pressure on home prices. And to crown it all, the regulators, who were pretty much asleep while the party was in full-swing have now taken it upon themselves to tighten lending standards.

Despite the many assurances from policymakers that the worst is behind us, the outlook for the US housing market is now clouded by a whole host of factors that suggest that housing demand is likely to dry up at the very time when the market is characterized by oversupply. The mounting trouble in the sub-prime market space has already resulted in the shutting down of 30 sub-prime mortgage lenders and defaults on sub-prime mortgages are expected to result in around 500,000 foreclosed homes returning to a saturated market over the next six months. To make matters worse, the resetting at higher interest rates of around US$500 billion in Adjustable Rate Mortgages is only likely to compound a difficult situation in the sub-prime mortgage space, while the generalized tightening in mortgage lending standards is likely to further restrict overall housing demand.

In the months ahead, as housing prices inevitably fall under the weight of excess supply and of the unwinding of large speculative positions, one must expect that the overall US economy will be negatively impacted in a material way. Sharply lower residential construction activity and employment alone could shave a full 1 ½ percentage points from GDP growth in 2007. More important still, in the same way that increasing home prices induced US households to run down their savings when the housing boom was in full swing, declining home prices could induce those same households to replenish their depleted savings. Since household consumption constitutes 70 percent of GDP, any attempt by households to rebuild their savings through lower consumption expenditure could have a large impact on the overall economy.

If the experience with the bursting of the bubble is any guide, the last thing that one would now want would be for policymakers to confine themselves to a cheerleading role. Rather, one would hope that the Federal Reserve anticipates the coming housing induced-economic slowdown and that it stands ready to aggressively ease monetary policy as needed to soften the fallout from the coming housing bust.

The author is resident fellow, Resident Fellow, American Enterprise Institute.



The market at work
Mortgage brokers are the dotcom day-traders of the current era. Can you say overcapacity? Those that over-reached prudent credit standards are failing, so what? Some hedge funds are sinking in low-traunche mortgage paper, too bad. The market will adjust if we let it. The tragedy is that the FHA is now expanding their sub-prime offerings. So next time - the taxpayers can share in the pain. Oh joy.

Crisis? What crisis?
It's just been one financial crisis after another since 2001.

The US trade deficit is horrible and getting worse.

The dollar continues to fall wrt the euro.

The cost of energy (gasoline, natural gas, power) has about doubled.

The national debt has nearly doubled.

We're left with a lot of nothing. Tax dollars gone to buy bombs for an illegal war have weakened our economy to the breaking point. I'm laying odds that it's more downhill than up from here.

Easy money is what got us into the current mess, you idiot
The Fed kept interest rates too low for too long. More easy money is not the answer. Do you really want a return to the stagflation of the '70's? Because that's what we'll have if the Fed follows your prescription and aggressively tries to lower interest rates at the first sign of an economic downturn. Hair of the dog will only make the final hangover/detox worse. Take a look at what's happening with gold and other commodities, or the GDP deflator for that matter. Core inflation has already exceeded 2%. Repeat after me: The sole purpose of monetary policy is to maintain the value of the currency. It is an extremely poor tool for fine-tuning the economy. The lag time between a change in monetary policy and its effect on the economy is about two years. Do the math.

The "Soft Landing" is a myth. No way it will happen.

What I forgot to mention...
is that monetary policy does have a nearly immediate effect on inflation. The German hyper-inflation of the 1930's was brought to an almost overnight halt when the German central bank stopped printing excess money.

Attempting to control a process by a mechanism with a long lag between changing the control setting and the effect is a recipe for oscillation. In economic terms, it's called boom and bust.

crisis starters
The Fed, like all organs of predatory governments have a 'reverse Midas-touch', everything they touch they screw up. So the Fed cause the 1929, depression, and now this smozzle as others are correctly saying. It is not a free market, but a command economy to that extent. Indeed, many real economists even maintain that there should be no Fed at all.

Independent of who's fault it is...
The US federal government is dragging everyone all down.

Of course not having a government is preposterous. But getting the Republicans and/or any other fascet of neoconservatives out of power would be a good first step.

More liquidity is not the answer...
That said, however: Inflation rates during the period from 1974 to 1981 averaged 9.4% with the rate during the last three of those years averaging 11.7%. That was what harmful inflation looked like.

Alternatively, the rate for the eight years from 1992 to 1999 averaged 2.6%. And that was what a robust economy looked like.

We do not need to get under 2% to enjoy a sustainable inflation rate in a healthy economy.

Stagflation: In the early 1980's we had a stagnant economy. Available working capital was off speculating in real estate. Interest rates on real estate loans were above 15% in 1981 and 1982. Prime interest rates were above 20% at that time. Industry could not reasonably borrow extra working capital at such rates. They could not do enough with those incremental borrowed funds that would have generated sufficient earnings to cover such interest. So everyone simply stopped. Our economy collapsed into the recession of 1982.

Here is what our soft landing looks like in 2007: People with sub-prime mortgages are employed. They will hang on as long as possible and the first thing to go will be their credit card payments. Those unsecured lines will increase interest rates up to the 30%+ limit the moment a payment s late and the minimum payments will quickly accumulate to a number that could never be covered. Massive default losses will hit portfolios holding such credit card paper this year.

Residential mortgages themselves are collateralized by underlying real estate. The homes will change hands but all these people need to live somewhere so the value of rental properties, including single family houses, will rise. Mortgage rates for those investors who survive are still reasonable. Therefore, such foreclosed properties will be picked up as rental properties that support themselves in most markets and detached houses will start appreciating again. More slowly this time.

Consumer spending should not be hurt. The sub-prime borrowers were not aggressive consumers anyway, for the last year or two. All their cash flow was tied up in mortgages they could barely make. And their credit cards were max'ed out a while back.

As long as these new renters are working they will now be out from under their mortgages and they will have not restarted making credit card payments again because the foreclosures destroyed their credit ratings for the next several years anyway. At such a point they might actually start consuming again and, perhaps, save a little money to invest in something safe like blue chip stocks.

The banks will take a one-time hit this year (especially with all those unsecured credt card lines that are certain to default). The smart CFO's have already booked appropriate reserves (in this 1st Quarter) against that reality and they will go into April Update with a revised Annual Plan that they can make.

This economy is robust and unemployment continues to be low. Interest rates are about where they need to be and inflation is historically low (no matter what the Fed says they might hope to see). The Dow will climb back up toward 13,000 by the end of the year.

Real estate is not overpriced but, of course, it was moving up too fast. Putting a home into your long term portfolio will continue to be far better than renting if you have the choice. The subprime option was an anomaly and a gamble that seemed to make sense at the time.

Inflation vs production
Monetary policy has a seesaw effect on production and the value of money; there's no net gain available over a reasonable range of values. (Extreme values of monetary policy -- hyperinflation or contraction -- just break the seesaw.) Raising production without lowering the value of money requires improving the conditions that make production possible.

Reducing drains on production such as taxes.
Removing anti-productive regulations.
Removing market distorions like farming subsidies.
Inovations (like the internet. Alas, these are not things that can be depended upon to come into existence through government policy.)
Removing disincentives to work like welfare, food stamps, etc.

Fiddling with monetary policy is a zero-sum game compared to the effects of not screwing up a capitalist system.

You are saying that there is a cause/effect relationship between production and inflation. That as production increases the value of money must drop so that (through inflation) there would be more money (increased liquidity) to take that production off the market at the same price.

Similarly, an increase in the money supply should demand more production of goods as people spend more. This seems intuitively correct.

Of course, Keynesian economics effectively disputed this classical "quantity theory" of money. But John Keynes was also wrong, as the stagflation of the late 1970's/ early 1980's demonstrated.

It is far more complicated than your zero-sum game because there are lots more variables than can be modeled into an equation (algorithm) that might be solved.

The good news seems to be that we are getting a better grasp of certain fundamentals such that, as we go forward, we should avoid the sort of stupidities that would get us into trouble.

It may be like driving an automobile. We genuinely do not know everything that is going to happen out on the road in the next ten minutes. But we are good enough to see a problem (to be avoided) developing and we try not to drive too fast for conditions.

One interesting thought. If tax cuts can stimulate an economy then could increased taxes be useful to skim off some of the excess liquidity out there when this might, otherwise, cause problems, such as inflation?

Seems like such a moment could be employed by the government to slow down the economy without raising interest rates and to pay down the National Debt when business is unsustainably better than expected.

It just appears by magic
I don't agree about easy money having a long lag time before it's effective. Easing a tight money supply has an immediately beneficial effect on economic downturns. It puts money on the street to boost employment. Then all those paychecks get spent, causing the factories to hire more people to keep up with demand. Or at least that's the way it worked back when we still had factories. Well, there must still be SOME places that are hiring, because the money's been easy for years, and unemployment's been low.

The problem is, you lose that tool in your tool belt when you keep money easy all the time. It's just a cheap way to maintain political popularity. But the bus ride has to come to an end, because what all this unnaturaly cheap money has done is to fuel another bubble-- this time not in air-filled tech stocks, but in overvalued homes.

So all these economic good times have just made us flabby and out of shape. Ease the money supply again and all we'll do is get back on the Magic Bus and spend, spend, spend. There's no need for discipline, and others can do the producing for us.

That may have been the case at one time, though there is little evidence for it.
Today, whenever bankers see that money supply growth is taking off (what you call easy money), they immeadiately raise interest rates, because they know that inflation is just around the corner.

How to play the ball from the existing lay
It's obvious we're in your area of expertise. With mortgage and consumer lending issues, you look like Brer Rabbit in the briar patch.

But I would alter one observation a bit. You say "As long as these new renters are working they will now be out from under their mortgages and they will have not restarted making credit card payments again because the foreclosures destroyed their credit ratings for the next several years anyway. At such a point they might actually start consuming again and, perhaps, save a little money to invest in something safe like blue chip stocks."

My guess would be no, these people have families and a lot of deferred consuming to do before they get around to letting any excess bags of cash pile up. Remember, they have lost everything, been forced from their homes, have flirted with bankruptcy, etc. This is a trauma only the return of material proesperity can assuage.

As soon as they get back on their feet they'll want their homes back. Only this time, once stung, they'll insist on the fixed rate mortgage.

It's the lenders who will have taken the hit on this downturn. And they will have done it to themselves. If they have any sense, they'll realize they don't really like being in the rental business. They should be glad to sell people their old homes back-- for a reasonable price and terms-- just to get the bricks out of their portfolio.

The smart ones would be wise to renegotiate their problem loans right now. They already have a good resident in place, they just rocked the boat by making the payments too high. Lenders would save a LOT of money and grief for themselves just to keep the loan payments at 2004 levels.

The alternative is to receive the property vacant and used, in the middle of a housing glut. It's going to soak up money like a sponge before it's even ready for market. And then it will be competing with herds of comparable properties.

So think about keeping your existing tenants. They're as good as they can be at paying you-- they think they're the owners.

Easy money
"Today, whenever bankers see that money supply growth is taking off (what you call easy money), they immeadiately raise interest rates, because they know that inflation is just around the corner."

Oh... you mean like they did in 2001, when Greenspan lowered the prime eleven times in a row. They didn't just get in on the feeding frenzy, fuelling the current housing bubble?

Oddly enough, have you noticed that general inflation is still not a factor in our economy, even with fuel costs having doubled? How can that be? And with unemployment so low, too.

The banks made a lot of money when times were easy. Now they get to lose it back again.

roy, quite displaying your ignorance
There is no one to one correspondence between interest rates and "easy money".

At no time, during the period where Greenspan was lowering interest rates, did money supply growth get out of hand.

Similarly for the current increases, they have not choked off money supply growth.

The reason why inflation is low, is because the Fed hasn't inflated the size of the money supply. General inflation has absolutely nothing to do with commodity inflation.

I think you missed my point
What I don't want but what the author of the piece seems to want is an Arthur Burns clone as Fed Chairman. It's not what the economy looked like from 1974 to 1981, it's how it got there. The Fed under Burns pumped out money to boost the economy, purportedly to ensure Nixon's re-election in 1972. The stagflation from 1974 to 1981 was the consequence.

Decreasing rates is not the answer. It is actually the problem.
The only thing saving the Fed and Congress from reallying hosing up the economy is it size and diversity. Instead of the 1970 when energy was over 10% of the economy one price shock took stag-flation and made it a near depression. The depression was concentrated in ENERGY consuming industries LIKE steel. (I grew up in Pittsburgh and am well aware of the disaster caused by easy money in the late 1960s and early 1970s.)

So now we have localized busts and booms, again all based on Fed policy driven by overspending by Congress. For example all the easy money went into stocks from 1998 to 2001 then bam stock recession. Then money went to realestate and in 2006 bam realestate recession. Now it is back to stocks. Of course we do not see the problems caused by this in loss of wealth by the poorest citizens.

Noone is smart enough to set the interest rates (price for money) or any other price.
The Federal Reserver is evil. They set a price of currency thus robbing some economic players at the expense of others. This is akin to setting the price of a barrel of oil or a bushel of wheat.

Only markets can set prices. There is no person, or computer, or combination of person with computer, or small group of people with powerful computers that can determine the price of anything at any given time. This is especially true for money which is the easiest thing to transact.

Look at the billions stolen from the Citizens of Japan when their rates were near zero. Currency traders purchased their currency and then used it to loan to other western banks at higher rates thus stealing it from the folks trying to use it.

Home owners with a sub-prime mortage, who have destroyed their own credit ratings by defaulting on their unsecured debt (credit card accounts) and who then have had their houses foreclosed will suddenly have a lot more cash in hand each month than they have been accustomed to for a while. As long as they are still working.

They may consume some of it, as you suggested and they may hold onto some of it to try to put something into the old retirement portfolio now that their real estate investment is gone.

They will not be "back on their feet" as far as their credit is concerned for 7-10 years. Whether they chose to file for bankruptcy or not. They will not be buying any more houses for a while.

The primary lenders already bundled up these mortgages into huge financial instruments sold onto the secondary market. The companies holding that paper will put foreclosed properties back on the market. As far as I know Fannie Mae, for example, does not rent units out of its foreclosed properties portfolio.

The problem for people who will lose their homes this year is that they no longer qualify for any mortgage. They cannot replace those mortgages that are exploding in their faces with fixed rate deals. The guidelines regarding their incomes have been tightened and their credit ratings collapsed the first day they were late on their credit card payments. They are truly toast.

The financial institutions are required to write off their non-performing assets and they must foreclose such collateral. They simply do not have the option to think about it. Thanks, Roy.

John Keynes...
The inflation we enjoyed in the 1970's should have stimulated the economy according to Keynesian Economics. Wrong.

Reaganomics was more of a "supply side" strategy with "trickle down" benefits for the entire society. Some politicians (and we are not naming names) liked to use the term Voodoo Economics.

The first thing Reagan's administration did was collapse the real estate speculation that was fueling inflation by simply shutting down the mortgage market. Nominal rates spiked to 18% but the banks would not actually make any of those loans.

My friends who were leveraged "condo-converters" in Chicago at that time lost everything. One of these guys (a Harvard MBA my age) had 200 condo units in the pipeline, all his money was sunk into them and all the bank money he could find. But no one could buy his finished flats because the banks would not make mortgage loans. His cash flow collapsed, he could not cover his interest payments and the banks simply took it all away. It was horrible.

But it worked. We went into a recession in 1982, interest rates dropped big time and inflation was beaten. Reagan reduced taxes for the richest Americans to stimulate their entrepreneuial urges. And America went back to work. Stagflation was history.

The problem was not so much with Richard Nixon as John Keynes.

ignorance from Roy?
So what else is new? He also likes command economies like the former soviet union, and also likes Chavez' Venezuela.

The perspective of the homeless
forest-- Let me gently submit that the following may be a mortgage banker's perspective. But it's certainly not the perspective of anyone who has just lost their home:

"Home owners with a sub-prime mortage, who have destroyed their own credit ratings by defaulting on their unsecured debt (credit card accounts) and who then have had their houses foreclosed will suddenly have a lot more cash in hand each month than they have been accustomed to for a while. As long as they are still working."

I suppose they have a lot more walking around money because they now sleep in the camping area at the state park (which there are in fact many families doing).

So your hypothetical newly homeless family, no longer having the burden of paying a mortgage, now decides how much they are going to put into their new plasma TV (they can plug it in behind the shower house) or maybe sink it into a broad based fund? I'm thinking they now have many more things to spend money on than they did before they were made homeless. And I'm also thinking they still have the debt on those cards of theirs, continuing to accrue interest and penalties every month.

What money they still have coming in is neither going toward new expenditures nor into savings. It's going toward raw survival. The children, for instance, no longer "live in" their school district. Have you really thought this scenario through?

"The financial institutions are required to write off their non-performing assets and they must foreclose such collateral. They simply do not have the option to think about it."

This may well be true-- as they are handling OPM there are undoubtedly guidelines constraining their behavior. But what you're describing is the behavior of a brainless herd.

One person with his own money invested in a defaulting mortgage would talk with the people and probably settle on keeping the payments at the old rate. That way he could keep the house full, the payments coming in and everything the way it was. If he insisted on hiking the payments, permissible under the loan terms, all he gets is lots of legal fees, a vacant, used house and dim prospects for renting or selling it once he finishes the rehab work. It would be the intelligent business decision. Or at least the one I would go with.

The approach I would NOT choose, assuming I had a chunk of investment money to place, would be to give it to a mortgage group that was subject to the rule that they must write it off rather than creatively solve the problem. I would retain hands on control.

Lower Housing Prices Benefits Everyone, Even Homeowners
Why moan about lower housing prices?

The only ones that benefit from higher housing prices are homeowners that plan to sell and move to a lower cost housing area in the near future. Otherwise, non homeowners will have an easier time buying a house, and homeowners benefit from lower assessed value and taxes. It doesn't even matter if you have a large mortgage.

Working people...

The sub-prime mortgages were not given to homeless types without good jobs. The sub-prime mortgages were sold to workers with decent incomes and who had reasonably clean credit reports. Sincere Americans trying to get ahead. It was a pretty lousy thing to do to them because they took low monthly payment deals that did not cover even all the interest in the deal. Such interest was actually added back into the principal. After a year or two, however, those payments started climbing big time and the underlying, adjustable interest rates were actually very high. The proper schedule payments for those deals were impossibly large.

The only way for these folks to get out from under was to refinance their deal into a lower, fixed rate mortgage or to simply cash out the property. Of course, the mortgage lender had already taken away most of the potential appreciation upside. And the sub-prime borrower was still sub-prime and he was going to have a problem qualifying for a better loan. If the real eatate market stalled (as it has) then such mortgages were very much exposed and the lenders knew that all along. But, until this happened the paper was high yielding and it found an eager secondary market.

OK. The worker who has just been foreclosed will move into a rental property. An apartment or another house. Possibly in the same school district and close to work.

His unsecured credit cards are probably too far gone to save. Some consumers will take a settlement and go into some sort of payment program. Fine. But their credit score is still going to be shot for years.

The mortgage industry operates by the numbers. When they have losers they write that paper down, take the period loss and sometimes dump those accounts over to specialty funds that make their living working with foreclosed properties. The industry should be in no particular hurry to make matters worse in the real estate market by dropping prices too quickly on such portfolios. The foreclosure numbers this year, while substantial, should not materially impact the larger market.

Roy. Your suggestions (about what should reasonably happen) are intuitively sound. But these are not people making such decisions. They are financial entities with behavioral cultures of their own. The people just work there. Intuition does not come into it.

Bad from the top down
forest-- You speak volumes in your closing comment: "Your suggestions (about what should reasonably happen) are intuitively sound. But these are not people making such decisions. They are financial entities with behavioral cultures of their own. The people just work there. Intuition does not come into it."

The drawback to allowing these lower beings (financial entities) to make decisions for us that human beings should be making for ourselves is that taking that path allows two areas of blight to open up-- quite aside from the fact that it allows those investment protfolios to lose value precipitously.

First, in previously intact neighborhoods you now have boarded up houses. And once the weeds grow high, kids throw rocks through those windows, spray graffiti on the garage doors and set small fires. Crack heads get inside and crap on the floors. It's not pretty.

Second, in adjacent neighborhoods a bit further down on the scale, there is an influx of refugees-- tenants with bad credit moving into the kinds of cheap rentals where the owners don't bother performing credit checks.

I suppose a theorist could describe all this as being an "increase in economic activity". But I'm familiar with housing issues, and nothing good comes from massive foreclosures. The neighborhoods are harmed in ways it takes two or three decades to overcome. And-- in dispassionately inhuman terms-- property values are adversely affected. Not just those of the foreclosed homes, either.

So then, with those non-human directors you describe at the helm, we now have an industry-wide problem the financial markets are worrying may undo the general prosperity. I may just be a country boy, but I think they could have used the kind of adviser you can go down to the corner store and find sitting on the critic's bench. You know, the kind with a can of Yoo Hoo in his hand and a chaw of Red Man in his cheek.

Any one of those boys could have set the industry straight. And not even charge a consulting fee-- they're naive about things like that.

Group behavior versus individual ethics...
There have been a number of biological studies in recent years indicating strongly that group behaviors among social animals (and that would include humans) so dominate all behavior that there may not be any meaningful individual behavior at all for such species. Certainly "culture" is very much about living in a group.

We do not need to go all the way to stating that the construct of individual ethics might be moot under this paradigm. That discussion calls individual responsibility into question, etc.

However, group cultures clearly exist independently of any individual and group behaviors themselves are predictable, scientifically demonstrable and reproducible in the laboratory.

If we want to manage society we need to manage groups rather than to manage individuals. If the group exists then, de facto, there will be people in there. Whatever acts the group's culture defines as reasonable behavior will be validated by the ethics of the group.

The government is a group with its own culture of behavior that is fundamentally independent of any individual politician or government worker. The frustration we are faced with is that some elements of the behavior necessary for a strong central government to remain competitive, while vital if we are fighting wars, might seem heavy-handed otherwise.

Nevertheless, a strong central government might continue to behave this way even when we do not really have any more world wars to fight. Governments mobilized to fight an imminent battle tend to be totalitarian. Nature of the group behavior culture itself.

It is time for some of these institutions to evolve their behaviors. Governments. Banks. Police departments. Their willingness to abuse individuals in pursuit of their agendas is not sustainable as we develop choices. Of course, if we fail to seek alternatives then these groups will not feel compelled to change in order to remain competitive. In the end "better, faster and cheaper" will always win out.

Simply getting another character into the White House will probably make no difference at all. It he starts to change anything fundamental, the Congress will immediately impeach him.

Off on a tangent
Interesting comments, although irrelevant to the subject under discussion. I feel like I've wandered into the next classroom, where they're holding a seminar on the sociology of groups.

In traditional societies, the ethos of the group is the only thing. Individuals only have worth if they adhere to group norms. Outsiders are ejected from the herd. To some degree we see this even in our own, highly individualist and idiosyncratic society, among the conservative elements, like many church congregations. These people normally decide what they believe through consensus, and mavericks are urged to sit down and shut up.

People in urban centers, normally members of no cohesive group who are exposed to members of dozens of other groups, have no need for consensus. It's apparent that everyone in their world is different from one another. Tolerance and understanding seem to be the way to go in these contexts.

There's very little hope for these two extremes to come to accord. As the conservative group defines itself as being "American" it follows that to them, the other group is "un-American". So in our political dynamic, both groups constantly strive for dominance. Despite the fact that most Americans innately prefer moderate positions.

As for managing groups, put me down in the "unmanageable" column. I distrust anyone who feels himself competent to "manage" me. And I say this as a career management person.

I am especially cynical about the motives of the current government. "Governments mobilized to fight an imminent battle tend to be totalitarian." And in this case, the pretext for the decision to embark on an elective and unnecessary war in Iraq was precisely to precipitate a turn of events that would require suppressing our freedoms.

The only positive thing coming out of this reign by belligerent crazies is the radicalizing effect it seems to be having on the American public-- a group exceedingly slow to radicalize.

So, as they say, "bring 'em on"! Let's let these guys invade Iran, and Syria for good measure before they are ejected from office. Maybe the resulting chaos will inoculate the public against engaging in crusades and adventures for the next few years.

Work groups versus society...

We are talking about the group behavior of sovereign government itself as this compares with the individual behavior of government workers.

The argument is that we are "serial group members" (rather than individual actors) in that we switch from one work group to another throughout our daily round. Each of these groups host activities that have a specific culture of behavior. If we violate such rules then we are, de facto, acting in an antisocial manner.

A simple example would be our reasonable behavior when we join the group called Automobile Drivers as we commute to the office. There are specific expectations about what everyone in this group might do. Further, those rules are quite different here in California as compared with what is considered reasonable in the Philippines.

When you are a college student sitting in a classroom you obey certain rules. When you are standing in line at the McDonalds the rules are quite different from those in force when you sit in a booth at the diner.

I decided while I was in Law School that I would not be very good at carefully preparing cases just so I could go lie in front of a judge and jury. I decided that I was not violent enough to play professional football. I was also not so interested in killing people that I wanted to go to Viet Nam. So I did not ultimately stay in those groups.

The point is that each established work group has its own culture of behavior and as individuals we should be free to join whichever such group each society allows to exist and to operate. That constitutes freedom.

In your small village, for example, there will be relatively few choices and, perhaps, none of them make sense to the actor. So he moves to the city. Where he has more groups to select from.

Our strong central government is just that: strong. With our two-party political system only inside candidates have much chance to come to power and almost no chance to effect fundamental change.

This is not to say that our government won't evolve its culture of reasonable behavior. For example, it is clear to everyone now that trying to impose democracy in Iraq left them with a weak central government. What they really needed was another totalitarian strongman to impose order. Their society demands a no-nonsense hierarchy and their culture is enduringly violent. Respect for leadership is born of fear. (Actually, we share some of those same sensibilities ourselves with our Christian ethic.)

Muqtada al-Sadr is probably the guy. So we have quietly cut a deal with him to get out of the way (he's in Iran) while we try to clean up the Sunni insurgent and al-Qaeda elements for him and then we can take credit for a more orderly outcome. Otherwise, we look like greater fools. So the Administration needs to play out this hand until the night before the election in the Fall of 2008. Everyone in Washington already knows this and that is why the Democrats are looking to take credit for what will surely happen anyway.

The government has learned this lesson. Not the Republicans and not the Democrats. The government itself. No matter how it turns out in 2008 we will never again attempt to overplay our hand with social engineering after we must thump a rogue nation. (Could happen with Iran too sometime soon, if they do not behave.)

All the political downside will be loaded onto the current President as he leaves office. But it was the entire government itself that completely messed up here. While we will all be led to believe it was only George. Great for the government to have a fresh start with someone to shoulder the blame. As for goes with the territory.

You know, Colin Powell walked away from the Administration at the perfect moment if we should need a world class warrior as Commander-in-Chief next year.

Curbing inflation
forest-- I'm just butting in here because we seem to have reached a dead end in our other thread.

To simplify, isn't it the case that a certain amount of money should be going into workers' pockets in order to stimulate demand? That way, factories respond by increasing production-- for the very good reason that their output is, in a sense, pre-sold.

When you have overproduction relative to the amount of money in peoples' hands, as was the case in the 2001 recession, priming the pump with low interest rates does no good. Factories are cutting back on production already and laying off workers because of too-high inventories.

What should have happened then would have been to extend unemployment benefits. The added demand would have injected fresh money into the economy at precisely the right point.

The problem under Burns, as I recall it, was that wages were high and consumption already at its peak. Everyone was rich rich rich. The extra money had no place to go other than toward price inflation, particularly in real estate and most especially in the condo bubble.

Many developers lost their shirts. But they knew they were playing a game of musical chairs, and that one day the music would stop. As I recall, they all survived that period.

Conditions today are vastly different. People don't have enough money to buy necessities, so they buy them anyway through the miracle of easily extended consumer credit. Thus we spend far more than we make, just like the USG.

Under these conditions inflation is unlikely. Such price increases as we see are driven by special circumstances. Basics like energy, medicine and insurance are going up sharply from internal causes. This means prices are higher. But with wages stagnant, actual inflation is unlikely. Consumption isn't even really reduced yet, because of the masking effect of all that credit.

These are just my untutored observations.

There are too many factors constituting supply and demand to put your finger on any one of them to control inflation. Inflation all by itself is an illusive measurement.

Here in the US we measure Core Inflation as the Consumer Price Index without food and energy because those prices are so volatile that they corrupt our view of the underlying fundamentals.

In a broad based inflationary cycle prices, wages, materials and overhead all move up nominally while the value of the money itself moves down in terms of its buying power.

Some inflation is healthy because it makes "paying back" nominal loan amounts with cheaper future dollars "less expensive" in real terms. The anticipation of higher inflation going forward, therefore, implies a higher (interest) discount rate to bring those future payments back to calculate the "net present value" of the debt instrument.

Any deflation at all can be horrible as the value of durable goods and real estate drops versus the nominal prices paid. In order to calculate the net present value of a future cash flow assuming deflation you need an interest rate (discount rate) that is negative. This is why the Japanese banks dropped their interest rates to zero and their economic depression continued until their deflation itself bottomed out.

The greatest risk with inflation is the anticipation of inflation because traders then start behaving as if inflation is certain to occur and they artificially bid prices up to "hedge", speculating that prices will continue to rise and they actually create inflation when there was nothing fundamentally wrong with the economy or with the money.

Inflationary pressures
"Here in the US we measure Core Inflation as the Consumer Price Index without food and energy because those prices are so volatile that they corrupt our view of the underlying fundamentals."

You have to be aware of how inaccurate such a reading would be. Energy of every description is going up. And as it does so, it increases the cost of delivering every commodity that has to be delivered. Take, for instance, everything sold in a store. How does it get on the shelf?

A: A truck carries it across the country. And before that, a ship carries it here from China.

Our food mostly comes from distant lands like California and Chile. Factory farms raise crops energy intensively. Processed food gets milled, mixed and packaged. Food costs mirror energy costs.

On this site I get a lot of grief from fundamentalists with a bit of economics in their background. They tell me it's not "inflation" unless there is an increase in the money supply. Easy credit doesn't do it. Rising prices don't do it.

I guess we just need another word for what we are going through.

Another problem
I think insufficient attention is being paid to the weakness of the dollar. According to the fundamentals, it should be much weaker than it is. It's only being held aloft by the combined efforts of a lot of folks who hold tons of dollars and don't want their savings to lose value. That would be our creditors, like the Japanese, Chinese and everyone else on earth.

What happens when their efforts become unsustainable? We have an atrocious trade balance-- our products can't compete on the world market and that's where we now buy nearly all our stuff.

If you have confidence that our creditors will always be able to shore up the dollar against natural forces I'd love to hear your reasoning.

Not always a benefit
The last time housing prices collapsed, at the start of the 80s, people who had to move couldn't sell their homes. They couldn't get from a sale enough money to pay off the mortgage. So they were stuck with two homes-- the new one and the one they couldn't get rid of.

They gave them to me to try to rent. But the monthly payments were so much more than any rent they could have gotten, they lost hundreds of dollars each month.

Also, so many new rental properties glutted the market. Homes had the choice of either staying vacant or being rented by bums with poor histories. It was an ugly time for a lot of people.

However all this was just the inevitable flip side of a booming market, where appreciation goes up far faster than construction costs, or indeed any other prices. It's an artificial bubble, and in time must inevitably pop.

We would be well served to keep expectations of appreciation under control. This could be done most readily by the mortgage menders, who lose a lot of money when bubbles pop. But every time, it seems that greed trumps good sense.

Only markets set prices
Bill-- The market does in fact set interest rates. The Fed does not dictate what someone can and cannot charge. I'm no expert, but here's how it looks to me.

The prime is the rate the Feds lend to the banks. So if a bank finds more loan demand than it has cash on deposit, it gets a good deal when rates are low, less good when they are high.

But lenders are already flush with cash. And the pressure of ordinary cash waiting to be lent makes the prime rate less important than other factors. Housing prices get pushed upward when everyone is so anxious to lend his money that he outbids the other lenders. Extravagant appraisals are not thrown out. And "values" continue to rise until the bubble is pricked.

From what I've seen, lenders usually like to lend at four or five points above inflation.

Re Japan, there is no reason money can't be loaned when rates are below zero. If the value of money is dropping (deflation) it will be worth less next year than it is today. So you could loan out your excess cash at a negative rate and still, in a sense, make money (lose less).

The global economy...
The dollar is not weak. US inflation is near all time lows. Other hard currencies are strengthening as the economies of the EU and Japan gain traction.

I do not believe that there is a substantial difference in one national venue over another anymore. I also do not think that it matters at all what color our money is. Hard currency is hard currency. The concept that another country is our creditor is meaningless in the Post Industrial Society. This is all one global economy composed of entities organized and paying taxes under the laws of one jurisdiction or another. In the end, it does not matter very much. The details are logistical issues.

No one is holding any more of our dollars than they want. There are FOREX account balances and the Chinese, for example, are buying dollars (there) to hold up the yuan and then shorting dollars against euros and yen. Those balances represent real wealth but the denominations themselves are artificial. The liquidity itself is ultimately created by the global banking system and the currency declared for any such account balance is incidental.

Central banks all over the world hold our interest bearing Treasury debt instruments instead of gold as their store of wealth. Yes, we are borrowing money and paying interest. This is called financial capitalism. All income producing entities must borrow working capital. If they do not then the financial community calls them "underleveraged". This implies that they are failing to exploit all of their opportunities to generate earnings. The United States borrows money because the benefits of deficit spending are greater than the rate of interest. (Although such benefits are difficult to put a value on, of course.)

When dollars are converted into another currency for the purposes of paying an invoice (so denominated) those dollars simply cease to exist. They are not piling up anywhere. The $2 trillion daily volume at FOREX completely overwhelms any such underlying commercial transactions and only serves to establish the exchange rate.

We have some exposure (out into the future) should the quality (risk of default) regarding our Treasury debt instruments fall below that of other such bonds and if those alternative investments should become available in sufficient quantity to displace our paper at the various Central Banks.

This could cause us to pay more interest on our National Debt as we roll that paper over. Until we stop spending quite so much on defense and entitlements America might not be able to afford that without increasing taxes to the point that our GDP should be harmed and wealthy entities who could escape to another tax venue...would.

Such a snowball should not be allowed to start rolling downhill.

Like there's no tomorrow
"The United States borrows money because the benefits of deficit spending are greater than the rate of interest."

When you put it that way it sounds like it makes a lot of sense.

One other way of putting it is we've become addicted to deficit spending. We neither want to raise taxes nor reduce our apending habits. And last year we paid out $350 billion just on debt service. That is, for nothing other than the privilege of having borrowed money years before.

This year will be greater, and next year will be greater than that. We will have borrowed yet more money by then, and also interest rates are going higher. We're already closing in on $9 trillion in debt.

What happens when our interest payment equals treasury revenues? Time to think of something else? Or should we maybe consider thinking of something else before that day?

This is also the tar-baby...

We are in a funny position. At the moment we are on our own policing the global political arena.

We cannot afford to keep running at this pace, of course. We will run out of money. Our experiment in social engineering (Iraq) will end with the next Administration. We will not try to do that ever again.

Of course, if a democratic Iraq with a robust economy had come out the other end of this expanded mission then we would be saving money in the long run because the Middle East might have pacified itself. Therefore, we made the investment of blood and treasure. And we will now cut our losses, because it did not work. In the meantime, we need to play out this hand and there are a few more tricks to go. We might be able to finesse a winner and still make our bid.

After that, however, it is right back to the Powell Doctrine when we must discipline a dangerous sovereign state. Pound the bejesus out of their ability to make trouble and then simply leave them to pick up the pieces.

We still have some time before the Social Security and Medicare entitlements start to drag us under. Nevertheless, Defense and Entitlements must be slowed down enough to let our growing tax revenues roll forward and cut into this debt burden. You are exactly right about the interest on all these Treasure instruments.

Our government is no dummy. They all signed up for this attempt. The theatre we are enduring as the Democrats attack just about everything that the Administration has been doing is to prepare us for dramatic changes in the fundamental way our government behaves.

I am afraid that government must increase tax revenues now and simultaneously reduce both Defense spending and Entitlements. It could get ugly. There seem to have been some pilot programs involving questionable integrity on the part of the IRS (recently) in the government's attempt to increase revenues without raising nominal tax rates.

It is probably important that a Democrat should sit in the White House as tax rates go up. And while total spending is trimmed back. Otherwise, the people will not understand what is happening to them.

You know, the government enjoyed budget surpluses during the Clinton years. We definitley need to get back to that.

Who the hell are we to decide?
"At the moment we are on our own policing the global political arena."

This doesn't tell you something? When we wanted to invade Iraq, the UN opposed the plan. So we went it alone, and twisted a bunch of arms to get this "coalition of the willing" to go along for the ride. Since then they have all dropped out, except for a UK where the majority of the public has always opposed participation.

As a guide to future do gooders, the lack of planning has made Iraq an unmitigated disaster. Saddam should have been an easy act to follow. But in fact since his fall we have made everything there even worse. Including the civilian death toll. Oh, there's a civil war now, too.

The world is going to have to learn how to develop a mechanism to protect itself against future nations who think they know what's best for everyone, and won't stop fixing everyone's problems even after it's abundantly clear how much worse they're making things. But first, the US has to get out of the global domination business. It's not policing, it's just intimidation. And I think in that regard only an economic collapse brought on by hyper militarization will be about the only cure possible. Nothing else will speed our learning curve.

BTW I could almost accept that the "surge" was a good idea. How do we know we've failed until we've given it one last good try?

Scorecard: Iraqi civilian death toll in February: 1,816. In March, 2,078.

Oh well, it was worth trying. Now we need to pack up and go home. In time maybe they will forget we were ever there.

Re having a Democrat in the White House while tax rates go up: you must have noticed the dynamic by now. Republicans slash taxes, revenues drop and deficits soar. Democrats have to be the grownups, raise taxes back up and resolve the deficits. This is politics at its worst, and a cheap trick that doesn't in the slightest have the country's best interest at heart.

The government is not as dumb as the politicians seem to be...
Iraq was really a wild card. It does go back to 9-11 and the reasonable question that if we knew all about these bad guys (Osama bin Laden and al Qaeda in that case) then why didn't we do something about them before they attacked us?

Who was attacked? Who do they chant "Death to..." about continually (besides Israel, of course) but America? It would have been irresponsible to have left Saddam Hussein in power after we took Afghanistan out of the game. It was simply too obvious how fundamentally unable we are to defend ourselves from 19-20 amateurs. Can you imagine the damage Iraq might have done to America with 1000 special operations professionals inside our borders? Remember we were still engaged in a daily air war with Iraq (since 1991) as we tried to get Saddam Hussein to behave.

As for our continuing role as global cop? We should only do what must be done. Who gets to decide what that is? The President. You and I need not like it...our phones will seldom ring.

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